Will Russia retreat in Ukraine?
The Russian economy is unquestionably in crisis. Western sanctions are, at least, making that crisis hurt more, and in sensitive spots. Will economic woes ultimately affect policy, and spur a retreat from Ukraine?

"The question is whether Ukraine can raise the costs on Russia to where eventually the Russian leadership says, ‘it’s not worth it,’ ” said one congressional GOP aide, quoted in Politico.

That won’t be easy, as Russian President Vladimir Putin sees the sanctions for the conflict in Ukraine as a challenge to his regime, and he has a history of taking on such challenges.

Where the sanctions bite

But the parlous state of the Russian economy could certainly force his hand. The Russian ruble has lost about 50 percent of its value since October. Russia’s central bank has sharply hiked key interest rates to a historic high of 17 percent, but the ruble continues its slide.

"Russia’s ruble now beats Ukraine’s hryvnia as the world's worst performing currency in 2014. There's a certain irony in that,” says Brookings Institute expert Steven Pfifer.

The slide in the price of oil is behind the ruble’s plunge, as Russia had earned about $300 billion annually from sales of the commodity. The International Energy Agency estimates that 68 percent of Russia's foreign currency earnings come from the oil-export business and around 50 percent of its annual budget comes directly from oil revenue.

The government distributes oil revenue to the state banks, and, as that revenue declines, bank credit becomes more difficult for industry to obtain. But Russia’s companies need hard currency, because a large number are highly leveraged in foreign currency loans.

This is where the sanctions bite. Normally Russian firms could borrow abroad. But European and American banks won’t lend to them with the sanctions in force.

For now, the ordinary consumer isn’t feeling the effects of the crisis, comments Bryan MacDonald, a journalist based in Russia, and who specializes in Russian affairs, in an article this week. "Russians don’t feel a tangible crisis, not yet anyway. Despite months of tumult, prices haven’t risen substantially and the shops are fully stocked. Of course, this situation could change if the decline accelerates.”

What is likely to make it change is rising food prices, due largely to sanctions, and spiraling inflation, driven by the falling value of the ruble. The average Russian household already spends about 40 percent of its income on food, according to International Monetary Fund statistics. But Putin has imposed sanctions on Western food imports, in retaliation for those imposed on Russia.

This is already making food more expensive. Russia also imports a majority of its consumer products, and these will also become more expensive as the ruble sinks in value. Analysts say that the official prediction of 10 percent to 11 percent inflation for the coming year is much too low.

So sanctions will bite here too, and Putin’s popularity is bound to suffer. As MacDonald points out: "Since 1999, under President’s Putin and Medvedev, Russian living standards have mushroomed. During this period, Russians attained a level of affluence and prosperity unprecedented in the country’s chequered history. Citizens have become accustomed to a standard of living their grandparents could only have dreamed about. Of course, this feeling of wealth is now in peril and conditions are almost certain to precipitate.”

Will Ukraine cost too much?

It is clearly possible that a sharp downturn in Putin’s popularity could spur a change of direction in Ukraine.

Already, U.S. Secretary of State John Kerry noted that " Russia is making constructive choices in recent days,” in its discussions aboutUkraine.

What are Russia’s options? Most likely to retain its annexation of the Crimea – where Russia is clearly welcome – but to move its troops away from the Ukraine border, and to allow the national government to retake the disputed eastern territories.

German Chancellor Angela Merkel has already, on Nov. 26, called for trade talks between the EU and a Russia-led economic bloc as a way of maintaining dialogue with President Vladimir Putin. Merkel’s olive branch might offer Putin an alternative to his continuing saber rattling.

And on Wednesday, the Kremlin announced that the leaders of Russia, Ukraine, Germany and France have agreed that a meeting of a contact group is urgently needed to kick-start dialogue between Kiev and the country’s East and achieve a lasting ceasefire, all are already talking about concessions.

President Vladimir Putin has held a teleconference with the German Chancellor Angela Merkel, and his Ukrainian and French counterparts, Petro Poroshenko and Francois Hollande, the Kremlin said in a statement on Tuesday night.

The Russian President stressed "the importance of a swift meeting of the Contact Group with the aim of implementing the Minsk agreements and facilitating dialogue between Kiev and [Ukraine’s] southeast,”Kremlin press release reads.

The exchange of prisoners and the removal of heavy weapons from the demarcation line are some of the "priorities now”, the Kremlin noted. The need to provide economic and humanitarian assistance to the affected regions in eastern Ukraine was also stressed.

The EU has also suffered from Russia’s food export ban. In 2013, total EU agricultural exports to Russia were worth €11.3 billion. The estimated value of exports affected by the ban in the EU is €5.1 billion or 45 percent of the total, according to experts at the London-based law firm Norton Rose.

So a change in attitude from both sides may come soon. It will be difficult for Putin to make such a change, but the loss of prestige and influence, capital flight, declining foreign direct investment, the loss of the Ukrainian market, and growing isolation from the international community and the West are beginning to wear.


Last Modified: 2014-12-30 16:12:27
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