Timothy Ash: Time to think about worst-case scenarios in Ukraine-Russia crisis SUMMARY: • Analysts have been behind the curve on the Ukraine/Russia crisis, typically neglecting to consider worse case scenarios, which have tended to result. Now might be the time to think through the consequences of less market-friendly outcomes. • The military status quo on the ground appears unsustainable. The Ukrainian military is making significant gains, and is eager to secure victory by the time of parliamentary elections in October. • Russia has to make some difficult choices, whether to accept ‘‘defeat’’ in Ukraine, and back off, taking a less confrontational approach, or double up and move to a more formalised intervention to stem the advance of the Ukrainian military. • We attach a relatively high probability to an attempt by Russia to muster support for intervention by a Russian-led peacekeeping force. We think the West will block such attempts at the United Nations Security Council but, depending on developments on the ground, Russia might still intervene more directly, using regular troops ‘‘branded’’ as peacekeepers. We think that such a strategy would risk a direct conflict between Russian and Ukrainian troops, which would represent a further and significant escalation of the current conflict. We think any such conflict would though be of a relatively short duration, albeit intensive and damaging, but with the risk that Donbas, alongside Crimea, becomes a ‘‘frozen conflict’’ and a source of long term friction between the West/Ukraine and Russia. • We see almost no chance of NATO becoming involved in a direct military conflict with Russia, but the West could move to arm Ukraine, in response to Russia’s direct intervention in Ukraine, and NATO is also likely to boost military assets available to the Baltics and Poland. • The West is likely to implement a further sanctions iteration on Russia, in response to further and more formalized Russian intervention in Ukraine. These sanctions will be slow to roll off, without agreement on a longer-term solution over the issues of the future of Crimea, the Donbas and also Ukraine. Sanctions will have a lasting and negative impact on relations between the West and Russia, and more directly on investment in/out of Russia and more broadly on Russia’s outlook for growth, development and also market perceptions. Introduction The crisis in Ukraine has been nothing if not unpredictable throughout. Indeed, time and time again the crisis has lurched to yet another worst case, or ‘‘Black Swan,” scenario. To recap, no one expected the Maydan protests, few predicted the ousting of former President Viktor Yanukovych, and similarly there seemed total incomprehension beforehand that Russia would annex Crimea as it did in April, questioning Ukraine’s territorial integrity and driving through the Budapest Memorandum of 1994 (a lynchpin of regional security and global nuclear non-proliferation) nor that Ukrainr could see a major conflict on its territory--- Ukrainians as recently as April were indignant to me at least at the prospect of Ukrainians fighting Ukrainians, or even Russians; I should add herein that most Ukrainians still do not see the current conflict as a civil war, but rather a war of liberation against foreign intervention and aggression by Russia. And again, few people predicted Western sanctions on Russia, or that Russia would not back down, but would remain on a course heading towards conflict and confrontation with Ukraine and the West. In understanding this abject failure to call this crisis I would highlight that the bulk of analysts tend to be either Russian or Ukrainian specialists, and there are few that cover and understand both credits, and how they interact, that well. I am also of the view that Moscow invariably misunderstands, and perhaps does not want to understand, Ukraine, viewing the country very much through a Russian prism --- the latter related to Moscow’s failure to totally accept the concept of Ukraine as an independent state, some 23 years after the collapse of the former Soviet Union. Of note also, with the Western focus on the battle against global terrorism, post-911, few Western government’s devoted that much ‘‘resource’’ to former-Soviet Union geopolitics --- there are only a handful of experienced post-Soviet specialists in the UK Foreign and Commonwealth Office as far as I am aware, and I sense a similar level of resource at the US State Department. So should we begin to think about possible future worst-case scenarios now --- they are no longer really Black Swan events, but quite possible outcomes? Prudence suggests that we should. In the specific case of the current crisis in Ukraine, the conflict shows little sign of abating, indeed, in the short term the conflict looks set to intensify, as Ukrainian forces move in to finally try and clear separatists from their strong-holds in and around Donetsk and Luhansk. The imperative therein from the Ukrainian side to move quickly is multiple and compelling: ∙ The Ukrainian military currently has momentum on its side, and wants to retain the initiative while it can, and perhaps before parliamentary elections likely by October, and before winter sets in; ∙ The longer the crisis goes on, the higher the humanitarian costs, and also the larger cost to the Ukrainian economy which is already struggling from the impact of the conflict and disruptions to trade ties, Russian sanctions and disruptions to energy supplies. Continued conflict in the Donbas --- which accounts for 13-18 percent of gross domestic product --- will make broader macro stabilization that much more difficult. ∙Similarly, while the conflict continues the very latent threat of a more formalized Russian intervention remains, with the threat then that this becomes a frozen conflict, which would then play to Russia’s longer term strategic objectives in Ukraine (No NATO, No European Union and no successful Maydan-style administration). The authorities in Kyiv simply do not want to give Moscow any further leverage to negotiate over the longer term future of Ukraine. With the Ukrainian military likely on the offensive, and poised to clear the Donbas of separatists, the risk then is that Russia would suffer a significant defeat in respect to its policy towards Ukraine, and indeed the near abroad. Therein we would highlight: No one has read the Ukraine crisis well, reflecting a lack of deep understanding of the region. But time to plan for worst case scenarios. The clock is counting for the Ukrainian military While ‘defeat’ looms for Russia ∙ It would likely face a much less Russo-centric Ukraine, with the recent crisis having re-invigorated support for Ukrainian statehood, and this likely reflected in the election of Petro Poroshenko as president in May, and the expectation that statehood parties win a landslide victory in early parliamentary elections expected now for October. Ukraine is likely to be much more Western-focused, likely set to re-arm, to counter the perceived threat from Russia. This new Ukraine would perhaps present a very significant latent threat to Russia’s security --- at least when viewed from Moscow. ∙ With Ukraine set on a European orientation, Russia’s hopes of forging a CIS Customs/Eurasian Union will lay in tatters --- these entities amount to little without Ukraine’s 43 million people. ∙ An economically successful Maydan administration would represent a clear challenge to Putin’s ‘‘power vertical’’ and ‘‘sovereign democracy’’ concepts, as the underlying values of the Maydan --- free markets, rule of law, and justice, could well play well in Russia, to Russians, and hence be transportable across its border, threatening the durability of the Putin regime at home. ∙ Having re-invigorated Russian nationalism at home, and having sold the ongoing conflict as a battle against fascism, it seems difficult to see how Putin can now accept defeat --- or the failure to adequately support the separatist cause --- the annexation of Crimea is unlikely to provide a sufficient enough and long-lasting feel-good factor. It is thus unclear whether Putin would be willing to accept the defeat of the separatists in the Donbas --- in whom Russia still appears to have invested significant political capital, and military support, not to ignore the large number of Russian nationals reported to be fighting in the Donbas, and in fact in the top leadership roles of the insurgency. The risk therein still is that Russia is further dragged into the current conflict, escalating its role in support of the separatist cause. Against the above backdrop we have tried to think through the most likely scenarios now lying ahead in terms of further Russian involvement in the conflict, and the likely Western response: What are the various scenarios? First, accept ‘‘defeat’’ in Ukraine, and step back, allowing the separatists to filter back across the Russian border, and then fall back to a position where Russia moves the focus to an economic war with Ukraine, e.g. by imposing trade restrictions --- rather similar to the scenario which played out in 2005/06 after the Orange Revolution. Presumably then Moscow would seek to ‘‘calm’’ the anti-Ukrainian rhetoric in the Russian press and focus on the great merits of the reclamation of Crimea. I would perhaps attach a 25% probability now to this scenario. Russia’s decision to step back therein would be driven by the threat of further Western sanctions, plus also the military calculation on the ground that any such formal military intervention could be high risk, and likely subject to failure --- e.g. in an Afghanistan-style war of attrition. A second scenario would be a continued and ever increasing military support for separatists but still implemented via ‘‘informal’’ support, with the hope of eventually stopping the Ukrainian military in its tracks, and ensuing a ‘‘frozen conflict’’ style scenario in the Donbas, where the West and Kyiv are forced to negotiate and offer concessions to Moscow. This scenario also probably rests on the military calculation on the ground, and whether the Ukrainian military have the appetite and means to engage in the likely tough battles to retake the large cities of Donetsk and Luhansk. This scenario would be for Russia to try and drag out the conflict on the ground as long as possible. I would perhaps attach a 25% probability to this ‘‘attritional’’ scenario. Third, the Russian military could simply opt for a full scale, formal military incursion into the Donbas --- unlikely extending beyond that. The calculation therein is whether territory could be taken, and held and at what military/economic cost, and the likely sanctions implications. I would perhaps attach a 5% probability still to this scenario at this stage --- the low probability therein is gleaned from the fact that if Russia had this as a prime game plan, it would have already probably done so already, e.g. around the time of the annexation of Crimea, when it had a more decisive military advantage. Fourth, and perhaps now the most likely scenario, is that Russia tries to intervene in the Donbas under the guise of a peacekeeping role, and again with the aim of halting the advance of the Ukrainian military. Russia might push for a formal UN mandate for such an operation, under the cover of providing much needed‘‘humanitarian’’ assistance. However, we think the US and the West would veto any such attempt in the UN Security Council arguing that the Ukrainian military is correct in its current efforts to root out ‘‘terrorism’’ in the Donbas. Under this scenario, and where the Ukrainian military continue to make advances, regular Russian troops could still roll across the border with Russian ‘‘blue’’ helmets, without a formal UN mandate. In effect they would aim to halt any further advance of the Ukrainian military, perhaps limiting their own advance to territory only currently held by separatists. An important question then would be if the Ukrainian military would resist any such actions --- we think they would, and hence this scenario could well produce a high intensity conflict but perhaps of a relatively short duration. We would think that Russian troops would likely be able to establish a sufficient bridge-head in the Donbas, to ensure a ‘‘frozen conflict’’ scenario which could run as long as similar situations in northern Cyprus, Nagorno-Karabakh, Trans-Dniestr, or indeed South Ossetia/Abhazia. Invariably these types of conflict are acutely difficult to resolve. We would now perhaps assign a 35% probability to this scenario --- unless of course the West responds by racking up the odds, for example, with the threat of yet more sanctions, and sooner rather than later. Fifth ---any other scenarios, 10%, as anything is possible in this current crisis. And how is the West likely to react? A critical question for both markets and likely in Moscow’s mind in terms of its own future actions in Ukraine will be how the West will react to a more direct Russian intervention in Ukraine. As a starting point I think it is fair to say that there is a very low probability of any direct NATO involvement in the current conflict, e.g. to extend a security guarantee to Ukraine. There is simply no appetite across NATO members to step in to militarily defend Ukraine --- this much was evident after the annexation of Crimea, as both the UK and US were guarantors of Ukraine’s territorial integrity as per the Budapest Memorandum. Indeed, if NATO was going to intervene, it was back in April. However, we would expect that NATO would feel obliged to react to perceived Russian aggression, and to shore up confidence of NATO members, particularly the Baltics and Poland. Thus NATO is likely to agree to arm Ukraine, and would likely boost defence capability close to Russia’s borders, in existing EU member states. The West will also likely feel obliged to move towards a further sanctions iteration. More Russian individuals and corporates are likely to be subjected to sanctions, and the scope of sectoral sanctions will likely be broadened and deepened. However, we still think that the West will stop short of moving to Iran-style sanctions. Perhaps it will be important to note that after a more formal intervention by Russia in Ukraine the West is likely to be eager first to stop military activities, which will presumably be ongoing, and then try and push more formal peace negotiations. Some Western countries will thus likely then argue for a step back, compromise and negotiation, before moving much more aggressively towards sanctions. An argument will probably be waged that Western sanctions had failed to stop Russian expansionism, and that another tack is to raise the stakes again now required --- albeit there is much evidence to suggest that existing sanctions rolled out have already changed Russian decision functions, and slowed both the pace and scope of its intervention in Ukraine. Concluding remarks In summary, we would argue that the existing situation on the ground in Ukraine, and the Donbas in particular, is not sustainable. This crisis looks set to further develop, with the risk that advances on the ground by the Ukrainian military provoke a more formal reaction from Russia. This risks a further round of Western sanctions, which could further drive Russian asset prices lower in one further blow-out, before all sides look perhaps for something of a time-out and attempts at a negotiated settlement. It has to be noted though that the crisis is still filled with many uncertainties, and further Russian intervention could still have very uncertain outcomes. Timothy Ash is an analyst of emerging markets for Standard Bank in London.
Posted on: Thu, 07 Aug 2014 07:00:06 +0000
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