Taming the Bear: Russia in the wake of the Ukraine crisis

This article is part of
Trends in Major Emerging Markets - June 2014

Tensions between Russia and Ukraine have been escalating since November 2013, when the then President Viktor Yanukovych stalled the signing of an agreement between Ukraine and the European Union due to pressure from one of its largest trading partners, Russia.

Since then we’ve had the Maidan protests that led to what Russia branded a ‘coup’, the annexation by Russia of Crimea that prompted international consternation and economic sanctions, and the landslide election of billionaire businessman Petro Poroshenko as president.

Violence in the eastern region of Ukraine continues to erupt frequently, however, in spite of a crackdown by the new leader. Western leaders continue to appeal to Russian President Vladimir Putin to pull out of the country amid accusation it is stoking tensions. The crisis is far from over.

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At a time when economic stability appears to have returned to the eurozone the ongoing conflict between Russia and Ukraine has reminded investors of the fragility of markets, with some sounding a note of caution over Russian investments.

Squeezed by sanctions

Meanwhile, Russia’s presence and role in the conflict has taken an economic toll, with Russian GDP growth at 0.9 per cent in the first quarter of 2014, down significantly from the 2 per cent recorded in the last quarter of 2013, as sanctions bite. It is expected to grow only 0.5 per cent for 2014 as a whole.

Towards the end of April this year, ratings agency Standard & Poor’s (S&P) announced it was downgrading Russia. The agency lowered its foreign currency ratings to BBB- from BBB, while the country’s local currency long-term rating faced a downgrade from BBB+ to BBB.

The ratings agency attributed the lower ratings to “a continuation of the large financial outflows observed in the first quarter of 2014, during which the size of Russia’s financial account deficit was almost twice that of the current account surplus”.

It also warned that the “tense geopolitical situation” between Russia and Ukraine could prompt additional outflows of foreign and domestic capital from the Russian economy.

For Craig Botham, emerging markets economist at Schroders, the latest GDP figures suggest the slowdown has been driven by lower investment spending and that PMI data reveals continuing contraction in manufacturing and services.

He warns: “The slowdown will worsen policymaker headaches – presumably already throbbing from sanctions and political pressure – as inflation remains high. Rates have already been hiked in response to this and currency weakness, but there will be increasing conflict if the political situation does not improve.

“Further sanctions are being discussed and the economic damage from extant sanctions and general uncertainty will build over time.”

Mr Botham observes that if there is no resolution in Ukraine then Russia’s GDP numbers will worsen this year. “As it stands the second quarter already looks likely to disappoint, and will probably put Russia into recession,” he cautions.

The situation in Russia and Ukraine is likely to be up for discussion among Western leaders at the G7 Summit in Brussels this week on Wednesday 4 and Thursday 5 June. The meeting was originally scheduled to take place in Sochi in Russia and between the leaders of the G8 countries.