Luke Bartholomew 00:06
Hello, and welcome to macro bytes the economics and politics podcast series from abrdn. My name is Luke Bartholomew, and this week we're going to be talking about the crisis in Russia and Ukraine. And what a time to be talking about that because we are recording this podcast on the 22nd of February. And just last night, we saw pretty serious escalation in that crisis with Putin, recognising two so called separatist states within eastern Ukraine, and then sending peacekeeping troops, apparent peacekeeping troops, across the border into those two separatist republics, which has been seen by many Western leaders as a serious escalation of the crisis and perhaps the first step in an invasion. So clearly a very febrile time, things changing very quickly. So I'm delighted to say I've been joined today by Viktor Szabo, and investment director on our emerging market debt team, and Edward Glossop, an emerging market economist to help us understand a the issues that are going on at the moment, also to give us a bit of perspective, as to where this crisis is coming from, think through some of the possible options from here, and also perhaps some of the longer term geopolitical consequences as well. So gentlemen, thanks very much for joining us today. I know it has been a very busy day for both of you around this. So Ed, perhaps I can start with you and just get us to sort of walk us through where we are in the situation as things stand right now perhaps putting a little bit more detail on that sketch I gave at the start there.
Ed 01:44
Thanks, Luke. Yes, I think you did quite a good job at sketching out what has actually happened. But I think just to take a step back, you know, obviously, the crisis with Russia and Ukraine started, the current version of the crisis, started back in December, you know, where Russia initiated, its his so called 'demands' - national security demands. And since then, effectively the crisis has ebbed and flowed. And, ultimately, the diplomatic talks so far, it appears that Putin seems to have not got what he wants from those talks. So Luke, as you mentioned, last night, we saw probably the most significant escalation and the crisis that we have had so far, with Putin doing a few things. So first, he recognised the independence of two regions within eastern Ukraine, he recognised their independence. I mean, I think this is partly symbolic, because those two regions are already pro-Russia, controlled by Russian separatists. So I think the bigger escalation was the fact that official Russian troops have now crossed the border, which as you said, Luke is essentially a prelude to a formal invasion, I think it's kind of worth noting that there is still a grey area as to whether this is a force whether this is an invasion or not. You know, we've seen some policymakers in the West, claim this as a full invasion, because troops across the border. We've seen others, notably, those in the European Union be a little bit more guarded, because of Russian troops simply just occupying space that Russian separatists have, and not claiming new territory, then, perhaps there's slightly more mild escalation. So I think there are lots more questions and we have answers at this stage. But I think that that is where we are so far.
Luke Bartholomew 03:38
All right, that was really helpful. Thanks. So perhaps before we sort of progress with what can happen from there might be useful, Viktor, if you sort of give us a bit of the broader context of this crisis? I mean, what's driving Putin? Sort of a bit of an amateur Kremlinologist there, but sort of your sense of what the deeper structural drivers are? What's behind all of this?
Viktor 03:57
Yeah, sure. That's quite an interesting question and before going into the drivers of Putin, just to clarify, I mean, Putin has given orders for the so called peacekeeping troops to move into the occupied territories or the newly independent territories. But the media reports are not yet clear over whether those troops actually have crossed the border or not. And with that, turning to Putin, I mean, no one really knows what is his ultimate objective no-one sees into his head, though there are many analysts who are trying to pretend that. So there are many possibilities. The first one is probably a top level strategic one. And we think the clue from the treaty proposals he published last December - the treaty with NATO and the US where basically he wants written security guarantees for Russia and also wants NATO to move back to beyond its 1997 borders, clearly identifying a sphere of influence. Russia is not happy that NATO has clearly moved into that sphere of influence. A lot of former Warsaw Pact countries joined NATO. Baltic countries joined. And clearly Russia sees this as a military threat and wants to counteract that. And other possibilities. So legacy issue. Putin may want to restore the greater Russia. That would probably involve uniting Belarus, Ukraine with with Russia, that's kind of a more grandiose plan for the centuries to come. That would mean a permanent annexation of Ukraine. So that's another possibility, or a quite often cited possibility is just as any politician who wants to stay in power and for him a successful and democratic Ukraine next door, would really present an unwanted example for his people that there is a possibility in a post-Soviet country to have a democratic and prosperous country. And from that perspective, he was clearly losing influence, with Ukraine gaining more and more independence. So he wants to have a regime change. And in that case, the conflict might end here with Ukraine, but if you think that it is indeed the first option, the strategic security, then this conflict still has many more legs to go,
Luke Bartholomew 06:42
On that point, have many more legs to go. And by the way, thank you very much for that helpful clarification at the start there. That's a good point well made. But yeah, in terms of where these legs might take us, Ed - do you have a sense of sort what the Russian plan could be from here? I mean, can you map out some potential scenarios around that?
Ed 07:00
I can certainly try. Thanks Luke. I guess, to me, it seems like the plan is to gradually ratchet up the tensions. And there are a few things. First is to sort of try to gauge the Western reaction function here, what kind of sanctions will come and perhaps we can get into those a bit later. And potentially, as well, I think broader, more broadly the plan is to gradually ramp up pressure on Ukraine, militarily speaking. So then it seems, given the reported orders reported, the troops have crossed the border. To me, it seems like the plan would be to gradually kind of embolden some of the Russian separatists to occupy more and more territory and effectively shift west into the country and ultimately end in a similar situation to we saw in Crimea in 2014. So effectively, another annexation of some Ukrainian territory. Now, kind of how we get there, as I say, is, debatable, but it seems like at the moment that we have, we have a few scenarios that we've articulated in the research team, and one scenario we have is this Crimea scenario, which is basically another annexation of fresh Ukrainian territory. And that certainly seems to be the way that we're going - although we're perhaps not not quite there yet.
Luke Bartholomew 08:35
Okay. So there's a sort of Crimea situation as you sketched out there. But I guess another potential analogy is, is maybe the Georgia scenario, which seems to involve rather than more military escalation. So perhaps you can sort of sketch out the potential scenario and risks around that kind of outcome?
Ed 08:56
Absolutely. Yes. You're right. I think the so called Georgia scenario, which as you know, we've named that obviously, with the 2008 invasion of Georgia by Russia in mind. And effectively, this, just to give you a bit of background was a similar situation to Ukraine, where there was a breakaway region, and then Russia, invaded Georgia, but only partially and stopped short of occupying big cities and the capital city. So this is effectively what the Georgia scenario would be in Ukraine - a broader invasion, but one that stops short of Kyiv and perhaps other large cities, mainly because, you know, occupying large cities is messy. It's a messy task. It is very costly in terms of military life. And you're more often likely to come across local militias and guerrilla warfare. So I think that's very messy and history suggests that Putin does not want to become embroiled in that. So I think there's a chance that Putin could go in and do kind of a broader invasion that stopped short of full invasion. And that might be enough to extract some political concessions from the West and from from Ukraine.
Luke Bartholomew 10:16
Okay, well, so that reference to the West is probably a good time, Viktor, to ask you what the sanction response or any other response so far from the West has been around this latest development and how its response is shaping up at the moment.
Viktor 10:32
Yeah, so far, we have seen the kind of knee jerk sanctions from the US - that is an Executive Order targeting on the Donetsk and Luhansk regions that prohibits any investments, imports, exports, financing, or facilitating such transactions, but that is limited to only those two regions. So you can argue that these are 'sanctions lite' given that the US has quite a broad arsenal of potential sanctions. This is probably the weakest possible, though I wouldn't exclude that there would be further economic sanctions attached to what happened last night, but we haven't heard about it yet. We had sanctions from the UK. They added five banks and three oligarchs to the sanctioned entities list. Once again, not really biting, because all these entities with the exception of one bank, have already been on the US sanction list for a long time. So there is nothing new. And as we speak, we are awaiting the sanctions decision from the European Union. So far, we have only seen the headlines. But they do suggest that these will go beyond what we have seen from the the US and UK just now. It's also quite interesting to analyse why the US opted for these sanctions-lite. It fits with a narrative of what Biden called 'minor incursion'. So they are not seeing what happened last night as an invasion. Basically, we're talking about the recognition of disputed territories. But clearly, were Russia to move further, as Ed mentioned in his scenario analysis, even to the territories which are currently not occupied by separatists, but belong to Donetsk and Luhansk. And here, it is quite important to point out that it hasn't been clarified. what borders exactly Russia recognises. So there's a big ambiguity there. Whether it's just the territories currently occupied by separatists, or whether it's the entire Donetsk /Luhansk region. So were the separatists or Russia to move into those territories, I think we would see a significant dial up in sanctions.
Luke Bartholomew 13:10
Okay. Yeah. So you've given us a sense of what might be a trigger for more sanctions. But as you say, what we've seen thus far is sort of sanctions-lite, but actually the full arsenal of US sanctions is actually pretty big. So can you give us a sense of what other sanctions are available? And perhaps some of the steps that would lead to those being triggered?
13:32
Sure. I mean, it's probably easier to talk about what kind of sanctions rather than the triggers, because that's a really fine balancing act from the country applying the sanctions. I mean, sanctions have to be proportional, targeted and effective. They also have to deter rather than punish. But in our case, probably we are more talking about export sanctions rather than deterring sanctions because deterrents it turns out are not really working in the case of Russia and it was quite clearly stated by Putin that he expects the sanctions and he thinks that it's irrespective of what Russia does. But turning back to the options on the table. I mean, clearly if there is a possibility to ban certain exports to Russia that's most probably high tech parts, equipment, which is no damage in the short term, but would really undermine Russia's long term growth potential. There's a lot of talk about sanctions against financial institutions like the one that the UK has just imposed. Several banks are already on the US's sanction list, but more might be coming. Possible sanctions against sectors and industries of the economy. And that can include extractive industries, which is a key source of revenue for Russia. Though because the European Union depends on Russian commodities that will be harder to put through. Sanctions on Nord Stream 2, the pipeline, which Russia is really keen on making operational, there is no real need for that extra capacity to supply Europe. But that will be one possibility of circumventing the current pipelines, which go through Ukraine. Sanctions against sovereign debt - we already have some sanctions on new debt, but this time around, that would be sanctions on holding and transacting the debt. That would obviously be quite painful for the sovereign, not being able to issue more bonds to foreigners. And last but not least, the nuclear option of cutting Russia off from the global financial system, whether it's banning the use of dollars or cutting them off the SWIFT system, which connects banks, this would have a real devastating impact on the Russian economy and all the relations, trade relations. Obviously, that raises the question of, for example, how Europe would pay for the gas supplies if there was no possibility of conducting financial transactions, but it's still an open question out there.
Luke Bartholomew 16:13
Okay. So that gives us a very good sense of how the West could sort of escalate these things. And we've talked already about how Russia might escalate further, but perhaps, Ed, I probably should ask also, I mean, what hope of deescalation from here? I mean, are there still diplomatic solutions on the table?
Ed 16:31
I think there are solutions on the table, as you put it, but needless to say the chances have probably diminished over the past 24 hours. I think just taking a step back, though, the ambiguity that we we sort of touched on a bit earlier as to whether the troops have crossed the border. And that ambiguity around whether Russian troops are occupying additional, any territory in Ukraine in addition to the current territories held by Russian separatists. Those grey areas are quite important, because they are probably likely to weaken the European sanctions responses, as Viktor alluded to. And then also it means that the diplomatic route is not completely dead. I think if there's a very severe invasion, then it of course makes it much more difficult for both sides to get back around the negotiating table. I think it's kind of worth stressing that the US and NATO do seem to be willing to strike a fairly substantive deal on things like military restraint and missile deployment. You know, there was the leaked, there was a leaked response of the US written response to Russian demands, which showed that member states like US, sorry, European and NATO member states, like Romania and Poland are willing to strike deals on missile deployment in those countries. So I think the West is likely to try to, of course, they would like a deal. And I think Putin has probably left the door open to one given the ambiguity of the recent events. I think it is unclear whether the West would be willing to cede enough ground on military restraint and missile deployment on these kind of non-direct NATO issues to placate Putin. And I think it's probably just finally worth stressing here that our probability distribution with these scenarios that we've sketched out in the research team was already skewed towards military escalation scenarios, even before the latest developments. And of course, these latest developments have strengthened our conviction on this that is, you know, it's difficult to see the, you know, the diplomatic route is kind of fading in our view.
Luke Bartholomew 18:56
Okay, that's understood. So maybe a final question, then Victor is just to ask you around some of the long term consequences of this crisis in terms of sort of I suppose the US's, and NATO's credibility, sort of Russian standing in the world, how we might think about, you know, future conflicts on the Eurasian mass with, you know, China and US politics, role of the relationship between the EU and US. I mean, taking a step back and a look to the future. I mean, have we learned anything about some of those big questions as well from this?
19:30
So there might be a perception that these events will redraw the global geopolitical map, but I don't think that that is the case. Clearly, the US has made its strategic direction quite clear - its pivot to Asia. The US no longer sees Russia as its prime adversary. It is clearly now China who is the prime rival to the US and I think the US will try to actually disengage as much as possible from Europe to be able to focus on Asia. I mean, clearly there will be long term consequences for the main parties involved. Russia can suffer a hit to its long term growth, which has anyway not been spectacular, given the countries facing its own demographic problems and over reliance on the commodities sector, but sanctions can on a long run, seriously undermine its competitiveness and growth potential. For Ukraine, I mean, clearly, it's a bigger threat. The US and Europe clearly indicated that they are not willing and not capable to defend Ukraine on the ground. And we know that sanctions are not able to prevent, to stop, any actions from Russia. But on the other side, there is a significant financial support, which Ukraine can rely on, which once this conflict dies down could really help its economy to recover. And then we should think about Europe as well. I mean, Europe will have to be more self reliant for its defence policy. US has given the backbone for not just for NATO's but also for the European defence policy strategy. So Europe will have to think about that, and that has been in the brewing for a long time. Politicians could easily push it into the background, but probably this conflict will bring it forward. And also, maybe it will push Europe to finally reduce its heavy dependence on Russian oil and gas and metals. So that might be the the positive read of events.
Luke Bartholomew 21:57
Great. Well, those are some very interesting long term thoughts. But for now, let's continue to hope for that peaceful resolution that Ed talked about. But I think that is all we have time for today. So all that remains is me to thank Viktor and Ed for their time today, their fantastic insights and as I say, taking time at a period which I know is extremely busy for them. And also to thank you the listener. Please do like and subscribe on your favourite podcast platform. And we look forward to speaking to you again soon. Thanks very much.
22:41
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