The European Union and new Biden administration have opened talks on the “what to do about Russia?” question and new sanctions are expected, but the question remains over what exactly can the Western allies do?

Russia observers increasingly believe that the West is “all sanctioned out” as State Department officials told the US press recently; all the easy sanctions have already been put in place and what remains is extremely painful options such as banning US investors from buying Russia’s primary sovereign debt or holding the Russian Ministry of Finance ruble-denominated OFZ treasury bills that would not only provoke a strong response from the Kremlin, but would also hurt US investors.

“Taking into account the already adopted restrictions, the scope of the new sanctions is becoming increasingly limited. In fact, in the set of meaningful economic sanctions, politicians are left with only very tough options, the use of which can lead to strong negative consequences not only for Moscow, but also for its trade and economic partners, primarily in Europe,” BSC Global Markets chief economist Vladimir Tikhomirov said in a note.

For its part the Kremlin is anticipating new painful sanctions, as US President Joe Biden is expected to take a stronger stand, in part as a reaction to former president Donald Trump’s perceived weakness over the Russia problem. As bne IntelliNews reported, Russian Foreign Minister Sergei Lavrov introduced new rules of the game during a visit to Moscow by the EU's top diplomat Josep Borrell, where the Kremlin will not tolerate any painful sanctions at all and is prepared to break off diplomatic relations with the West should that type of sanctions be imposed.

In the first weeks in office Biden has made it clear that he will try to restore the US primacy in global relations but he has also made it clear that “diplomacy is back” and wants to mend relations with the EU in particular that were damaged by Trump. That means any new US policy on Russia much be done in co-ordination with Europe and that is going to be hard, as the EU is divided over what to do about Russia.

Both sides have taken up their positions and are just waiting for the kick-off whistle. But there is a lot of activity going on behind the scenes.

Tikhomirov points out that currently the pause between vocalising the threat of new sanctions and the implementation of those sanctions is one of the longest in the sanctions saga that started in 2014, after Russia annexed the Crimea.

“This coming week will mark six months since reports about the poisoning of opposition leader Alexey Navalny appeared, which the West soon blamed on the Russian special services. From the very first days of this saga, Western politicians began to call for tougher sanctions against Russia; a month ago, the fund headed by Navalny explicitly asked for the same,” says Tikhomirov. “However, thus far no practical steps have been taken. For several reasons, this is perhaps the longest period of time in recent history when verbal threats to impose sanctions have not been followed by specific measures.”

There are several obvious reasons for the delay, the main one being Biden needed to win the presidential elections in the US. But that done, he has reportedly asked for a report on the Russia problem to be drawn up jointly by the State Department and the intelligence services, which is currently in progress.

More delays are being caused by the need to co-ordinate US foreign policy on Russia with Washington’s EU partners. Here too, intergovernmental consultations are also currently underway.

Clearly the Kremlin is expecting sanctions and it has also made it crystal clear that it will respond in kind. Ironically, despite the lack of good sanctions options, these very geopolitical fears are almost as good as new sanctions themselves. Although Russian assets have rallied with equities in particular seeing strong inflows – the RTS index was back to almost 1,500 as of February 16, up from around 1,350 at the start of the year – further growth in valuations is capped by investors’ worries about what will come next.

“The permanent threat of new sanctions significantly limits the activity of investors and increases risk premium in valuations of Russian assets and the ruble,” says Tikhomirov. “In other words, in the current situation, when most of the sanction resources have already been used, such means of indirect pressure become as effective as imposing specific restrictions.”

But the debate is moving towards a conclusion. Consultations between the representatives of the EU members in Brussels have already begun and on February 22 relations with Russia will be discussed at a meeting of the union's foreign ministers. The final decisions on new sanctions may be made at the Eurogroup Summit on March 15, when it seems likely that the US will also announce more concrete proposals for punitive measures against Russia.

The high asset valuations and diplomatic showdown that would result from sanctions on Russian debt (not to mention the pain that would cause in the boomerang effect) mean the market is anticipating personal sanctions in the form of a new oligarch list that includes top Kremlin bureaucrats and managers of state-owned enterprises (SOEs).

Lavrov has hinted that the Kremlin could live with those kinds of sanctions, and they won’t trigger a full-scale diplomatic fist fight, but with Moscow’s new hard line they won’t be ignored either. Sanctions against Nord Stream 2 will probably be excluded from the new round of punishments as Berlin has made it very clear it is fully committed to the pipeline, although some sort of compromise conditionality will probably be attached to its use.

“[Lavrov has signalled] quite clearly that Moscow is no longer ready to tolerate the casting of its role on the world stage as that of a ‘bad student’, constantly listening to the West giving lectures and expecting new punishments. And although we do not believe that Russia is in position to initiate its own sanctions, it is obvious that its response to possible new unfriendly steps from the West will now be much faster and possibly harsher than what we have seen before,” Tikhomirov said.