Ukraine Update

The situation in Ukraine poses a great many issues in both the short and long-term. In the aftermath of the internal unrest which arose following the then-Government’s decision to ally itself with Russia as opposed to the EU on economic matters, we have seen Russia exert itself strongly in the region, with the invasion of Crimea changing the geopolitical map and increasing tensions in the region to a level which hasn’t been seen in many years. The situation continues to unfold and, just last night, Ukrainian forces killed three pro-Russian militants in the country’s east overnight, ahead of international crisis talks in Geneva.

 

According to today’s reports, Ukraine’s national guard responded to an attack on their base in the city of Mariupol by about 300 people and it is clear that the level of civil unrest is reaching unsustainable levels. Backed by many local Russian-speakers, some are demanding a referendum on transferring many powers from Kiev to the regions, or even joining Russia.

 

Ukraine’s new pro-western government claims Russian agents are behind unrest that the Kremlin says could spark civil war, and rejects demands for federalisation that would give Moscow great influence in Russian-speaking areas. However, these claims have been refuted by Russia itself who claim that this is an internal protest from Ukrainians who are rebelling against the Government.

 

The EU and US have imposed sanctions on Russian political and business figures with ties to the Kremlin, and pledged to go further if Russia continued its alleged interference in Ukraine. The West says some 40,000 of Moscow’s troops are massed near Ukraine’s eastern border, and could invade within hours if given the order. This is deeply concerning, and serves to add to the tension.

This confrontation between Russia and the West over Ukraine imperils the Russian economy, but the problem runs both ways. Russia’s pre-existing economic malaise also explains why the country is vulnerable to an international crisis. Indeed, it so happens that the Ukraine crisis has arisen just at the moment when economic growth in Russia has come to depend more heavily than ever on capital-intensive investment – a lot of which comes from the EU.

 

As the Financial Times pointed out this week, Russia’s present economic problems are structural, even if some cyclical factors such as recession and stagnation in the eurozone – by far Russia’s largest trading partner – have added to the gloom. The slowdown in European growth  has dealt a much more serious blow to Ukraine’s economy than to Russia’s, and must be reckoned among the underlying causes of the events that have contributed to the present crisis.

 

Political confrontation with the west following the annexation of Crimea has undermined this external investment in Russia in a significant way, with capital leaking out of Russia as domestic business owners do not see enough investment projects inside Russia with a sufficiently attractive risk-reward balance.

 

That is how things stood six short months ago. But the political confrontation with the west following Russia’s annexation of Crimea undermines this investment case. Returns will be impaired by slower growth and a weaker rouble. Western sanctions will create new risks – even assuming that the economic option of forbidding Russian trade and finance is never exercised, and it is unforeseeable that the situation will ever go that far.

 

However, Russia’s dependence on external sources of long-term finance explains why their economy slumped far more after the financial crisis than any other major oil exporter. This is the situation as it stands: the threat of military intervention in Ukraine, and the intervention in Crimea, has served to undermine Russia’s economy.

 

The situation in Ukraine is unstable but, if agreement can be reached in these talks – and I believe it can be – then we can continue to work towards restoring a stable situation in Ukraine, though it is worth remembering that – following this conflict – either the EU or Russia will need to work with Ukraine to assist its economy. “I think we still have a chance to de-escalate the situation using diplomatic means,” Ukraine’s foreign minister, Andrii Deshchytsia, said yesterday, but he also said that the diplomatic discussions must also be tempered with efforts “to look for a more concrete and adequate response to Russia’s plans and actions”.

 

In this sense, while the situation in Ukraine is urgent and requires our full attention, the solutions that we need to look at must be viewed on a medium to long-term basis also.

 

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