EU edges toward new sanctions against Russia's economy

Hearses with coffins containing the remains of MH17 victims at an airbase in the Netherlands.</p>

Hearses with coffins containing the remains of MH17 victims at an airbase in the Netherlands.

LISBON, Portugal — The European Union appears to be finally moving toward imposing meaningful sanctions against the Russian economy.

Proposals that could be adopted Tuesday include a ban on credit for Russian banks, an arms embargo and the prohibition of high-tech exports to Russia's oil industry.

Although watered down from a previous proposal to exclude exports to Russia's key gas sector, the punitive measures would go far beyond what has been adopted so far by the EU or the United States and could have a serious impact on a Russian economy already languishing in recession.

According to leaked extracts from the sanctions plan, big Russian state-owned banks now in the EU's sights raised almost half their $21.3 billion capital needs on EU markets last year.

Such moves would show the EU can muster powerful weapons against a Russian economy that’s closely intertwined with that of the 28-member EU.

But until the killing of 298 people in the shooting down of Malaysian Airlines flight MH17 last week, that economic interconnection has been a source of weakness rather than strength, as EU countries sought to protect their national interests against any boomerang effect from sanctions against Russia.

EU nations remained divided even after the crash.

France and Britain bickered publicly this week when Prime Minister David Cameron denounced Paris’s decision to press ahead with plans to sell a state-of-the-art warship to Russia. French diplomats retorted that Cameron would do better to curtail London's role as Russian oligarchs' preferred financial center.

Business leaders in Germany warned 300,000 jobs there could be threatened if sanctions hawks launch a trade war with Russia.

Although such concerns have helped make the German government among the most wary of antagonizing Moscow, Chancellor Angela Merkel has signaled a change of heart in recent days.

Her spokesman said the EU's most powerful leader now wanted the "swift" application of economic sanctions in response to the Kremlin's refusal to reign in its fighters in eastern Ukraine.

Dutch attitudes also reflect how the mood has changed.

"This is not about economics or trade, it’s about security in Europe," said Foreign Minister Frans Timmermans as he went into sanctions talks with EU colleagues on Tuesday.

His impassioned speech to the UN Security Council this week has come to represent the sorrow and anger in the Netherlands, which lost 193 citizens in the destruction of MH17.

Until the missile strike, however, the Dutch had been among the most reluctant to allow Russia's destabilization of Ukraine to interfere with business relations.

Timmermans's government twice dispatched King Willem-Alexander to Russia in recent months in an effort to cultivate friendly relations.

In February, when many Western leaders boycotted the Winter Olympics in Sochi, Willem-Alexander was photographed at the games joking with Russian President Vladimir Putin as they knocked back glasses of Heineken.

Those pictures came to haunt the Dutch this week as Willem-Alexander solemnly welcomed home bodies of MH17 victims.

"There was a lot of criticism at the time of the decision to send the highest possible delegation," says Marietje Schaake, a member of the European Parliament from the opposition D66 party. "In retrospect, that looks ever more painful now."

A poll in the best-selling daily De Telegraaf showed 78 percent of Dutch citizens support economic sanctions against Russia even it if means pain for the their economy.

"For who were not convinced yet that there was a real need to change relations with Russia, this cannot be anything but the rudest of wake up calls," Schaake said in a telephone interview from the EU parliament in Brussels.

The extent to which the Dutch economy is linked to Russia illustrates Europe's potential to hurt Putin's regime as well as why the EU has been reluctant to do so.

The Netherlands is the single biggest destination for Russian exports, $70 billion worth last year. Much of that is oil, coal and other minerals that are processed at the giant port of Rotterdam and sold on to other markets.

Royal Dutch Shell is developing gas plants with Gazprom, Philips lights up the Hermitage museum in St. Petersburg and Heineken sells more than one in 10 of the beers quaffed by Russians. Russia is the third biggest destination for Dutch exports outside Europe, after the United States and China.

Russians are also among the most enthusiastic participants in schemes that enable international companies to avoid taxes by recycling money through the Netherlands.

Tax loopholes helped attract $36 billion in Russian investment to the Netherlands over the past seven years, according to Russian central bank figures, a level bettered only by Cyprus and the British Virgin Islands.

Much of that money is recycled back home by Russian conglomerates and their oligarch owners.

"It's a huge tax dodge and all the multi-nationals are using it," says Rebecca Wilkins, senior counsel at Citizens for Tax Justice, a think-tank in Washington.

"The Netherlands objects to us calling them a tax haven, but we stand by it," she says. "Billions and billions of dollars are moving through there every year."

Russian companies are far from alone in using the Netherlands to avoid taxes. Citizens for Tax Justice estimates that almost half the US companies on the Fortune 500 list have subsidiaries there for tax purposes.

However, reports this week that the Russian company that exports anti-aircraft missiles of the type used to destroy MH17 also has an Amsterdam office to help avoid taxes have intensified calls for the Netherlands to clean up its fiscal act.

The Netherlands isn’t the only EU country offering tax breaks to Russian companies and business leaders: Cyprus, Ireland and Luxembourg are also favorite bolt holes. Britain has been accused of turning a blind eye to tax dodges by Russian oligarchs in London and British overseas territories.

Collectively, EU countries are Russia's main trading partner.

Russia’s role as the vital supplier of oil and gas to many of the bloc's members is another key reason for the reluctance to enter an economic showdown. There's fear of energy shortages and price hikes that could undermine the EU's fragile recovery from a five-year euro zone crisis.

Germany relies on Russia for 40 percent of the natural gas it needs to power industry and heat homes. Italy gets half its gas from Russia and EU countries such as Finland, Bulgaria and Lithuanian get all their gas from Russia. EU nations meeting Friday struck out a proposal to ban high tech exports to the Russian gas industry due to fears that could hurt European supplies.

In the financial sector, French banks have more than $50 billion worth of outstanding loans in Russia. Italian banks' exposure stands at over $28 billion, Germans' at $24 billion and British banks at $19 billion.

Despite the risks, public sentiment has hardened. German and Dutch newspapers carried comments on Friday by business leaders accepting that sanctions are now needed. British media are denouncing public figures with links to Russian business. German tabloids are calling for soccer’s 2018 World Cup to be taken from Russia.

EU officials say new economic sanctions are inevitable unless Putin quickly ends his support for the fighters in eastern Ukraine. That seems unlikely given US assertions that Russian regular forces are now openly shelling Ukrainian positions across the border.

EU experts drew up legal texts for the package of economic sanctions on Friday. They are expected to be adopted at a meeting of representatives from the 28 member countries Tuesday in Brussels.

"The direction of travel is clear, but we are still traveling," EU foreign affairs spokeswoman Maja Kocijancic said Friday in Brussels. "The urgency of this is immense."

Among the expected measures, the restrictions on bank loans could have the biggest impact.

Even the modest international sanctions already in place are already having an effect. On Friday, the Bank of Russia was forced to raise its key interest rate to 8 percent, warning of shocks to the economy from the "aggravation of geopolitical tension."

The arms embargo won't include existing contracts, so France's $1.6 billion warship sale will be excluded.

Restrictions of sales of sensitive "dual use" technologies such as electronics and machine tools are also in the package, but are expected to be limited to those with military end users. A trade and investment boycott of Russian-occupied Crimea is also on the cards.

The EU early Saturday announced the names of 33 individuals and entities added to a sanctions blacklist. Their assets are frozen and they are banned from traveling ot EU nations. Among them are the ruler of Russia's Chechnya republic Ramzan Kadyrov and several leading security and intelligence officials, including Alexander Bortnikov, head of the FSB spy agency. The list now totals 107 and more are expected to be added Tuesday.

Two European lending agencies that last year financed projects worth over $4 billion in Russia have been ordered to stop.

Russia, which has so far laughed off the European response, may find that about to become harder to do.