2/1/16: Россия, Украина и ЕС: полтора года переговоров впустую

My comment for BBC Russian Service on the stalemate in EU-Russian-Ukrainian talks concerning the EU-Ukraine trade agreement:  http://www.bbc.com/russian/business/2015/12/151229_trade_russia_ukrain_eu.

In summary: the failure of the talks is mutual.

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.

27/3/2014: Troika of Sorts for Ukraine: IMF's chip are on the table

IMF announced the agreement to provide USD14-18 billion in Stand-by Arrangement with Ukraine.

This is a 'troika'-like arrangement:

• 2 year stand-by line of credit
• Total package of USD27 billion
• IMF share of the package USD14-18 billion
• Main funding vis bi-lateral and multilateral agreements
• Presumably multi-lateral will envolve EU
• Bilateral packages are for US and possibly Russia

Macro analysis:

“Ukraine’s macroeconomic imbalances became unsustainable over the past year. The (until recently) pegged and overvalued exchange rate drove the current account deficit to over 9 percent of GDP, and a lack of competitiveness led to the stagnation of exports and GDP. With significant external payments and limited access to international debt markets, international reserves fell to a critically low level of two month of import in early 2014. The 2013 fiscal deficit was 4½ percent of GDP, and the government accumulated sizeable expenditure arrears. The 2013 deficit of the state-owned gas company Naftogaz reached nearly 2 percent of GDP, driven by the sharp increase in sales at below-cost prices. Without policy action, the combined budget/Naftogaz deficit would widen to over 10 percent of GDP in 2014."

So in other words, 2013 combined deficit was around 6.5% of GDP, but 2014 deficit - following 'some stabilisation' (see below) is to reach 10% of GDP. I wonder why?.. Is it down to expected price increases on gas and oil? Or is it down to the havoc wrecked by Maidan protesters? It is certainly not down to the Crimean crisis, since removal of Crimea off Kiev's books should save the Ukrainian Government money.


“Following the intense economic and political turbulence of recent months, Ukraine has achieved some stability, but faces difficult challenges. To safeguard reserves and address currency overvaluation, the National Bank of Ukraine (NBU) floated the exchange rate in February. Measures implemented in February and March helped stabilize financial markets and ensured that critical budget payments have been met. Nonetheless, the economic outlook remains difficult, with the economy falling back into recession. With no current market access, large foreign debt repayments loom in 2014-15."

Now, key question here is why is Government deficit rising if currency is being devalued? Especially as official debt levels in the Ukraine are relatively low? Is it because Ukraine running huge current account deficit (even with subsidised prices for Russian gas)?


"Monetary policy will target domestic price stability while maintaining a flexible exchange rate. This will help eliminate external imbalances, improve competitiveness, support exports and growth, and facilitate the gradual rebuilding of international reserves.  The NBU plans to introduce an inflation targeting framework over the next twelve months to firmly anchor inflation expectations."

This is pure nonsense. Devaluation is bound to drive inflation up. Rebuilding economy will require lower interest rates, which will further support high inflation. What on earth can NBU do to set price stability as its objective? Dollarise the economy? Tried and failed in the form of pegs, and given the role of Maidan (populist movement) how can vast amount of pain be inflicted on the economy to drive price inflation to reasonable bounds?


"Financial sector reforms will focus on: (i) ensuring that banks are sound, liquid, and well-capitalized; (ii)  upgrading the regulatory and supervisory framework of the NBU, including complying with international best practice and supervision on a consolidated basis,  and (iii) facilitating resolution of non-performing loans in the banking sector."

The above reads like a Cyprus-Greece scenario. Good luck finding Russian oligarchs to hit with a deposit tax.


"The initial stabilization in 2014 will be achieved through a mix of revenue and expenditure measures. For 2015-16, the program envisions a gradual expenditure-led fiscal adjustment—proceeding at a pace commensurate with the speed of economic recovery and protecting the vulnerable—aiming to reduce the fiscal deficit to around 2½ percent of GDP by 2016."

Yes, I know… it is… austerity. Higher taxes, lower spending, followed by lofty lower spending and lower spending. I think we shall recall that the current Government has been installed into place by the populist uprising.


"A key step is the commitment to step by step energy reform to move retail gas and heating tariffs to full cost recovery, along with early action towards that goal."

Read: 40% hike in domestic gas prices is only the beginning.


In conclusion, IMF release focuses on real issues - institutional deficits in terms of governance, corruption, procurement, transparency. All are laudable and much needed.

The key takeaways:

1. The entire package is still up in the air as to bilateral and multilateral funding - sources, costs, etc;
2. The package still needs engagement from Russia - majority of the above fiscal measures will require serious pain to be imposed and this pain can be ameliorated by Russia restructuring Ukraine's debts and providing some transitioning assistance on energy front, as well as continuing to give Ukrainian firms access to its markets;
3. The package is cheap from IMF's point of view (small outlays over short term) but is heavy on Ukrainian reforms side (needed, but how feasible in the current political environment?);
4. This is not a Marshall Plan I called for - it lacks clarity on the final cost of funding (which should be close to zero) and it lacks maturity span (which should be 20 years or so);
5. Overall, the reforms sketched out above are likely to lead to another Orange/Maidan Revolution in few years time and the funding that backs them is unlikely to provide support for political stabilisation.

Let's wait for more details on the above points.




Details here (click on individual image to enlarge):

26/3/2014: Comment on Russia: Expresso, March 22

My comment to Portugal's Expresso on Russian economy:

18/3/2014: Crimea's Fate Sealed, It's Time for Risk-on on Russia

Key takeaways on today's news from Crimea, so far:

• Crimea is now fully legally incorporated into the Russian Federation and this makes the region's split from Ukraine and accession to Russia irrevocable, no matter what sanctions are being put forward.
• President Putin's address to joint meeting of Russian Duma and Federation Council raised a number of very strong geopolitical points. The main one being the role played by the Nato expansion over the last 20 years in triggering the latest crisis. Despite this, President Putin clearly extended a proverbial olive branch to Nato and positioned this offer of continued cooperation on the shared interests footing (mutual respect and coexistence with recognition of the legitimacy of Russian 'Near Abroad' sphere of influence).
• The Crimean crisis was from the start largely a Russia-Ukraine issue. Thus, Western engagement in it became excessively overbearing on the one hand (starting with the EU pushing forward its own Neighbourhood policies toward Ukraine without having any respect for or consideration of the country's massive economic, demographic, cultural and political links with Russia and without engaging constructively with Russia on bilateral basis) and strategically weak and indecisive on the other (with EU offering no constructive platform for a dialogue with either Ukraine or Russia since November 2013).
• Overall, President Putin's speech was yet another signal to the West that he is ready to consider more constructive engagement and dialogue, and that Russia is not interested in any serious acceleration in the confrontation. The latter point was very clear from the onset of the Ukrainian crisis, not just during the Crimean crisis.
• President Putin is correct that the Crimean crisis was resolved without any loss of life, in contrast to Bosnia, Kosovo, etc.
• Putin's speech, by bringing Russia back on track to seek normalisation of its ties with Ukraine and the West, means that Europe and the US are once again being left without any visible strategic alternatives and puts Moscow one step ahead of them in this geopolitical game. Effectively, the US is now firmly stuck in the proverbial corner: it cannot de-escalate vis-a-vis Russia and it cannot accelerate current sanctions to anything more meaningful. Instead, it is now more likely the US will focus its resources on trying to salvage the current Government in Kiev.

Most significantly, Putin can now set out a number of contrasting and legitimising points to the accession of Crimea:

1. The referendum on Sunday stands in stark contrast to the lack of referenda when Crimea was 'gifted' to Ukraine in 1954 and when Ukraine and Russia (alongside with Belorussia) agreed to dissolve the USSR back in 1991.
2. Crimean accession was carried out on the request of the Crimean government that had effectively no less legitimacy than Kiev government has today. It was created on foot of a popular revolt by the democratically-elected parliament (although in the case of Crimea, as far as I am aware, opposition was present at the vote, unlike in the case of Ukraine).
3. Officially (and that is not to say that this is a complete truth, which we may know one day) Russian military presence in Crimea did not exceed the contractually allowed 22,000 troops. Hence, technically, there was no violation of sovereignty. There was no opposition from the Ukrainian army, further confirming the above point (even if this lack of opposition was driven by the confusing orders from Kiev). The role played by militias (subject to the first caveat above) is no different from the role Maidan forces played in Kiev... etc, etc… All of which (not to justify the events that took place) goes to confirm that there is very little difference (at this point in time) between what happened in Crimea and what happened in Kiev.
4. Whilst Ukrainian constitution does not recognise secession referenda held in a single region as valid, it is worth reminding that the same legal reasons for rejecting the Crimean independence were also raised in the event of secession of Ukraine (and Russian and Belorussia) from the USSR in 1991. It is, therefore, kind of hard for Kiev to have the old the cake and still keep it at the same time.

So today's news put the score at Russia 2: West 0. And with it, Russian markets should be shifting into a 'risk-on' mode over the near future.


Note: as I said before, my preference was and remains for the territorial integrity of Ukraine to remain intact. But setting aside my own preferences (and controlling in the above arguments for my imperfect knowledge of the events and facts on the ground), the current outcome is a new status quo. There is absolutely nothing anyone can or should do about it.