22/7/2014: Shaping a Road Map for Resolving the Ukraine Impasse

With the conflict in Ukraine is tumbling toward a breaking point (http://trueeconomics.blogspot.ie/2014/07/2172014-conflict-over-ukraine-is-now.html), it is heartening to see the Guardian wading into Ukrainian crisis dimension with a proposed solution that actually attempts to bridge the gap between Eastern Ukrainian separatists, Kiev, Moscow and the West:
http://www.theguardian.com/commentisfree/2014/jul/21/putin-save-face-mh17-russian-leader-ukraine-rebels

As readers of this blog know, I have called for a staggered reforms approach based on "elections + Aid & Development Programme + referendum" formula since February this year:
http://trueeconomics.blogspot.ie/2014/02/1922014-ukraines-political-economy-is.html and http://trueeconomics.blogspot.ie/2014/02/622014-what-does-future-hold-for.html

The dynamics have changed a bit since the original suggestions, but the nature of the required compromise did not. To move on from the civil war situation toward peaceful resolution of the political and economic crises Ukraine faces, the nation needs:

1. Immediate bi-lateral ceasefire agreement backed solidly and enforced by EU and Russia; both acting as guarantors and enforcers of the agreement on the sides of, respectively, Kiev and Donetsk;
2. Following the ceasefire, Ukraine needs structured and facilitated peace talks;
3. Peace talks must start with the opining positions of both sides recognising ex-ante: secured national integrity of Ukrainian state, full recognition of the legitimacy of the current Government in Kiev, recognition of the need for regional-level direct democratic decision making in shaping the future political configuration of Ukraine;
4. Kiev must, up front, recognise the need for local referenda in determining the future outlook of political institutions in Ukraine, while separatists must recognise that the future referenda cannot be held on the basis of secession, but must be grounded within the confines of the united Ukraine. Kiev also must recognise the need for full recognition of the rights of Russian and other ethnic minorities and there has to be external monitoring group set up to oversee such recognition is implemented. Much of this already enshrined in law in Ukraine, but Ukrainian laws are held in low regard in the East;
5. The talks must produce a road map - including timings - for: A) local referenda on the structure of regional relations with Kiev; and B) constitutional - nationwide referendum - aiming to reform and confirm constitutional institutions of the state; 6) Before any referenda can be held, there is a need for a normalisation period, during which reconstruction and development of the regions can take place. Funding for this should be supplied by the guarantors of the peace process (EU and Russia) on the basis of the World Bank-administered loans with referential conditions (Marshall Plan);
6. EU and Russia must engage in a multilateral (EU, Ukraine, Eurasian Union) coordination of trade and investment policies aiming to prevent disintegration of Ukraine's trade and investment capabilities in either market.

The above are not the only conditions for launching a successful institutions-building exercise in Ukraine, but they are the central ones.

The key point is that, as the Guardian puts it: "we cannot afford a decade of cold war. It’s time to swallow hard, and bring the region’s dominant powerbroker inside the tent, to help ensure the integrity of Ukraine – and peace in Europe."

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:

• Bloomberg report of rising pressures within Russian elite circles: http://www.bloomberg.com/news/2014-07-20/russian-billionaires-in-horror-as-putin-risks-isolation.html
• Bloomberg View contribution by @Bershidsky http://www.bloombergview.com/articles/2014-07-21/flight-mh17-victims-bodies-were-looted-or-maybe-not that sums up very well the simple and ugly reality that we will not, in all likelihood, know exactly the core facts about what happened to MH17 and who is responsible.
• WSJ report on Russian response theory of what happened to MH17: http://online.wsj.com/articles/russia-presents-its-account-of-malaysia-airlines-flight-17-crash-1405952441 [Note: my view is still, on balance, that probabilistically separatists shot down MH17]
• WSJ report on MH17-related U.S. disclosures: http://online.wsj.com/articles/ukraine-knew-of-separatists-air-defense-capabilities-say-officials-1405781508 [Note: on June 29, Russian news agency Itar-TASS reported as much, so the U.S. intelligence is redundant: http://itar-tass.com/mezhdunarodnaya-panorama/1287030 except for one thing, the U.S. is accusing Russia of supplying BUK to the separatists, while separatists claimed they captured BUKs at the Ukrainian military base they overrun. Ukrainian Government confirmed the base was overrun and that it had BUKs, but first denied that any BUKs were taken over. The Ukrainian military subsequently said they disabled BUKs that separatists captured. Let's remember, the disabled WW2 tank that stood as a monument for some 7 decades has been easily restored by the separatists into a functioning one.] In addition, the report outlines U.S. theory of the BUK acquisition and deployment.

• WSJ report on lack of cohesion and institutional governance frameworks in the separatists' camps: http://online.wsj.com/articles/disaster-highlights-disorder-among-separatists-1405902562

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.