Guest post: soft war, or when finance is the continuation of politics by other means
Guest post: soft war, or when finance is the continuation of
politics by other means
By Roland Nash of Verno Investment Research
As the conflict between Russia and the west for influence in Ukraine unfolds, finance has found itself
in the unfortunate position of sitting squarely in the front line. From the acceptance by Viktor
Yanukovich of a $15bn loan from Russia to the freezing of oligarch bank accounts in the US and
Europe, finance has been used as a tool to push the political agenda of both sides.
The immediate consequence has been a fall in the value of Russian assets, the latest of many that
have plagued Russia over the past 20 years. If a market correction is the only impact, recent weeks
will prove little more than another example of how Russian markets have a tendency to overreact to
newsflow. But there could well be a more far reaching impact ? and perhaps with rather different
consequences from those intended by the US and EU.
In the 14 years that Vladimir Putin has dominated Russian politics, arguably the biggest threat to his
authority was the 2008 financial crisis. By suddenly facing the removal of access to financing,
Russian businesses and the elites that controlled them found they were unable to meet obligations ?
not just to the west, but to each other, the Russian public and the Russian government. The equity
market lost $1tn in value in the space of three months, western banks threatened to take control of
Russian industry in lieu of debts, and the economy declined by 8 per cent in 2009 ? the biggest
recession of any major country globally. While Putin had created a highly successful power-vertical
in Russia, it transpired that the whole edifice of the Russian economy could be threatened by what
was little more than collateral damage from decisions taken in the US and Europe to support their
By the same token, the crisis also demonstrated the soft power of western finance in Russia. It is one
of the great ironies of Russia?s post-Soviet experience that one of the events that did most to restore
the influence of the state across the Commonwealth of Independent States was a financial crisis in
the west. With the removal of sources of external private finance, businesses, banks, oligarchs and
even governments had no choice but to turn to the Russian state for liquidity. Into the vacuum left
by western finance walked the only entity that had been saving during the 10-year post 1998
economic boom: the Russian state. Through Sberbank, VTB and VEB, the state provided liquidity and
in return gained influence.
The experience of 2008 was a lesson that appears to have been learned by both the West and Russia.
From the western standpoint, finance has been chosen as one of the few mechanisms available to
apply pressure on Russia in response to events in Crimea. Targeted asset freezes and restricting
certain Russian companies? access to finance are measures that appear to be viewed as a surgical
way of directly pressuring those making decisions related to Ukraine. Rumours of the threat of wider
sanctions abound, with the effect of artificially creating the circumstances that so impacted Russian
economic stability in 2008. Actual concrete decisions are not always necessary ? rumour alone can
be highly destructive.
From the Russian standpoint, just as the lesson from 1998 was not to let government finances ever
become over-exposed to the west, so the lesson in 2008 was to limit private sector exposure.
Companies and banks have been encouraged to increase domestic borrowing and decrease reliance
on the west. Oligarchs have been far more reluctant to leverage their holdings through western
banks. From a policy standpoint, the central bank has floated the rouble and the Kremlin has been
vocal about its awkwardly titled policy of ?de-offshorisation?.
Both sides are manoeuvring. Russian stocks are particularly vulnerable to geopolitics because so
much of the free float is owned by foreigners, creating the opportunity for considerable value
destruction if holders become nervous of deteriorating politics. Of the 18 per cent fall in the equity
market so far in 2014, at least half can be directly attributable to the impact of events in Ukraine,
which would imply a $60bn cost to Russia.
But equally, a collapse in Russian valuations hurts foreign funds disproportionately because they
own so much of the market. Indeed, Russian corporates are looking at lower valuations as an
opportunity to buy back their stock from foreign holders. A similar trend is under way in debt
markets. Companies that borrowed in western financial markets at 5 per cent are now able to buy
back their debt at yields several hundred basis points higher.
In Ukraine itself, finance is likely to play a key role as military tensions subside. The west?s arsenal
of multilateral lenders is likely to be deployed to prop up the Ukrainian economy and persuade it of
the advantages of looking west. In Crimea, Russia is likely to want to illustrate the merits of stronger
ties with the homeland and, given the smaller scale of the project and the relative priority of policy,
could well prove to be the more successful.
In the longer term, the costs to Russia are likely to prove more substantive. Partly this will reflect a
lower availability of financing at a time when Russia needs to be investing. But it?s the quality of
financing rather than the quantity that may have the bigger impact. Russia is only capital
constrained because such a large proportion of domestic savings are exported abroad. Financial
markets are global, and if the west is not prepared for political reasons to provide financing, then
other sources are likely to take advantage of any improved economics. Organisations like the
Russian Direct Investment Fund have already proved successful at both raising and deploying
institutional funds in Russia. But if, as is likely, capital deployment in the absence of the west
involves greater state involvement, then there could well prove to be an efficiency loss that will cost
Russia over the longer term.
From the west?s standpoint, financial engagement has been one of the major successes of the
integration of Russia into the global economy since the break-up of the Soviet Union. Incentivising
Russian organisations to adopt the standards and the disciplines that most effectively ensure access
to western finance encourages many of the trends that the west should, in its own interests, be
working to achieve. Disincentivising western finance from engaging with Russia may indeed damage
Russian growth, but it will also undermine some of the most encouraging trends of the last decade.
There is a feeling in Moscow that the model of finance that has developed in Russia over the last 20
years may have been permanently changed by the reaction to events in Ukraine. This, like other
crises before it, will undoubtedly create opportunities for capital deployment. But it may also change
attitudes that will have unintended costs for both sides.
Roland Nash is senior partner and chief investment strategist at Verno Investment Research. A
version of this post was previously published by bne.
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