Vladimir Putin is many things, but indecisive is certainly not one of them. His bold annexation of Crimea, the large landmass on the northern coast of the Black Sea which sits between Ukraine and Russia, has world leaders worried.
Is conflict on the cards? Recent history has taught us that when the Western world worries, it attacks. Yet Obama is demonstrably a President with more restraint – or some might say inertia – than his predecessors. Putin’s actions have been met with widespread condemnation but not much more. Whilst last week, the US imposed punishment on a list of people linked to the Crimea insurgency, a full-scale national sanction has yet to come into play. Democratic solutions are clearly the modus operandi; Mr. Putin’s phone is abuzz with concerned world leaders willing him to negotiate an end to the conflict. His choice is between the loyalty of his own people, and the trust of the world at large. Of course, only one of those groups can vote for him in the next election. The Russian premier’s actions to this point suggest his mind has already been made up.
However, Washington is now pressing the EU to threaten Moscow, with sanctions planned against entire sectors of the Russian economy – most notably energy, finance and defence. The US envoy for sanctions, Dan Fried, visited Brussels on Wednesday to give the US approval to so-called “level three” measures. However, he would only seek to do so in lockstep with the EU, diplomats have said.
At home, there is a very different story. Crimea is comprised mainly of Ethnic Russians, who want to be a part of their perceived homeland. A referendum on whether to join Russia resulted in a 96.77% (Crimea) and 95.6% (Sevastopol) affirmative vote, with an 86% turnout. Putin’s ratings have soared even during this so-called crisis – in May, an overwhelming 73% of Russians said they would vote for him if he were up for re-election. Crimea is clearly a topic close to the nation’s hearts, and Putin is playing this card admirably.
In Crimea We Distrust: Russia’s Failing Economy
Still, these manoeuvres have the world talking, and their language is negative. While Putin remains insouciant in the face of the new and looming sanctions, businesses and investors have their back up. The Moscow stock market has plummeted 10.8%, haemorrhaging nearly $60bn from the value of Russian companies. The rouble has also been weakened to an all-time low, despite the estimated $12 billion already spent by the Russian central bank in its aid. Interest rates have been raised to a high of 7.5% as officials seek to curtail rampant inflation and stabilise the currency. In the first three months of this year, the central bank said it saw a $63.7 billion net capital outflow – more than the $63 billion spent in the whole of 2013. Annexation has not come without home sacrifice.
Of the investors in exodus, the majority are foreign – a reasoned guess would say they are Western. They are understandably fearful of putting their money to work in an unstable geopolitical environment. The Crimea conflict has struck deep at the heart of the Russian economy. Russian growth has been estimated at a mere 0.5% in 2014; its lowest rate of expansion since the 2008 financial crisis. Standard & Poor has even downgraded Russia’s credit rating to ‘BBB-‘, just one level above junk bond status. Geopolitical instability has rapidly translated to financial instability. Only a conclusion to the ongoing conflict can stem the exodus of investors.
Did Putin expect other world leaders to stand idly by as he oversaw the first annexation in Europe since the Second World War? Despite its impressive growth in recent years, Russia’s economy is probably unprepared for the kind of sanctions it is expected to face. Putin’s nation has yet to develop a diversified and globally competitive market for manufacturing and services. Europe is being forced to seek alternatives to Russian gas and oil, but the culmination of this trade is mutually damaging. Russia relies on its export of commodities, and enjoyed a roaring trade in Europe the likes of which it will not find elsewhere. Now, two of its biggest previous buyers, the UK and Germany, are planning new domestic initiatives like fracking.
A New Reich In Russia?
As mentioned, there has been no territorial capture in Europe since WWII. After such sustained political quiet, it is only natural that strong action will invite strong words. The most compelling of reactions to Putin’s movement has been the remark of British heir to the throne, Charles. A journalist captured his maladroit comment that Putin’s moves have been ‘like Hitler’, earning him widespread condemnation from diplomats. However, the feeling back home is that while the Royal was ill-advised to say so, it’s easy to see how his conclusion was drawn. Nazi Germany too saw the rise of a charismatic autonomist, who similarly reasoned that the expansionism he oversaw was to protect the nation’s racial minorities in other states. Putin has captured Crimea, and is now thought to want to move further into Ukraine. Well known as a zealous nationalist, many fear he wants to rebuild the Stalinist state of old.
Putin also seems to be preparing for war… but, mercifully, not in Hitler’s sense. There will be limited physical conflict; no rapid militarisation back home. Inside, the truly global battle here will be waged with resources, with sanctions on his nation expected to be imposed by the US and EU. The two largest global economies both back the claims of Ukrainian officials that Putin’s move is in violation of Ukraine’s constitution and international law. The threat of economic isolation has been mounting, yet no truly damaging sanction has been made yet. And Putin has pre-empted any Western barracking of trade quite effectively, in June signing a 30-year $456bn deal to export Russia’s gas and other petrochemicals to China. In real terms, this is equivalent only to the value of Russia’s current exports to Germany. Still, the US inertia is disquieting to some. Territorial allowances were made to appease Hitler prior to WWII, with obviously devastating consequences. Putin knows the game he is playing. It seems he may have a few more turns yet to take.
Crimea River: The Ukrainian Crisis
But while we may endlessly speculate on Russia’s future, the truth is that things are immeasurably worse in Ukraine. Street protests and barricades in the capital are now a part of everyday life. Russian troops run a regime of fear on the ground. Russia’s geopolitical situation is unstable, but Ukraine is in revolt. Prime Minister Arseniy Yatsenyuk has warned that the Ukrainian economy will shrink by at least 3% this year. Some Ukrainians, who have witnessed the disruption first hand, believe even this is hopelessly optimistic.
As the crisis deepens, Russia has ramped up its stranglehold on its unfortunate neighbours. On Monday the Russian gas conglomerate, Gazprom, cut gas supplies to Ukraine after Kiev couldn’t find a way to settle its debts. Ukraine started falling behind on its gas payments last year and, until a few weeks ago, had not made a payment for Russian gas in months. The $786m June payment went some way towards settling arrears, but there was still $1.45bn to be paid for November and December’s supplies. Gazprom is even claiming a further $3bn for April and May supplies. This, though, may just be taking the biscuit. The prices of the deliveries and the size of the debt are both strongly disputed. Such debts would require the aid of the IMF, which recently approved a $17.1bn bailout for Ukraine to help the country avoid default on its debts.
However, national pride is at stake in doing so. Ukraine has chosen not to pay the Gazprom bill because it disputes the price – which Gazprom hiked from $268.5 per thousand cubic metres in January-March to $485 from April, leading to the rather extortionate quotations for April and May’s gas. It has certainly not helped quell the tensions between the countries.
Indeed, Southeastern Ukraine is still facing the threat of Russian military intervention. Amid reports of skirmishes and violent protests involving provocateurs and vigilantes in various parts of the country, members of the general public remain fearful for their future. There are reports of citizens buying guns and weapons, distributed from military armories to the public and paramilitary groups. A new national guard and local self-defense units are being organized.
The incumbent Ukrainian government doesn’t exactly bring hope to many of its citizens in this time of crisis. Their economy is smaller now than it was in 1992 when it left the Soviet Union. The incompetent leadership, perceived corruption and continued economic plight since separation have all helped cultivate a large pro-Russian sentiment in some areas of the country. The spectre of separatism is alive again, and Putin is helping to fuel it.
And finally, there is the consideration of the rest of the old Soviet Union, much of which is now desperately poor in its respective isolation. There is a captivating allure to both Russia’s perceived riches and strong, unquestionable leadership of Putin. If Putin’s promises are kept to Crimeans, there are worries that previously Soviet areas in the West, such as Hungary, Romania, Slovakia, and Poland, may look jealously to their more prosperous co-ethnics across the border, and begin revolts of their own.
Crimea’s Caveats: Putin’s Price For Power
But let’s not jump the gun. Even if a new super-state is what Putin wants – and there is still only limited evidence to suggest that – there are many, many roadblocks yet to a re-emergence of the Eastern bloc. These go beyond the vagaries of an unstable home economy. If the annexation is allowed to proceed – as the dearth of decisive action taken by Western powers suggests it might – then Putin must spend to bring Crimea up to Russian living standards, or see its people turn against him. Early estimates suggest at least $3bn a year must be subsidised by Russia to Crimea to ensure comparable living standards. A raise in the pension funds for citizens, from the Ukrainian rate to Russia’s vastly superior counterpart, is also on the cards. But it is the promise of infrastructure upgrades that has really captured the Crimeans’ imagination. The Russian government has promised a new bridge to link Russia with Crimea in addition to large scale upgrades to the currently primitive system on the peninsula. Whether these are genuine assurances or empty promises for political gain will likely be seen in the coming months.
Aside from costs to the state, Crimea’s annexation will hold repercussions for the elite group of Russian oligarchs. While a vast minority, they have been a primary driving force behind the country’s economic growth and emergence as a global power. With potential US and EU sanctions looming, there are fears that the numerous unfavourable conditions already caused by the conflict – higher borrowing costs, a weaker ruble, bad credit ratings, a sliding stock market, and Western reluctance to do business with Russians to name a few – are only the beginning.
Putin has distanced himself from much of the developed world with his actions. In an uncertain future for Russia, he could do without alienating his own people as well.
Russian Market Analysis
With knowledge of the major developments of the Ukrainian crisis and the impact that it has had on the Russian stock market, we are aptly armed to consider some statistics. The RTS index of the 50 biggest Russian stocks was predictably sensitive to news coverage of the conflict in Crimea. The likely reason is large sums of western institutional money being pulled out due to political risk uncertainty. (Interestingly enough, Ukraine’s stock market has fared far better. This suggests, perhaps predictably, a far smaller Western contingent of investors in their markets, thus a diluted dip effect following the crisis.)
Of course, markets often over-react to political news, their flames ever fanned by media sensationalism. The index seems to be making a recovery recently, which may be due to Russia’s new $400bn gas deal with China.
Consider also the other factors that affect Russia’s stock market. Pictured below are the daily data for the past five years on Russia’s RTS index, which contains 50 of the biggest companies in Russia, which has undergone a multi-factor regression analysis on the data against some key variables. The equation used is: Returns(RTS) – Risk free rate = Alpha + Beta(MSCI World returns – Risk free rate) + ∆ln(Brent Oil Spot Prices) + ∆ln(USD/RUB).
The Beta measures risk-adjusted returns of Russian stocks against risk-adjusted returns of world stocks in order to measure the systemic risk found in the Russian stock market. The data on oil prices and the currency exchange rate between USD/RUB shows how much the Index changes in percent terms, given a percentage change in either variable.
On average, the Russian stock market has a beta of 0.861, which suggests only moderate risk. The alpha value is -0.000370. For every percent increase in the price of oil, the stock market mirrored it, increasing by 0.191 percent. Likewise, for every percent increase in the USD/RUB (indicating a weakening Rouble), the stock market decreased by an average of 0.481 percent.
Pictured here is the rolling 1-year regression analysis at periods of one month on the coefficients, demonstrating how these variables have changed over time.
Reflecting Russia’s status as a dominant commodities exporter, the price of oil foretells greater returns on the market. A strong Rouble against the dollar is also a key indicator of higher returns. The R^2 is included to show how much of the fluctuations in the stock market our model can explain based on the variables we have analysed it against.
Words: Richard Saint and Josh Lelliott
Images: Josh Lelliott