Authoritarian regimes trying to skirt sanctions are developing alternative markets

The pomp surrounding Chinese President Xi Jinping’s recent visit with Russian President Vladimir Putin in Moscow obscured the announcement of a new economic partnership between China and Russia — one designed to help both countries escape the consequences of Western sanctions.

Sanctions that isolate corrupt actors from the global financial system have historically offered the United States and its allies a low-cost and low-risk way to confront those who violate international law and work against their interests. But the United States is no longer the financial hegemony it once was, and authoritarian regimes are taking full advantage by working to create alternative financial markets.

Sanctions are — and should remain — a fundamental U.S. foreign policy instrument to counter vile behavior. But the United States needs to reevaluate its approach for them to remain effective. This means partnering more closely with leading economies when imposing and overseeing sanctions.

The strength of the U.S. financial system and the importance of the dollar to the global economy are what have made sanctions an effective tool for decades. However, by actively diversifying their economic portfolios, “de-dollarizing” their economies and creating financial workarounds independent of U.S. influence, authoritarian regimes are working on establishing opaque financial systems ripe for corruption.

For example, both China and Russia have been trying for years to build systems to get around SWIFT, an international messaging system that links financial institutions and facilitates international financial transactions.

Exclusion from SWIFT was part of the sanctions program for Russia after its 2022 invasion of Ukraine. Disconnecting Russian financial institutions from the global market makes trade and facilitating payments more challenging, successfully hindering Moscow’s ability to finance the war.

Beijing has been developing the Cross-Border Interbank Payment System (CIPS) since 2012. The network settles renminbi transactions to internationalize the Chinese currency, distancing it from the U.S. dollar. CIPS still depends on SWIFT for certain transactions but is growing increasingly independent. In 2021, CIPS processed financial transactions valued at more than $12 trillion and has support from major institutions such as Citigroup, HSBC and the Bank of East Asia, plus banks in Russia and African nations.

Similarly, the Financial Messaging System of the Bank of Russia (SPFS), Russia’s equivalent of SWIFT, has grown considerably since the recent invasion of Ukraine. Networks such as CIPS and SPFS don’t yet pose a significant threat, but policymakers shouldn’t disregard them either. Chinese and Russian banks are already connecting their respective networks, foreshadowing the possibility of further partnership. 

These systems are emerging as economic relations between sanctioned governments intensify. China and Russia have partnered to bypass sanctions by slowly straying from Western currencies, China’s trade with North Korea is returning to pre-COVID-19 levels, and Iranian oil exports are surging.

Previous collusion between sanctioned countries depended on black market channels and illegal transactions. However, as barred countries continue de-dollarizing and creating alternative financial systems, it’s safe to expect corrupt authoritarian governments to strengthen economic ties.

Being that sanctions are intended to alter the behavior of countries that violate international law or endanger global security, intricate systems capable of operating without international accountability mechanisms will make the problems with sanctions’ effectiveness worse. That’s because opacity enables corruption. 

The United States and its partners still have the power to deter corrupt governments from engaging further in alternative markets, but it requires being more judicious and surgical with their approach.

The United States, the Group of Seven countries, and the EU should develop a forum that focuses on enhancing sanctions with effective governance, advising, and information sharing.

The groundwork already exists: The G-7 and the EU allied to impose comprehensive sanctions on the Kremlin following the invasion of Ukraine. And the G-7 is already creating an enforcement coordination mechanism targeting Moscow’s key industries. While details aren’t available, the framework for collaboration should apply to all sanctions programs and include consultations from the coalition of partner countries.

The United States should also reprioritize economic diplomacy and use sanctions in tandem with trade accords. This includes agreements restricting or prohibiting corrupt and authoritarian behavior while granting the coalition supervisory rights over compliance in return for relief from sanctions.

There are some challenges to overcome, including some friction between the United States and European allies. Some in Brussels have expressed dismay with what they consider a coercive, unilateral approach to sanctions that only benefits the United States. The EU has also considered creating its own alternative payment channel independent of the U.S. financial system. Yet, apart from the Instrument in Support of Trade Exchange (INSTEX), which allows for trade with Iran, these systems all have significant exposure to the U.S. dollar.

To stem corruption and authoritarianism, the United States and its partners must work together to stay ahead of evolving economic structures. Sanctioned countries are adapting to the restrictions. Western democracies must adapt, too.

Albert Torres is an associate of freedom and democracy at the George W. Bush Institute.