1 . How did we get into this mess •Ukraine is one of only two countries of the FSU yet to recover to its 1991 level of GDP –Total reform failure –Got democracy but Yanukovych was a bad choice •In the last decade Russia has been transformed into a “normal” country (albeit with a lot of problems)

1. Big risks rising in Europe

2. 1 . How did we get into this mess
• Ukraine is one of only two countries of the
FSU yet to recover to its 1991 level of GDP
– Total reform failure
– Got democracy but Yanukovych was a bad choice
• In the last decade Russia has been
transformed into a “normal” country
(albeit with a lot of problems)

3. 1 . How did we get into this mess?

4. 1 . How did we get into this mess?

5. 1 . How did we get into this mess?
• Russia was weak in the 1990s but now it is
rapidly getting stronger
• This change has yet to be acknowledged
politically

6. 1 . How did we get into this mess?
Russia
China

7. 2. Showdown

8. 2. Showdown
• The bigger fear is Nato expansion
• Prelude:
- USA daws from ABS treaty 1995
- missile defence policy

9. A new Cold War?
• Yes: military build up
• Yes: aggressive politics of mutual mistrust
• Yes: proxy wars and geo-political games
• No: ideologically on same page
• No: commerce ongoing (from IPOs to energy sales)
• No: Putin’s goal Greater Europe

10. The Pain Game

11. 3. Pain Game – who will win?
• Russia is suffering… but not that much
• Despite low trade share, Europe has been surprised
by how important Russia is to European economy
($100bn, 400k jobs)
• Trade war is already wrecking nascent European economic recovery
• Unintended consequences:
– wrecking CIS economies too
– divisive for EU project
– accelerated political BRIC integration
• This was the year that should have emerged from 2008 crisis and actually
going into a new crisis

12. 3. Pain Game – short term
• End to fighting in East Ukraine likely
• Minsk II will probably fail => frozen conflict
• Sanctions on Russia remain in place
– US financial sanctions effectively global
– European business in Russia now targeted
– Ukraine cut off from gas 2020
– Military tensions remain high

13. 3. Pain Game – Russian economic pain
Negatives
• Russian economy in deep recession
• No access to capital vs high domestic rates
• No investment (FDI or domestic)
• All spare money going to military
• No economic vision = stagnation

14. 3. Pain Game – Russian economic pain
Positives
• Import substitution (cheese, Ford)
• Consolidation in many sectors
• Company focus on efficiency vs expansion
• Sovereign/corporate debt low: 0% debt 2017
• Residual income from raw materials…
• Can turn federal budget deficit on and off via military
spending
• Low oil forcing a “new normal” on Russia
(oil break even budget from $115 to $75)

15. 3. Pain Game – Russian economic pain
Politics & Policies
• Nascent opposition movement dead
• Siege narrative => more restrictive regime
• Consumer model being replaced with weak ruble model
• SOE have all money:
- concentrates power with Siloviki
- increases corruption
- emphasis on SOE and state projects
• Economic liberal agenda still there, but sidelined by geopolitics

16. 3. Pain game - impact
• Economics
- Real incomes falling first first time
- Retail t/o anemic
- GDP contraction this year circa
3%, growth 2016 of 1%?
- Unemployment remains low circa
6%
- Inflation stubbornly high circa
11%
- Fixed investment negative, need
25% growth rates
• Bank sector
- Massive deleverage process going on
- Real incomes falling first first time
- Consumers over indebted (2 months
wages equivalent)
- Consumer lending contracting
- Corp lending recovering but anemic
- NPLs low but creeping up (6-7%
sector ave)
- CAR down but stabilized 13%
- NIM squeezed hard by high interest
rates
- No more CBR rate cuts in short term

17. 3. Pain Game

18. 3. Pain Game - sectors

19. 3. Russia’s role in region
• Russia also plays an even more important role
in the region
– Kazakhstan had to devalue Tenge, may again
– Bulgarian exports/tourism slumped
– Poland in deflation, agriculture hurt (apples)
– Serbian FDI damaged (SouthStream)
– Armenia, Tajikistan, Moldova would collapse if
Russia collapsed

20. 3. Pain Game

21. 3. Pain Game

22. Business to the rescue

23. 5. business
• What does Putin want?
– Doesn’t want to recreate USSR
– Doesn’t want to invade/occupy Ukraine or Baltics
– Doesn’t want war with EU/US
– Doesn’t want to see Ukraine collapse
– Does want commercial relations with EU
– Does want Ukraine’s commercial relations with EU (DCFTA) to
account for Russian interests
– Does want guarantee Ukraine will not join NATO
– Does want Greater Europe of trade (China problem)
– Does want respect

24. 4. Russia’s role in region
• Minsk II: next phase all depends on results
– Withdrawal of Russian military aid
– Stick to terms of ceasefire (artillery)
– Regional elections in Ukraine (November)
– Constitutional changes de-centralisation (Sept)
– Amnesty law for fighters (?)

25. 5. business
• Ukraine 1.3mn refugees, most gone to Russia
• UNHCR Russia #1 world asylum applications
2014 – mostly Ukrainians
• German business lobby hard for peace
• Much of SE Europe also want good relations
• Falling trade, profits cost EU $100bn 400k jobs

26. Ben Aris
Editor-in-chief/publisher
bne
editor@bne.eu
+7 916 290 3400
http://bne.eu