As EU Preps Sanctions Extension, Russia Adapts -- Update

The European Union is set to extend economic sanctions on Russia in the coming days, a sign of the bloc's continued efforts to penalize Moscow for its interference in Ukraine, but economic and political ties between Europe and Moscow are broadening again.

EU and Russian officials say the sanctions, which curtail defense, energy and financial ties, harm the Russian economy. But Russia appears to be adapting.

While Europe's diplomatic contacts with the Kremlin remain strained, the EU is seeking to broaden what it terms "selective engagement" with Moscow.

On Monday, EU foreign ministers are set to extend for another year sanctions they imposed in 2014 on Russian companies and others who gained from the Kremlin's annexation of Crimea in March 2014. EU leaders will discuss a six-month extension of broader economic sanctions at a summit late in the week.

The EU and the U.S. have linked economic sanctions to the February 2015 Minsk cease-fire accord, which aimed to end fighting between Ukraine's forces and Russia-backed separatists. Progress on the agreement has stalled, European diplomats say, meaning there was little real debate about sticking to the course and extending the sanctions until January 2018.

A formal decision will come shortly after the summit, officials said. The EU has also placed a travel ban and an asset freeze on 37 businesses and 150 people, including top aides to Mr. Putin.

Despite the expected extension, U.S. and European sanctions could be set to diverge for the first time since the Ukraine crisis began. The U.S. Senate last week backed a bill that would impose new sanctions on Russians linked to human-rights abuses, arms sales to Syria and cyberattacks. The measures also curtailed President Donald Trump's ability to ease sanctions, something he floated doing during the presidential campaign, causing consternation in the EU.

Still, the proposed bill has drawn criticism from Germany and Austria because it would let Mr. Trump penalize European firms involved in the construction of Russian energy-export pipelines.

Russia's economy in 2014 entered a two-year recession, sparked by sanctions and plunging oil prices, but the World Bank forecasts it to grow 1.3% this year.

So far, U.S. and European restrictions on drilling technology haven't curbed Russian oil production, which has broken post-Soviet records. The sanctions target attempts to develop huge resources in the Arctic and hard-to-recover oil in Western Siberia.

Financing for Russian companies dried up in 2014 as Western banks and investors hesitated to lend to any firms there. But Western capital markets have more recently cracked open, allowing Russia's government and large firms to more easily tap international debt markets.

A huge Arctic gas project led by Russia's second-largest gas producer, PAO Novatek, said Tuesday that it had agreed a credit line of EUR425 million ($475 million) with several European banks. Novatek is barred by U.S. sanctions from raising loans in dollars.

European officials say the sanctions are hurting parts of the Russian economy.

They acknowledge easier credit conditions for some Russian firms. A European Commission paper circulated to member states Thursday, seen by The Wall Street Journal, said half the Russian bonds issued so far this year were listed in the EU compared with 15% in the first four months of 2016. However, officials say sanctioned Russian state-owned companies are still squeezed because they must repay $26 billion in overseas debt over the next two years while Russian banks are still struggling with high levels of nonperforming loans.

The paper said that European exports to Russia of dual-use goods--products that can be used for civilian or defense purposes--fell 9.6% last year. EU authorities denied 164 export requests for products to Russia last year, more than for any other country.

Russian President Vladimir Putin said Thursday that sanctions had an impact but the measures--and Russia's countersanctions on EU food exports--had even helped some sectors, including agriculture.

"Yes, they affected us," Mr. Putin said. "Dramatically or not? I think not."

The commission paper said the drag on the EU economy created by its sanctions against Russia and Russian countermeasures was just 0.1% of EU output in 2016 and is expected to be zero in 2017.

Meanwhile, the deep political freeze between Moscow and major European capitals following the Ukraine crisis is easing, despite the election of French President Emmanuel Macron, who accused Russia of trying to undermine his campaign.

Attention has gradually turned away from Ukraine to other crises, like the fight against terrorism, where Russia and the EU have at least some common ground.

In April, EU foreign policy chief Federica Mogherini was one of several top European officials to visit Moscow recently for the first time since the Ukraine crisis. She returned with plans to restore regular bilateral meetings on foreign policy issues.

Tensions with Russia over Syria have faded since the end of the large-scale Russian bombing of major cities like Aleppo. European diplomats are watching to see whether U.S. ties with Russia ease if Mr. Trump meets Mr. Putin on the sidelines of the Group of 20 leaders meeting in Germany next month.

To be sure, the full sweep of trade, energy and political talks that took place between the EU and Russia before the Ukraine crisis no longer happens. Gone are the twice-yearly EU-Russia summits. The Kremlin remains locked out of what is now the Group of Seven leading economies.

However, Russian diplomats are feeling more at home again in the EU capital.

Opening a press briefing last month, Russia's EU ambassador, Vladimir Chizhov, pointed to the "heavy program of contacts" Mr. Putin was having with European leaders, including visits by German Chancellor Angela Merkel and Italian Prime Minister Paolo Gentiloni.

There was a time, Mr. Chizhov said, when "some people in the West liked to talk about Russia being isolated on the world stage...I think an understanding has blossomed that we need dialogue."

Write to Laurence Norman at laurence.norman@wsj.com and James Marson at james.marson@wsj.com

(END) Dow Jones Newswires

June 18, 2017 10:50 ET (14:50 GMT)