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reflections

Dec 23, 2014 | 00:01 GMT

Russia's Economic Concerns Could Have a Calming Effect in Ukraine

(Stratfor)
It can be difficult to separate the important from unimportant on any given day. Reflections mean to do exactly that — by thinking about what happened today, we can consider what might happen tomorrow.

Just as Russia continues to be plagued by uncertainty over its faltering economy, a different, yet related crisis appears to be easing: the standoff with the West over Ukraine. Several talks on the issue have been held in recent days, including a phone conversation between Russian President Vladimir Putin and his counterparts in Ukraine, Germany and France on Monday. These leaders in turn agreed to hold further mediation talks in Minsk this Wednesday and Friday. While a full-scale settlement of the crisis in eastern Ukraine is likely not imminent, there are growing indications that constraints on the Russians and the Europeans are pushing the two sides closer to an understanding on the issue.

The fighting in eastern Ukraine, which has been going on for the better part of a year, has its roots in former Ukrainian President Viktor Yanukovich's decision to reject an association and free-trade deal with the European Union in November 2013. This move famously set off protests in Ukraine, which eventually resulted in a Western-backed uprising against Yanukovich in February and his replacement with an EU-oriented government. This prompted Russian counteractions, including the annexation of Crimea and Moscow's support for pro-Russia separatism in the eastern provinces of Donetsk and Luhansk. The West then responded by passing increasingly strong sanctions against Russia, while continuing to back pro-Western governments in Ukraine and elsewhere in the former Soviet Union, such as Moldova and Georgia.

This past year has been marked by a deterioration of relations between Russia and the West to their lowest point since the Cold War. There appeared to be no end to the growing escalations between Moscow and the West, as each side responded to moves from the other that it considered threatening.

However, there was an unanticipated factor that would ultimately have a tremendous impact on this vicious cycle: the price of oil. In the second half of this year, oil prices have dropped nearly 50 percent, from $115 per barrel in June to around $60 today. This has wreaked havoc on the Russian economy, given that oil makes up more than two-thirds of Russia's exports and nearly half of the government's budget revenue. Russia already was facing a cyclical downturn, and its economy was feeling the effects of sanctions from the West — factors that have had major repercussions on the Russian economy, including massive capital flight, a steadily depreciating currency, and high inflation.

These economic pressures peaked last week, when as a result of a nearly 7-point interest rate hike by the Russian Central Bank, the ruble lost more than 20 percent of its value in one day, reaching a low of nearly 80 rubles to the dollar. The ruble has rebounded and stabilized somewhat since then, thanks to several Central Bank interventions, and is currently in the range of 55-59 rubles to the dollar. However, Russia's economy remains very weak and fragile, and it is not yet clear whether the Central Bank's interventions are sufficient to ensure a longer-term stabilization, or if more drastic actions like capital controls will be necessary.

What has been made clear, however, is that the Russian economy is extremely vulnerable, and the West is in a position to take advantage of the situation. Thus, it may not be a coincidence that pro-Russia separatists in eastern Ukraine have eased their attacks on Ukrainian positions in recent weeks, particularly since the latest cease-fire was agreed to Dec. 5. Also, Russian officials have toned down their rhetoric, with some going so far as to say that the status of the breakaway territories may be up for negotiation — which is a far cry from the broad support of the independence of the Donetsk and Luhansk "people's republics" and their possible incorporation into Russia.

The de-escalation of the fighting and softer rhetoric out of Russia have also coincided with growing concerns from Europe about sanctions against Russia. The Russian economy is so weak that there are fears of contagion into Europe at a time when the European Union is still mired in its own financial crisis. For example, the managing director of the Association of German Chambers of Industry and Commerce stated that one in three German companies doing business with Russia will have to fire employees or cancel projects. Many officials from EU countries, including France, Austria and Bulgaria, have called for the bloc to ease its sanctions against Russia.

Meanwhile, Putin now has more reason than ever to support the de-escalation of fighting in eastern Ukraine, as any major military moves could prove too costly and undermine his strength at home. These factors could provide the context of the recently intensified diplomatic activity regarding the Ukraine crisis. With EU sanctions set to automatically expire in various phases next year, and with Russia now less aggressive than it was just a few months ago, these circumstances could pave the way for further de-escalation on the Ukraine issue.

Still, this does not mean that a broader deal between Moscow and the West over Ukraine is imminent. For that, Russia would need to pull its military and financial support for the separatists completely and agree to resume political and economic ties between the breakaway territories and Ukraine proper — something that it has not yet proved willing to do. But Moscow's tenuous financial situation likely will make it more flexible in dealing with these issues and less willing to act aggressively in Ukraine, and the West in turn could soften its own demands on Russia. In this way, the rise of one crisis between Russia and the West could tone down another.

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