Russia/Ukraine: shifting moral high ground
The tragic downing of MH17, resulting in the death of 298 passengers and crew, currently appears to be an unintended consequence of the Ukraine conflict between Russia and the West.
The linear projection in the aftermath of this appears to be the adoption of a harsher stance towards Russia leading to stronger sanctions. Level 3 sanctions are possible which would mean Russian companies lose access to the dollar denominated monetary system. This view is driven by reports which indicate that the aircraft was brought down by Russia-backed separatists fighting the rebellion against Ukrainian authorities in eastern Ukraine.
The secondary effect of any stringent move from the West on Russian economic interests potentially also endangers Russian gas supply to Europe (Russian gas accounts for more than one-third of Europe’s total gas needs). Indeed, if Russia were to cut-off European gas supplies, then a renewed recession in Europe would quickly become a central scenario on the economic front.
However, we think that the moral high ground occupied by the various parties in the conflict has shifted significantly post the downing of MH17. Russia has lost precious credibility in the wider global arena, which we believe will weaken Putin’s stance towards Ukraine (albeit temporarily) in coming days.
Since the crisis erupted a few months ago, Russia has carefully calibrated its stance towards Ukraine by using a “dynamic” approach in protecting what Russia sees as its key geopolitical interests. Although the pressure to adopt a harsher stance towards Russia is likely to strengthen, we think it is highly likely that Russia would react to this loss of moral high ground by softening this stance, in turn creating the necessary breathing space for all parties involved.
Indeed, if were to happen, then it is highly likely that pressure on Western governments (especially, Europe) to take a stronger stance against Russia would ease as well. For Europe the stand-off couldn’t have come at a worse time. The Eurozone economy is going through a tough time already, given deep-rooted structural issues that have led to strong disinflationary impulses in recent months. In this scenario, question marks around the reliability of gas supplies would only worsen the situation.
In addition, it is also important to appreciate that Western appetite for engagement in another war (especially one at Russia’s doorstep) is low. Here, threat of level 3 sanctions to force Russia to change her stance towards Ukraine is the only viable “nuclear option”. Exercising this option would mean that the West would have exhausted its “stick” approach (unless the situation deteriorates exponentially and the whole of Ukraine comes under threat). Additionally loss of access to the dollar denominated monetary system would force Russia to play the gas card. Economically, it is easy to see that the situation entails significantly more bilateral damage than is depicted in most media coverage , a reality which we think perversely acts like a shock absorber in the current situation.
