Neither War Nor Peace

As separatists in Eastern Ukraine hoist new Donetsk Republic flags over captured government buildings, Russia masses 40,000 troops along the Ukrainian border, and the Ukrainian acting President puts his nation’s forces on combat alert, European Union and American officials are pondering over what to do next.

The West is trying to help Ukrainians diplomatically, financially, and with their heating bill. Slovakia and the Ukrainian transition government have signed an agreement supporting the transfer of natural gas from Slovakia.  Because Slovak gas comes from the Nord Stream pipeline from Russia to Germany, Ukraine could use this gas even if Russia shuts down the pipelines flowing to it directly.

Image courtesy of World Economic Forum,  © 2009, some rights reserved.

Image courtesy of World Economic Forum, © 2009, some rights reserved.

U.S. Secretary of State John Kerry has been active in both DC and Kiev, pledging support for the new Ukrainian government and calling for a strengthening of NATO in response to the crisis.  During his March visit to Ukraine, Kerry promised a one billion dollar assistance loan as well as condemning Russia’s seizure of the Crimea. Both US and EU officials have said that Russia has failed to abide by the agreement reached at Geneva on April 17, calling for the eastern separatists to disarm.

Most importantly for the beleaguered country, the IMF approved a $17 billion loan.  Prior to the aid, Ukraine was in dire shape.  The country had been forced to stop defending its currency peg because of lack of foreign reserves.  Its currency, the hryvnia had depreciated 29 percent relative to the dollar in 2014 alone.  The economy had also been shrinking rapidly since its resource-based growth halted in 2009.  The current instability has worsened the process, with the IMF predicting a 5 percent decline in GDP this year.  The country also owes a large debt to the Russian national natural gas firm, Gazprom.  With the IMF loan, Ukraine hopes to resume its payments for natural gas, service its foreign debt, and moderate inflation in the coming months.  Attached to the loan are some stringent conditions – Ukraine must adopt a floating currency and end its ruinously expensive subsidies of natural gas.  It will be difficult for Ukraine’s interim government to adopt meaningful reforms with its limited public legitimacy and the chaos in the east.  However, Ukraine has already failed to adopt the required reforms from previous IMF loans twice before, and may not receive another chance.

The Obama administration has ruled out military intervention or arms shipments, arguing that the Ukrainian national army stands no chance of withstanding a Russian invasion in the immediate future.  Ukrainian admission into NATO was also turned down.  600 American paratroopers were moved from Italy to the Baltics, but this was more an American effort to reassure worried allies than an attempt at credible deterrence.

On the other hand, the West is moving forward on its diplomatic offensive against Russia.  New sanctions have recently been imposed, these targeting even higher figures of Russia’s administration.  General Valery Gerasimov, the head of the Russian army, and Igor Sechin, the head of Russia’s state oil firm, Rosneft and a personal friend of Putin’s.  More Russian banks are being blacklisted due to ties with prominent administration figures as well; the latest additions are SMP Bank and InvestCapitalBank.  The US Commerce Department is also beginning to restrict exports that could be used by the Russian military.  While most of these goods can be acquired from other countries, American companies are now more reluctant to ship anything to Russia due to stricter licensing.

At the same time, the disunity in Western diplomacy is weakening their position.  The EU has been reluctant to press forward with sanctions, as Russia can cut off natural gas in the upcoming winter.  Germany in particular would suffer from Russian counter-sanctions, with exports to Russia worth over 50 billion dollars.  Western oil companies also have invested heavily in Russian fields and utility firms, and are pressuring their governments to ease future sanctions.  Prominent European figures, like the CEO of Siemens and former German chancellor, Gerhard Schroder, have warmly received President Putin in recent months, despite his government’s annexation of Crimea and fomenting of separatism in Ukraine.

The greatest threat to Russia’s aggressive foreign policy may come from within.  Capital flight has accelerated, with 51 billion dollars leaving the country in the first half of this year.  This has led to a weakened ruble, fewer funds to invest in Russian firms, and the prospect of high inflation.  To combat this, the Russian Central Bank has been forced to raise interest rates by two percentage points since March.  Confidence in Russian government bonds has fallen, with Standard and Poors downgrading their credit rating to one step above junk bonds.  The Russian Economy Minister Alexei Ulyukayev shrugged off the downgrade, claiming that it was politically motivated.  Nevertheless, GDP growth forecasts for Russia are sliding, with most estimates now predicting a stagnant economy.  Will these growing economic burdens and Western pressure change Russia’s course?  Only time will tell.