Global markets are relieved that the risk of a shooting war has receded (but not disappeared), and they are rallying. The situation remains highly volatile. Threats and counter-threats are issued daily. We do not know how this drama will end. There are some substantive developments, however; and these are the subject of this note.
Russia is in control of the autonomous region of Crimea and intends to stay in control there. While the West will press for the withdrawal of the heavy reinforcements to the Russian military presence there, the fact of Russian control seems likely to be accepted as unavoidable. Whether or not Russia will move to make Crimea formally a part of Russia is unclear, but the latest developments are not encouraging. Russia continues to strengthen its military hold on the region. Furthermore, Putin has requested lawmakers to accept the results of a planned referendum on Crimea joining Russia. Russia has not invaded Eastern Ukraine. Putin says he sees no need to do so “at this time” and has moved back his forces that had built up on the border.
On the side of the Western powers there are important military and economic developments. During the weekend of March 1 and 2 the Lithuanian and Polish presidents called for urgent NATO consultations under Article 4 of the alliance’s founding treaty. Article 4 says that NATO members “will consult together whenever, in the opinion of any of them, the territorial integrity, political independence or security of any of the parties is threatened.” NATO Secretary-General Anders Fogh Rasmussen convened an extraordinary meeting of NATO ambassadors on March 2. This marked only the fourth time that an Article 4 meeting has been called. The other three were all called by Turkey — in 2003 on Iraq and twice in 2012 on Syria.
[Hear More: Marc Chandler: Ukraine-Crimea Situation More Bluster and Hype Than Geopolitical Threat]
Following the meeting Rasmussen stressed the support of NATO for Poland and the Baltic states: “These developments present serious implications for the security and stability of the Euro-Atlantic area…. Allies stand together in the spirit of strong solidarity in this grave crisis.” Some cooperative activities of NATO with Russia have been suspended. Further specific actions cited by the US Defense Secretary include boosting the joint training of NATO forces in Poland and increasing NATO’s air missions over the Baltic region, close to Russia’s Western District, where Russian forces recently carried out an unannounced large-scale live-fire drill. And on Thursday Rasmussen told Ukraine PM Yatsenyuk that NATO will “step up our engagement with Ukraine’s political and military leadership” and “strengthen our effort to build the capacity of the Ukrainian military, including with more training exercises.” These developments together draw a line in the sand that is much more meaningful than the war of words, which has extended to threats to exclude Russia from future meetings of the G8.
On the economic front, the European Union (EU) has moved rapidly to agree to offer Ukraine $15 billion in aid over the next two years. This will be in addition to $1 billion in loan guarantees pledged by the United States and an anticipated aid package from the IMF. Ukraine needs this assistance to head off bankruptcy and to undertake the tough but much-needed economic reforms the IMF will attach as conditions for its assistance. These economic actions will fully offset the loss of financial assistance from Russia and will strengthen Ukraine’s ties with the West. A trade agreement with Europe also looks likely.
These are the important, substantive developments. The sanctions regarding visas and the freezing of assets that have been announced to date by the US and European states are limited and understandable steps to be taken against certain Ukrainian and Russian individuals. Escalating to significant economic sanctions would be very costly to both sides. Russia’s role as a major energy supplier to Western Europe is the key consideration. Europe needs the energy, and Russia needs the revenues. David Hale summarized the situation in a note last week titled “The Ukraine Crisis”: “The European Union accounts for 88% of Russian oil exports, 70% of its natural gas exports, and 50% of its coal exports. It will not be easy to stop this trade because Russia accounts for 31% of all European gas imports, 27% of crude oil imports, 24% of coal imports, and 30% of uranium imports.” Europe will be very hesitant to go down the road of economic sanctions unless the situation deteriorates significantly. Russia, however, has dialed up the pressure by threatening to cut gas supplies to Ukraine, charging that Ukraine owes $1.9 billion in unpaid gas bills.
The economic ties of the US with Russia are much more limited, but they do exist. Firms such as Citibank and Exxon-Mobil have significant investments there. The Russian government’s move to pass legislation authorizing the seizure of assets of foreign firms from any country that imposes economic sanctions is meant as a warning. Unfortunately for Russia, the legislation undermines that country’s lengthy efforts to convince Western firms that Russia provides a safe environment for foreign investors.
So far, the economic and political costs for Russia as a result of its aggressive reactions to the revolution in Ukraine look to be significant. While we cannot predict Russia’s future moves, it is difficult to see a positive outcome on balance for Putin, whatever his planned endgame may be. We intend to continue to exclude Russia from our International and Global equity ETF portfolios.
