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Russia, Ukraine, And The West: Peculiarities Of Current Positioning – Analysis

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Russia, from an economic point of view, is tactically not in as vulnerable a position as one might have expected a couple of months ago. Despite this, in strategic terms, economic, technological and social degradation seem to be an inevitable scenario for Russia in the coming years, according to the theory of the reverse spiral.

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For a clear understanding of why Russia’s current positioning looks sustainable, it is necessary to pay attention to a few relevant details and at least take a cursory look at the numbers.

Europe’s oil embargo accounts for about 65% of Russia’s European exports and applies only to maritime supplies.

40%-45% of the Russian budget is formed by oil and gas revenues, but not only by exports and not only to Europe. Part of these revenues are provided by the domestic market, and the MET is the same for all oil and gas sales regardless of the buyer.

The cost of the direct embargo – about 5 trillion rubles a year, based on the average discounted sales price of $ 80 per barrel and the dollar price of 60 rubles. Direct military spending, according to the Finance Ministry in April, averages about 7 trillion rubles a year.

That’s about 5% of Russia’s GDP.

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Russia’s state debt is about 21% of GDP and is still one of the lowest in the world.

Russia is perfectly capable of borrowing 5% of GDP on the domestic market and expanding its debt to 26%-30% of GDP. Moreover, a direct expansion of the money supply by 5% of GDP would not be a direct and quick catastrophe; the contribution to inflation would not be significant, adding less than one percentage point. That said, inflation is now trending downward amidst the measures taken to limit liquidity and purchasing power, which are also stagnating from falling disposable income.

In addition to this, the sanctioned oil will go to other importers anyway, albeit at significant discounts below $80 and at great cost, which will nevertheless reduce the costs of the embargo for Russia. This means that it will have to compensate not 5 trillion rubles, but much less.

Plus, more than 15 trillion rubles in the accounts of the Ministry of Finance of various categories in the Central Bank will allow to finance the expenditure side of the budget, including foreign policy activities, including the war.

It should also be noted that, firstly, the deadlines for limiting oil imports from Russia have been shifted to 6-8 months, secondly, exceptions have been made for some countries and supplies will remain at the same volume, and thirdly, the substitute oil supply schemes between Europe, the Middle East, Asia and Russia are not yet restricted and may well be implemented.

The West cannot completely abandon all of Russia’s resource exports, because some resources from Russia constitute a significant share of the world market and are needed in the technological production chains.

Thus, economic sanctions in their nominal model will not be able to stop the NWO and initially do not assume this.

Of course, it is worth mentioning an important factor that levels the strength of the Russian positioning, namely the transaction and indirect costs. These include economic losses and efforts to compensate for them, as well as the costs of maintaining the social approval and legitimacy of the Russian ruling elite.

Intensification of economic impaction and processes related to economic stagnation, as well as stimulation of social turbulence by both economic and political measures on the part of the Western community certainly increase the costs of the Russian authorities in conducting invasion in to Ukraine.

However, as has been repeatedly mentioned, these costs by themselves, even in the case of their rapid growth, are not capable of forcing the Russian leadership to dramatically change preferences and stop the military aggression. Such costs are effective as expectations of negative consequences and can work in the case when the conditions of cancellation of external restrictions and factors creating these costs are clearly defined.

Therefore, the sanctions pressure and all related negative consequences for Russia have a more or less long horizon.  And given the inert economy, low public debt, competent financial and economic management, and, most importantly, mass social approval confirming the internal legitimacy of the policy of the Russian leadership, the negative consequences of the sanctions and their derivatives, although expected by the elites and the population, the deadlines have been shifted into the future. This means less tension and less incentive for the Russian political leadership to change preferences than if the costs were acute, abrupt, and voluminous.

A practically unrealizable alternative for the West to dramatically change the situation would be to create acute abrupt and voluminous costs for the Russian side.

Such costs would result from the following measures.

  • expansion of the range and intensification of supplies of the Alliance’s military arsenal to 30%-50% of the Alliance’s total volume, as well as a significant expansion of financial donations.
  • a broader rejection of oil, imposing a tax on Russian gas imports, strengthening and expanding the terms of secondary sanctions, and limiting opportunities for bypass schemes to supply oil and gas resources from Russia. This would allow for an extreme reduction in the revenue side of the Russian budget.
  • limiting Russian imports of almost the entire range of goods, materials, technologies and services imported into Russia and strengthening the secondary sanctions. A total restriction of imports would create a deficit economic environment in Russia, disperse inflation, trigger social activity and significantly increase the expenditure side of the budget.

But this alternative has clearly and definitively been rejected by the West.

Why is Western Europe shifting the real political agenda into the moderate zone and not using such a maximalist alternative?

Most importantly: the West is determined not to get directly involved militarily in the conflict as long as Russia is limited to a zone of foreign policy activism and countries outside NATO or the European Union. And this means that all measures taken are not escalatory in nature of rapid coercion, but are economic-political incentives to stop military action.

A sharp and voluminous rejection of hydrocarbons from Russia on the background of the infrastructure oriented for them and not yet reoriented infrastructure will sharply reduce the competitiveness of European producers.

Such a total refusal will lead to an even greater acceleration of inflation and, consequently, social discontent, despite the public reflection in favor of Ukraine today.

To neutralize social discontent, European governments will be forced to increase the availability of money, which is impossible in a stagflationary cycle of galloping inflation and declining business activity. Expanding leverage in the face of extreme problems on the production and supply sides will lead to economic catastrophe.

Active effective support for Ukraine as Ukraine wants it will certainly be a shortcut to aggravation and escalation of military confrontation in Ukraine and almost certainly to a prolongation of the period of military action. This means prolonging the negative effects on the staggering European and world economy.

As a result, Western Europe is interested in an early cessation of active hostilities. To this end, various options are being considered “from a return to the political contours of February 24, to the special status of the complete territories of the Donetsk and Lugansk regions and an agreement on the actual control of these territories by Russia.” 

The general tone of the rhetoric of official representatives of Western European governments and the expert community gradually creates a narrative of “war weariness, the need to stop active hostilities and the inevitability of reaching an agreement with Russia on terms that may not be desirable for it, but are compromise”.

What’s on the Ukrainian side?

This is the most difficult question in the current situation. The Ukrainian population has not yet moved into the “stage of acceptance” and weighing up options for ending the military conflict. So far, the primary social emotion of “denial” – rejection of the “invasion” and an unequivocal desire to fight until “victory” – dominates.

The splitting of public opinion is yet to come, when under the influence of this or that circumstance there will be more evident shades of social positions, from the denial of any possibility of negotiations with Russia and the need for a guerilla war in case of hypothetical success of the Russian side, to the acceptance of the forced agreement with a part of Russian claims to the corresponding Ukrainian territory, with certain reservations, status restrictions, etc.

Nevertheless, today it is practically impossible to sell the possibility of settling the conflict with the need to find a compromise with Russia to the Ukrainian people. In the extreme conditions of a defensive war, total social emotion of “defensive indignation” and effective unity in the face of an external enemy, the usual political mechanisms of changing or mediating public opinion will not work or, at least, their effectiveness will be extremely weak. In addition, such an attempt would be extremely disastrous for the incumbent leadership in the political sense.

That is why the official rhetoric of the Kiev authorities is harsh not only in relation to Russia, which is obvious and natural, but also in relation to the West, which does not provide sufficient resources for the success of the Ukrainian resistance and which, according to Ukraine, makes half-hearted decisions.

Certainly, the Ukrainian political leadership is aware of all that has been said above. The task now, in addition to finding solutions as such to end hostilities, is to develop a political narrative for packaging and selling such solutions to society, especially if the solutions are “too” compromising, which cannot be ruled out, as I mentioned earlier. Both of these tasks are in the active phase of solution.

Thus, the following can be confidently asserted today:

In tactical terms the measures that the West has taken so far are obviously insufficient for

– To effectively compel the Russian side to cease military operations and withdrawal of forces,

– The following is evident from the tactical perspective.

The current macroeconomic context and the European economy, focused on Russian oil and gas and other resource export, do not allow Western Europe to take maximum economic and political measures to limit Russia’s active foreign policy actions in the form of military aggression and create effective incentives to intensively compel the Russian authorities to change their foreign policy discourse and stop the war.

The stability of the Russian economy and social stability today is due to the general inertia of the economy and undervalued volume of commodity reserves, significant macroeconomic stability and adequacy of economic and monetary policy, relative restraint of sanctions pressure and some liberalization of conditions for small and medium business, including actual state encouragement of gray imports.

In the strategic horizon, the sanctions isolation and buyout of Russia’s participation in the creation of global value added, shifting the socio-political and institutional frame into the zone of dictatorial autocracy are the factors of economic and social degradation and primitivization for years to come, which positions Russia as a resource primitive economy of autarkic type.

Ukraine is obviously in the most difficult and vulnerable position in tactical terms. First, the reason for this is the direct military action and aggression on the part of Russia, which destroys the economic and social environment of the state. Secondly, it is the West’s obvious restraint in scaling up assistance to Ukraine and strengthening its military and economic potential.

Armistice, stopping of active military actions and compromise are hampered by an active social position on all direct and indirect sides of the conflict. In Russia, selling “victory” to the population looks the least difficult. It may be more difficult in Western countries, where voters, on the one hand, are emotionally demanding protection of the Ukraine and maximization of its supply of everything necessary, and on the other hand, are increasingly expressing discontent with worsening economic conditions caused, among other things, by the consequences and prolongation of the military conflict. Political leaders in Western countries have to maneuver between the ignorance of voters and the reality of the situation. In Ukraine, a compromise truce is the most difficult task, because in the current phase of the conflict cycle, social consensus is conditioned by the emotion of “defensive resentment,” which is one of the longest-lasting of the classified social emotions. Under such conditions, it would be extremely difficult to create incentives to shift public opinion into the zone of compromise.

A linear political solution in this direction would be fatal for the current political leadership of the country.

Paul Tolmachev

Russian-born Paul Tolmachev is a portfolio manager at BlackRock (London, UK) with $500 million in personally managed assets. He also is a visiting scholar at the Stanford Institute For Economic Policy Research, where he researches institutional and political economy.

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