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Russia Outplays the West

Bloomberg commentator Leonid Bershidsky confirms what we always said would happen: Ukraine is in a bind, Russia holds all the cards, and the Russian economy is bouncing back as Western investors flood back in.

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This post first appeared on Russia Insider

Regular readers of Russia Insider will know that since we began publication we have consistently made two claims:

The first is that in the Ukrainian conflict Russia holds all the cards.  


Ukraine’s economy is so interconnected with Russia’s that Ukraine cannot function economically without Russia, while the exceptionally tight links between Ukraine and Russia mean that any attempt to distance Ukraine from Russia is certain to fail.

Beyond that, in the ongoing conflict, Russia holds all the military cards, since the Ukrainians simply cannot overrun the Donbass against Russia’s opposition.

Our second claim is that the West misunderstands and has gravely underestimated Russian society and Russia’s economy.  

We refused to buy the crisis talk so widely current at the end of last year. On the contrary we said the ruble was being oversold, that claims Russia would default or that its economy was in meltdown were nonsense, and that the devaluation of the ruble was ultimately good for Russia.

More and more people are gradually coming round to these views.  The latest article by Leonid Bershidsky for Bloomberg ("Putin Needs Neither War Nor Peace in Ukraine", Bloomberg, 29th April 2015) is a case in point.

Bershidsky is one of the shrewdest and most intelligent writers on the Russian economy. He is a pro-Western liberal and a known critic of Putin. He is scarcely someone who is going to give Putin or the Russian government the benefit of the doubt, so when he takes the same view as us, that should be considered definitive.

Here is what he says about Ukraine:

“The government is Kiev is stuck. It can't make a military move to reclaim its territory, because it can't risk another defeat. President Petro Poroshenko will probably end up tacitly agreeing to freeze the conflict for now, because Ukraine also stands to benefit from the psychological effect that a relative peace would have on investment.”

We have consistently said that the key reason there is no progress towards a negotiated peace in Ukraine is because Kiev refuses to implement the political part of the Minsk Memorandum. Here is what Bershidsky has to say about that: 

“Ukraine, at the same time, has been unwilling to grant more autonomy to rebel-held regions, as prescribed by the Minsk deal, until local elections are held there in accordance with Ukrainian law. That's a dead end: There won't be any elections until the rebel commanders --- and their masters in Moscow --- are satisfied with their new powers.”

And here is what Bershidsky says about who wins from this situation:

“It makes sense for Russian President Vladimir Putin to find this kind of equilibrium, allowing his country's investment rebound to gain momentum, while keeping Ukraine on the hook. That implies a frozen conflict scenario, in which there is no war and no deal, a situation that could be maintained more or less indefinitely -- as Transnistria, the unrecognized state in limbo between Ukraine and Moldova since the early 1990s, shows. 

For Putin, the advantage is clear: Keeping the conflict unresolved may hinder Ukraine's integration with Europe and the North Atlantic Treaty Organization.”

As for Russia’s economy, Bershidsky has recently made known his view that the worst is over, but here is what he says in his latest article:

“The ruble is the best-performing major currency so far this year, having gained 14 percent against the U.S. dollar. That's mainly because the oil price, all-important for Russia's fiscal health, has stabilized at a higher level than doomsday prophets predicted -- above $60 a barrel of Brent crude. And Russian economic data, while hardly encouraging, don't indicate an impending collapse.”

As for sanctions:

“Western sanctions against Russia didn't inflict much economic damage, because when they rendered big Russian state companies unable to borrow in Western markets, the government stepped in to help them. Yet, for some time last year, the sanctions did succeed in scaring investors away. That was a mainly psychological effect, which is now wearing off thanks to the truce.”

And as the scare factor of the sanctions starts to wear off, as Bershidsky reports, Western investors are coming back:

“According to the global fund tracker EPFR, the influx of cash into mutual and exchange-traded funds targeting Russian securities so far this year has almost wiped out last year's outflow.”

Even lending to Russian companies has now resumed:

“Why not give Russia a chance, especially since it promises higher yields than most other big markets?

International lenders led by Societe Generale, ING and Natixis have just provided $530 million to Uralkali, Russia's world leader in potash production, at 3.3 percentage points above the Libor benchmark rate. European companies with similar credit ratings pay less than half that premium now.”

We don’t agree with Bershidsky about everything. He assumes that Moscow is behind the conflict in Ukraine. We say it is a civil war into which Ukraine, aided and abetted by the West, has dragged Russia. We think he is wrong that Ukraine will choose stalemate over war. We expect fighting to resume soon. He attributes Russia’s recovery this year to the higher oil price and the truce in Ukraine. We say it is due to Russia’s strong economic fundamentals.

The point however is that on these questions, whichever of us is right,  the end result is the same. Both in Ukraine and on the economy it is Russia that today looks far stronger than the West expected, and which has the advantage.

And as to that, all we can say is: we told you so.

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