Monday, July 21, 2014

21/7/2014: Conflict Over Ukraine is Now Heading for a Breaking Point


So far in the Ukrainian civil war, my view of the Russian economy has been that
  1. We are witnessing a structural slowdown in economic growth that has little to do with Ukraine;
  2. Sanctions imposed on Russia have been largely indifferent to the Russian economy;
  3. Reputational damage from the Ukraine conflict was manageable; and
  4. Despite the above, Russian economy is starting to show stress arising from the country increasing isolation in the advanced economies' markets (finance and trade).
Events of last week - the downing of MH17, most likely by the Eastern Ukrainian separatists, and prior to that a new set of escalating U.S. sanctions, based on what may or may not be reasonable demands for more Kremlin pressure on separatists - are changing the overall risk outlook.

Specifically, the economic and geopolitical risks are now mutually reinforcing and this pushes us into the final spiral of conflict before we either see a major active de-escalation or a massive spiralling of the conflict out of control.

Here are some links worth reading on the topic of changing risks:

The key takeaways from the above two links are the following:

  1. The entire conflict between Russia and the West at this stage is pure PR-war, with reports and information from all sides coming with heavy doses of assertions, conjectures and accusations, factual evidence un-collaborated and unverified by any third parties and even 'watchdog' organisations (usually self-appointed media and new media organisations) now trenchantly partisan or employing trenchantly partisan analysts and reporters;
  2. Russia is in a poor strategic [and moral] position to defend itself even in cases where it might be right; and
  3. The demands from the U.S. (and to a lesser extent, Europe) relating to future actions by Russia are rapidly becoming detached from reality (see below).
The reasons why the U.S. demands are starting to reach the realm of absurd are two-fold. 

Firstly, prior to MH17 downing, U.S. demanded that Russia compels the Eastern Ukrainian separatists to surrender to the Ukrainian forces. This, with no conditions, no prospect of peace talks and no constraints onto what Ukrainian forces might do to those surrendering. Ukrainian forces are currently carrying out strong military actions against the separatists and there is no peace talks on offer. In these conditions, no authority can compel them to voluntarily and unilaterally surrender. [Note: just to prevent a torrent of abuse from trolls, my view is they should surrender.] 

Secondly, we do not know if President Putin has any control over the Eastern Ukrainian separatists, irrespective of whether or not Russia served as a power base for them in the past. The separatists are fragmented, poorly organised and coordinated. It is doubtful if there is a central authority that can simply issue an order to stand down. Even if Russia had power of compulsion over the separatists at the times when peace talks were on the table (which is questionable as separatists did not seem to change their course when Russia recognised the Ukrainian Presidential election and when Russian Duma rescinded its authorisation of the President to use force to protect Russian-ethnic populations), today, cornered separatists are unlikely to listen to Kremlin unless Moscow can act as a credible guarantor of their safety at the peace talks.

The above implies that we are at a breaking point in the crisis:
  • The U.S. demands may be no longer feasible, and the U.S. is escalating these demands. 
  • Russia's opposition to these demands is becoming highly rhetorical and politically unacceptable to the U.S. 
  • Russian leadership costs of compliance with the U.S. demands is now rising and might, at some point, exceed the costs of non-compliance. 
  • In the mean time, there is absolutely no pressure from the European or U.S. side onto Kiev to offer any conditions to separatists that can guarantee their lives and a peace process. we have no reliable information what acts toward 'collaborating civilians' and separatists Ukrainian forces are carrying out. We have no reliable information as to the casualties on the ground in Eastern Ukraine. We have no reliable information how prisoners taken by the Ukrainian army are treated. We do know that Kiev counts on 'volunteer' units to participate in combat. And we were told before that these units have been at least rhetorically conditioned to kill 'Russians'. We have no idea is Kiev controls these units and what actions toward civilians and enemy combatants they take.
In simple terms, Russia is being forced into a corner by the U.S., separatists are forced into their own corner by all the parties involved; and everyone somehow expects the crisis to be resolved, while Kiev is left to carry out whatever it wants or can or both.

Someone needs to step back from the brink. My preference would be if de-escalation happened simultaneously from the U.S. and Russian sides, with both applying pressure on both Kiev and separatists to bring them to the peace talks. Guarantors of these talks should be EU, U.S. and Russia.

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