International Sanctions. How Do They Affect a Country’s Economic and Financial System?


Bachelor Thesis, 2020

64 Pages, Grade: 82/110


Excerpt

IMPACTS OF INTERNATIONAL SANCTIONS

Author: HATAM ANSARI

INTRODUCTION

In the current era, the international relation among countries has a great importance because countries are more in need of each other as their societies and economies get involved together. As we can see these days a lot of countries do trading among them which make them better off in economic situation, and some countries have created a union together to facilities their trading and relations such as European union. Still there are some countries which disobey international laws and they do not respect human rights or they threat the international peace and security, so they can be expelled from international unions and communities, one of the main and strong tools to do so is, international sanction which can be imposed to those countries.

International sanctions have become an important and most usable tool in international politics, as US and UN are playing the main actors in imposing sanctions. International sanctions are part of diplomatic attempts by countries against countries, organizations or a person, with aim to protect national security or to protect international laws and human rights. Sanction principally has a limited time which target the economy, trade, diplomacy, culture of targeted country and can be lifted when the motivating security concerns no longer apply, in some cases can be renew or be more intense to put targeted country under more pressure. This practice can be one of the most effective weapons of the international community with offenders. sanctions are with aim and not a ruthless one-sided weapon, and the aim is to dissuade the offending country from acting or to bring it to the negotiating table. International sanction basically targets economy and diplomacy, however according to the international economist and researchers, economic sanctions are criticized for not being successful in achieving their goal and for having a negative effect on human rights, democracy, poverty, healthcare and basic living condition which can have more negative impacts on the people of third world countries.

Sanctions are technically divided into four groups, which they are UN SECURITY COUNCIL, EU SANCTIONS, UNILATERAL SANCTIONS OF GOVERNMENTS AND US CONGREDD SANCTIONS, each with its own approval and repeal mechanism. For example, according to the IMF, the 65% of deposits and 70% of all transactions in Lebanon are in US dollars, so breaking US rules means that Lebanese bank would go out of business. As I am coming from a country which has been under the intense international sanctions for many years till now(IRAN) and I have seen some impacts of it in the society and the condition of living by my own, I was always eager to know more information about impacts of the international sanctions on countries' economy and more importantly on the people economy of targeted country. Is it international sanction affect more government or people and who is the winner of this diplomacy battle, so I chose this topic and in the next three chapters (1-impacts of international sanctions on the currency of targeted country and central bank,2-how to save an economy or reduce the negative effects during a severe sanction,3- using cryptocurrency for escaping sanctions effects) we speak more details about each.

1 CHAPTER ONE

EFFECTS OF INTERNATIONAL SANCTIONS ON THE CURRENCY AND FINANCIAL MARKET OF TARGETED COUNTRY

As (Ahmad Azizi, 2018) said, International sanctions can be in variety forms such as, economic sanctions, diplomatic sanctions, military sanctions, sport sanctions, sanctions on environment or sanctions on individual. For now, we speak about one the main and powerful sanctions which can impose severe consequences on the targeted country, when (Hufauer. Gary, 2007) mentioned these days the united nations (UN), united states (US) and European unions (EU) sanctions against some countries, due to some of their activities which endangered international peace or violate human rights.

We can mention US sanction according to the US department of treasury, against NORTH KOREA (1950), IRAN (1979 then lifted in 1981, reintroduced 1987), SYRIA (1986), SUDAN (1993), CUBA (1958) and VENEZUELA (2019), and the main reasons for these sanctions are poor human rights, unauthorized or unpeaceful nuclear program and civil war. Also according to (Evsey Gurvich, Ilya Prilepskiy,2015) we can say international sanctions against RUSSIA. Modelling the capital flow component, shows that international sanctions have directly hit sanctioned country's banks, oil, gas, petrochemical and arms companies by intensely imposing foreign funding and have indirectly affected non sanctioned companies by decreasing inflows of foreign direct investment (FDI) and causing funding condition to decay.

In the Russian case, the total negative impact on gross capital inflow over 2014-2017 is measured at approximately $280bn, however the impact on net capital inflows is considerably lower ($160-170bn) due to the Russian companies' self-adjustment. So as (Naghme Bozorgmehr, 2011) indicates in the case of Iran, but also we can say the international sanctions can have severe negative impacts on financial and monetary system of sanctioned state, by depreciation currency of the targeted country in foreign exchange market which cause the intense outflow from the country and decreasing the inflow to the country because people do not have trust anymore in the currency of country. While (George A. Lopez and David Cortright, 1977) argued about sanctions have some advantages in means of redressing international wrongs, undeniably, they are a blunt tool, so for some this is intentional.

The conventional theory saying that the sanction's imposition is an economic pain which creates political gain, so the more is the hardship in the economy caused by international sanctions, and the higher political compliance by authorities of government in the sanctioned country. For example, after many international sanctions which have been imposed on Iran from the world powerful states such as united states (US), European union (EU) and United Kingdom (UK) and United nations (UN), after many years of economic hardship for Iranian government and people so finally it brought Iranian government to the table of negotiation for having an agreement among them and enforce Iran to have more secure and peaceful attitude towards the other states. In any political system, an effective sanction is one which is successful in creating the desired attitude response from entities or a state which is communicated.

As (Margaret Doxey,1983) said, in the united nations context sanctions have also been linked to the defense of human rights. In following figure (F1.1) which has been created by the author according to the Iranian program and budget organization (Ahmad Azizi, September 2018) we can see more specifically the varieties of international sanctions.

Abbildung in dieser Leseprobe nicht enthalten

1.1 FINANCIAL SANCTION

As we have mentioned above, sanctions can be imposing in different ways and of these ways is financial sanctions which targets more banks and monetary system of the targeted country. (Zachery Laub, 2015) defined financial sanctions as limitations imposed to some countries by united states (US), united nations (UN), European union (EU) and United Kingdom (UK) to achieve foreign policy or national security aims. These sanctions have power to limit and restrict financial services that includes also the country's central bank. In the (Tejarat farad Journal, 2013) we can see financial sanctions are divided into two categories which are normal financial sanctions and aggravated financial sanctions. Beyond the effects of other international sanctions, (George A. Lopez and David Cortright,1997) added that the imposition of financial sanction looks like to have more effect within the targeted country.

1.1.1 NORMAL FINANCIAL SANCTIONS

As we mentioned above (Tejarat Farda Journal,2013) mentioned normal financial sanctions consist of two basic elements. First element is blocking of funds or the prohibition of trading with funds or tax economic resources which belong to countries or persons and entities subject to sanctions. And the second is the prohibition of providing funds or economic resources to countries or persons, directly or indirectly. These two elements are common to every financial sanctions. (OFCI, HM treasury,2020) explained normal financial sanctions can be in form of asset freeze. There is a prohibition to deal with the frozen funds and resources, which belong to or owned and controlled by a designated person, or left funds and economics to be available indirect or not indirect way to designated person. Also is not allowed to be involve in direct or indirect actions which lead to circumvent of the financial sanctions prohibitions. Certainly most of the sanctioned countries try to circumvent of the sanctions and by doing so it occurs ‘sanctions busting' due to the definition of (Keith Preble and Dr. Bryan R. Early, 2018), it means when sanctioned countries, entities circumvent sanctions restrictions by replacing partners in business and trade or contriving methods for maintaining existing relations notwithstanding the sanctions. However, there is a high risk of sanction for the third-party states or entities which help sanctioned country in the financial restrictions or etc. due to the high beneficial trades some countries, organizations and people help targeted country to circumvent the sanctions.

1.1.2 AGGRAVATED FIANCIAL SANCTIONS

As we have already mentioned before from (Tejarat Farda Journal, 2013) In addition to the before elements, there are another two elements in aggravated financial sanctions. First is the ban on the prevision or prevision of financial services to countries or persons subject to sanctions, and second, the prohibition of providing insurance services to sanctioned person or persons acting in their behalf. Blockage of asset means the prohibition of trading in funds and economic resources belonging to countries or person subject to sanctions or funds and economic resources owned or controlled by such countries or entities. Decrease in foreign exchange earnings from oil export cause the reduces in the supply of currency in sanctioned country and the country will face the capital outflow, so there are less people for investing inside the country due to the reason of currency shortage and decreasing the value of the country's currency. People are more motivated to invest outside of country because they have more stable and profitable condition from their investment.

According to the (Akbar-E Torbat, 2015) article in 1994, Iran's export from the oil was 2.6 million barrels per day which worth around 13 billion US dollars per year, among the buyers, there were US companies, they were buying 600,000 barrels per day with the total value of 3.5 to 4.0 billion US dollars per year at that time. In 1995, US imposed comprehensive sanctions on Iran, so the American companies were forced to stop their trade with Iran. As a result, Iran suffered temporarily some losses and then they were able to find new buyers such as south African countries, however, American companies bought oil from other countries. Undoubtedly the US sanction ban import of Iranian oil can affect the Iranian oil export, but it can also affect US oil import in the long run, which indicates welfare loss is zero. The main damage to the Iranian economy from the financial sanctions is because of the weak investment environment that has resulted, as Iran could be better off in the absence of the sanctions, because it could finance the oil project itself. It is not easy to calculate the exact amount of damages to Iran's economy which has been specifically caused by the financial sanctions, because various factors are involved and their costs are unknown. There is no doubt, that sanctions can push Iran to sign unfavorable oil contracts and forced it to borrow money at high costs.

In the short term, (Christopher Harmer,2012) said the most vivid effects of financial sanction are that make it more difficult for the Iranian financial authorities to process oil-related transactions that are denominated in dollars. Fundamentally, the financial sanctions have not stopped the Iranian government from exporting oil, however, they have made it more difficult and added one more step or layer of transactional complexity and higher cost, and they could only decrease the volume of Iranian oil exports marginally.

Aggravated financial sanction have had the biggest effect on the shipping industry, as large western insurers begin to reduce their insurance coverage on tankers carrying Iranian oil, thus, the only and available option for shipping Iranian crude will be Iranian state controlled or owned shipping companies.

As we mentioned above, financial sanctions can play an important role in changing the money supply of the sanctioned country. Change in the money supply always has been considered to be a key factor in the macroeconomics performance. In macroeconomics, (Alandear Droff and Karl Brunner) indicated money supply is the total value of money available in a country's economy at a point of time. Money supply is important because is linked to inflation by the equation of exchange which is proposed by (IRVING FISHER in 1911):

Abbildung in dieser Leseprobe nicht enthalten

(M) is the total dollars in the nation's money supply, (V) is the number of times per year each dollar is spent (velocity of money), (P) is the average price of all goods and services sold during the year and the (Q) is the quantity of assets, goods and services sold during the year. According to the international monetary fund (IMF) report from October 2019, it shows skyrocketing inflation rates in Iran of 35.7%, meaning that the average price of consume goods over the past years has been increased by 35.7%, however, the statistical center for Iran (SCI) reported an even more pessimistic assessment with an overall inflation rate of 47.2%, with rate as high as 63.5% for food and fuel. or we can mention other sanctioned countries with high inflation rate such as VENEZUELA, NORTH KOREA, CUBA and etc.

Abbildung in dieser Leseprobe nicht enthalten

As we know people spend their major part of income for the necessity goods so there is not much money left for anything other than that, this leads to an increase in the purchasing power and decreasing the total demand for goods which lead to severe economic condition such as stagnation.

Stagnation definition by (Jim Chappelow,2019) in Investopedia is a period of no or little growth in an economy. In the other word economic growth less than 2% to 3% it can be considered as a stagnation, which increases the unemployment rate in that period. Stagnation normally happens for a temporary condition, such as a growth recession, but also (Kimberly Amedeo, 2020) indicated when you put a high inflation rate beside the negative economic growth, you have ‘stagflation', which simply means stagnation plus inflation and high unemployment rate, and it is a social and economic disaster.

1.2 BANK SANCTION

According to the research of two Iranian bank's exports (Mehrnoush Torabi and Sanaz Vesali, 2009) the current era may be a very bad experience for economic actors, because the boom in the investment and production in this sector requires a safe and stable environment more than anytime else. Economic sanctions and international sanctions on banks increases national risk and costs. Imposing continuous sanction, it deprives the country's economy of security and peace, and causes outflow of capital from the country. Among the sanctions that have inflamed the economy for years, sanctions on banks overshadow economic activities, especially the activities of the private sector more than any other. The sanctions of the central bank are different from sanctions of the institutions of the country. Central bank sanction affect other sectors more than they affect the central bank, because all monetary and financial flows and financing trade and exchange take place through the central bank. Naturally, the impact of the central bank sanctions on other sectors is greater and its indirect effects are more severe, this means on the one hand, it negatively affects the flow of imports and exports, and if the central bank and financial institutions of other countries, all those cases will be cut off because the central bank embargo is a threat to banks that have financial tie with sanctioned country. The inevitable decline in imports appears to be a positive result of sanctions against the central bank. Another seemingly positive result is more reliance on domestically produced consumer goods, and there will be an increase in employment in the sanctioned country, but due to the need of domestic producers to import intermediate goods to continue production, and increase the price of imported goods. Domestically produced products will enter the market at the higher prices while their quality will reduce, because country face an intense increase in the aggregate demand for the domestic products. (Will Kenton,2020) was saying when a country has a big increase in the aggregate demand for domestic goods, and an increase in the prices, will rise the inflation rate in the country. Rising inflation, declining economic growth, and a weakening national currency, put the country in the state of stagflation in the long term, so (Kimberly Amedeo, 2020) idea was that, instead of increasing employment, the unemployment rate increases. (Ahmad Azizi,2018) added that The increased demand of domestic markets for domestic products has reduced the possibility of exporting goods abroad, at the same time, it increases the export of goods from neighboring countries to the sanctioned country, increasing smuggling of goods and turning to luggage trade are other consequences of imposing sanction on the central bank.

1.2.1 THE EFFECTS OF BANK SANCTION ON THE COUNTRY'S FINANCIAL AND MONETARY SYSTEM

As (Aaron Arnold, 2016) said the effectiveness of financial sanctions rely on the global structure of financial system, especially, the leadership of the US dollar in global trades, also as correspondent of banking system. In 2009 (Mehrnoush Torabi and Sanaz Vesali) stated that the bank action is an important determinant of money and credit improvement in the recent years, it has become more clear that neglecting role of bank such a passive view of banks is unwarranted. The volume of large money in the economy system is the result of the interplay of the banking sector (including central bank) with the sector of money holding. Broad money contains currency in circulation, bank deposits and is usable or informative for aggregate spending (AS) and inflation. According (Aaron Arnold,2016), increasing the risk regarding the bank's resources, since many people have financial dealing with branches abroad, by imposing these sanctions, a large part of bank resources in these countries will be endangered at the same time, some foreign customers have also had contacts with these branches, this leads to the fact that the business process with country's companies and individuals has become more difficult and increase its cost. 'Derisking' is becoming an important topic to be discussed in the financial sectors. Generally, de-risking is a process when commercial banks shut down whole lines of business rather than affording the increased adoption costs. Many in the financial sector indicate de­risking as a direct impact of bank and financial sanctions. Over the past five years, the united states (US) government has put criminal fines against some banks for sanction violations. As an example which has been taken from the (US department of treasury), in 2014, BNP Paribas, which is one of the largest commercial banks in the France, was guilty to sanctions violation, due to the transactions billions of dollars for entities located in Iran, Sudan and Cuba. The bank finally reached petition agreement with the united states prosecutors, by agreeing of $9bn fines, or recently the Crèdit Agricole corporate and investment bank has been pledged to pay to the united states office of foreign assets control (OFAC) around $330m fines, which was the penalty for the bank for the willful helping Iranian government in international transactions. (Mehrnoush Torabi and Sanaz Vesali,2009) added to their before statements which we have mentioned above, that by imposing sanctions and restrictions on companies in providing the foreign exchange resources they need through banks, costumers who provide the resources they need through credit openings are in trouble and because of the complementarity of foreign exchange and money facilities in the production process, they cannot produce their products according to the planned schedule. Hence due to the inability to repay their facilities sanctioned banks are likely to face increasing claims in the short term. Although is expected in the long run, due to the decrease in the opening of letters of credit, the upward trend of increasing the bank's foreign exchange claims will decrease. From the moment the first sanctions imposed on the country's banks, because of the concerns about export security, credit risk of transactions with sanctioned country has increased and the insurance and the insurance coverage rate for the export of goods to the country is increasing, this leads to an increase in costs and the final price of goods exported to the country. The trust of international sellers and investors in the banking system of sanctioned country has been plummeted so that they avoid strongly not to deal with these banks, and the spread of this issue in large banking area will be very irreparable. According to the experts of Iranian bank of Melat in 2009 One of the main important effects of the international sanctions on banks is the increase in financing costs. Increase the premium rate of the facility, increase discount rates for country's documents in foreign banks, increase bank fees paid in dealings with foreign banks, increase the cost of buying from intermediaries, increase the cost of opening a letter of credit and finally the replacement costs of bank brokers, these are among the costs which sanctioned bank must face. The most important factor, which includes all sanctioned banks, is the possibility of losing people credence in the domestic banking system, which increase more capital outflows from the country due to increased time and cost (In the section of importing goods and services through openings) and it extends to other sectors, particularly in the production sector. Currently, a large amount of banks resources is at the disposable of national banks, therefore, it is very likely that opening credit and financial transfers with other countries will be a problem. So, the companies that cooperate with these banks are in trouble and the foreign transactions of such companies will be accompanied by serious challenges and will affect the financial statements and profitability of companies. Under these circumstances companies are unable to use international financial resources to implement their development plans. On the one hand, this has increased the likelihood of capital inefficiency and delays in corporate developments. As a result, the expected profit of shareholders will not be realized, on the other hand, it will increase unemployment and reduce the volume of GDP and economic problems. It is obvious the psychological effect of international sanctions on the country's market. Undoubtedly it has increased concerns for shareholders and created long queues for selling their shares in the stock, which caused reduction in the profitability of stock companies. Given that, one of the bail accepted by banks is the shares of the stock companies. If the receivables are not repaid on maturity, the bank will be restricted from reviving these funds. Therefore, in these circumstances, the bank should be more careful about certifying the shares of companies listed on the stock exchange. In the modern world, the most common way to import from other countries is to use documentary credit and it is the banks which open letter of credit. In the absence of bank support, the industry owners and those involved in the import and export goods in the sanctioned country will face serious restrictions. Because of sanction's statement on certain goods, it has banned member state from doing business with traders of sanctioned country. As previously mentioned in 2009 (Mehrnoush Torabi and sanaz Vesali) said that companies in the sanctioned country have provided their raw materials and imported goods with multiple relations (multi-layer communication) and the cost of their product multiplies, which makes the final price of goods so much higher. Undoubtedly, it has had a negative impact on the demand for these products, and although it makes it difficult for companies to finance the resources they need. They will also face a crisis in repaying bank resources (current and future). International sanctions against country's bank have pushed country's companies which trade goods with foreign countries to avoid problems and open credit through brokers and brokers in third countries (inevitably in the absence of bank support), the most direct consequence of doing so, is increasing transaction costs and spending longer time to achieve goals and negatively impact their quality and timing. In addition to create an inflationary burden, this situation also puts pressure on producers and reduces profit margins, it may even cost them more than the sale price. It is natural that in such circumstances, producers will not able to meet their financial obligations to banks as previously expected and repay the facilities received with a delay. Sanctions make it difficult for companies to obtain the foreign exchange they need from banks and domestic capital suppliers, therefore, producers who supply their required resources through financing and usance are faced with a bottleneck and due to the complementarity of foreign exchange and country's money facilities in the production process, they cannot produce their products according to the planned schedule. It is therefore likely that due to lack of necessary financial resources and consequently, failure to meet expected revenues, and they are unable to repay bank facilities on time and payment of their money facilities should also be delayed. Due to visa restrictions for sanctioned countries people, considerable time is spent on this issue especially for taking European countries visas, which is possible disruption many calculations of manufacturing companies on productions and sales schedule or exchange rate calculations. Foreign parties are also reluctant to travel to sanctioned countries because of restrictions imposed by third country. By imposing international sanctions, foreign investors and other foreign financing institution, will be less motivated to invest in the sanctioned countries due to the unstable situation of currency and difficulty to forecast the future currency rate. In addition to the concepts of sanctions discussed above, as far as there is indeterminacy about severity and extent of the sanctions and fear of expanding sanctions, it makes investors and producers worry and causes disorderliness in economic activities, which create uncertainty in the economy and businesses. According to the (Morales J.R, 2019), In the case of Venezuela, firms were motivated to do business with Venezuelan government and entities before the sanctions, but after the sanctions have been imposed on the Venezuelan government, they decided that the benefits no more worth the risks, or tankers which carrying Venezuela oil they stopped oil shipments due to the risk. (Francisco Rodriguez,2019) indicated that the financial sanctions hit the Venezuelan oil exports, after declining oil price, nation's oil company suffered by less investment, which made exchange rate depreciated rapidly between 2014 and 2016, it was more rapidly than the real value of currency according to the general price level, therefore, all of these effects decreased foreign direct investment (FDI) as economic condition was unstable and not secure. In another case western financial sanctions against Russia according to the (Iikka Korhonen,2019), caused a decline in the Urals crude oil prices almost 50% between 2014 and early 2015 as it was linked with less export and tax revenue effect in Russia due to the tightening financial conditions. In (2019) PESTOVA and MAMONOV found that prices of oil have an important influence on the Russia's GDP growth, while (2019) BARSEGYAN found out, on average, Russia's per capita GDP is 1.5% lower between 2014 and 2017 that it would have been without sanctions. As (Mehrnoush Torabi and sanaz Vesali,2009) said, it is not easy to estimate costs and future revenues of activities and disrupts the allocation of resources and the efficiency of economic activities. Often the price of goods and services is adjusted by manufacturing and distribution agencies at the retail level. Sanctions can create harsh condition for the economic sectors, including households, enterprises or the public sectors. Deviation in the investment decisions of economic enterprises can be another disorderliness in the economy which caused by the international sanctions. In 2008, Prof Nader Habibi mentioned that the abundant revenues of oil have made it possible for Iran to increase imports of primarily necessities and goods in the past years, thus, while the international sanctions decreased speed of the development of Iran's energy sectors and manufacturing, which are critical in the long term growth of their economy. International sanctions cost Iran's economy to lose billions of dollars in the trades and investments, and these economy costs have led to an internal debate within the regime over the nuclear program and human rights violation. Following solutions which have been collected from some banks in the sanctioned countries, it seems that they can mitigate sanction's effect on the economy and the banking system to some extent: -promoting the role of private banks in the economy, under international sanctions, (Yoko Doi, 2010) mentioned, private banks or banks that have been recently privatized, appear to be under less pressure and restrictions than the state-owned banks, therefore, strengthening the role and performance of these banks, especially in the field of foreign exchange and international activities can decrease the problems of international banking transactions to some extent.

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Excerpt out of 64 pages

Details

Title
International Sanctions. How Do They Affect a Country’s Economic and Financial System?
College
University of Siena
Course
economics & banking
Grade
82/110
Author
Year
2020
Pages
64
Catalog Number
V966210
ISBN (eBook)
9783346337160
Language
English
Tags
international, sanctions, they, affect, country’s, economic, financial, system
Quote paper
Hatam Ansari (Author), 2020, International Sanctions. How Do They Affect a Country’s Economic and Financial System?, Munich, GRIN Verlag, https://www.grin.com/document/966210

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