Navigating the choppy waters of the Black Sea: As tensions escalate, what does this mean for Russia and Ukraine?
Geopolitical risks between Russia and Ukraine have once again drawn international attention in recent weeks, following the seizure of three Ukrainian vessels by the Russian coast guard and Ukraine’s imposition of martial law. However, despite growing tensions in the region, the reality is that it’s business as usual for the Russia-Ukraine story. The market has grown accustomed to the volatile relationship between the Black Sea neighbours and sadly accepts mild escalation of tension without major surprise. But what is the outlook from here and what does that mean for both Ukraine and Russia? Will there be further escalation in tension, or is a possible resolution to the conflict in sight?
Russia would like to see a weaker Ukraine, and therefore we can’t rule out further incidents in 2019. In my view, the Russia’s strategy is to involve Ukraine in a drawn-out conflict, depleting their resources, increasing instability and distracting their shaky government from implementation of much needed reforms. A drama with an external enemy always attracts media attention and helps boost the local popularity of the current government, which is very much needed by Poroshenko, whose election is in March next year.
Russian conflict is not the only test facing Ukraine at the moment. Ukraine remains the most leveraged country in the EMEA region, with public debt representing nearly 70% of GDP with heavy debt repayment schedule for the next five years. Therefore, cooperation the IMF is essential for Ukraine to avoid default in the medium term. In October this year they already secured a $3.9 billion aid agreement with the IMF and look set to attract further funding, provided their 2019 budget is approved by the IMF Board after the 10th December. If all goes smoothly, a $1.9 billion is expected to be released at the start of 2019. One of the demands placed on Ukraine by the IMF is the hiking of gas prices; having already raised prices by 23% in November this year, a further increase to reach 80% of import parity is necessary by May 2019. While the IMF commitment to Ukraine is strong, the gas price hikes in particular will be very painful for the local population.
This puts current President Petro Poroshenko in an even more uncomfortable position for the March 2019 elections, which could potentially be a game changer for Ukraine and investors. He faces a tough re-election race and his opponent Ylia Timoshenko, who is a strong front runner in the current polls and anti-IMF measures. Given the uncertainty and unpredictability of March 2019 onwards, we would only be looking at short dated bonds for investors in the region.
In terms of the impact on Russia, new sanctions are possible in early 2019. While isolation from the West undoubtedly hurts the Russian economy, the country is instead building its relationships with China, India and the Middle East, which lessens the impact. Russia also benefits from a strong debt position and very solid external and fiscal balances, despite the existing and potential additional sanctions. Overall, we are confident about Russian external debt and would take any weakness as an opportunity to buy.
Olga Fedotova, APQ Global IAC Member