So I thought that I might answer these in a Q&A format for my own ease.
Q: So how do you see this conflict panning out now from here?
Answer - Well it’s war, and they are unpredictable by nature. But I think already we can draw some conclusions which have some durability:
First, what is now clear, as compared to the situation in the early days of the conflict, is that Russia failed in its maximalist objectives of taking Kyiv, bringing regime change in Ukraine thereby imposing a government of its choice, and essentially taking the bulk of the country and changing its geopolitical orientation. They had the chance and failed, and they are unlikely to get a second chance. For Putin it was “now or never” but we now know “it’s just never”.
As is now clear Russia’s military operation has been pretty disastrous - poor tactics, poor kit, and a lack of motivated troops. Russia cannot take and hold a large part of the country, partly because of its own failings but also because of the remarkable bravery and tactics of Ukrainians, and also the increasing supply of Western kit which is proving far superior to Russian equipment.
Second, once the fighting ends, a sustainable, independent Ukraine will exist. It has fought for and proven, through its spirit, the right to exist.
Third, the Russian military might have performed poorly, but it still is a formidable machine for wreaking destruction. And the Russian leadership has shown time and time again, in Grozny, Syria, and now Ukraine that it has scant regard for human life, and is willing to use brutality as a military tactic. It’s almost medieval siege-type tactics, but used in the 21st century.
Moscow can continue a long war of attrition, which it still hopes can sap Ukrainian resistance and Western resolve. So this war can still go on a long time.
Fourth, it seems as if Moscow will try and sell what limited territorial gains it has achieved so far - limited in Donbas, Kharkiv, Kherson, and Zaporizhia with the land corridor now to Crimea, as some great victory over “Nazis in Ukraine”. There has been a talk of referenda sometime this year, to bring those regions newly captured into a Greater Russia construct.
The question here is is this enough of a win for Putin - when set against the huge costs in terms of manpower lost (10-20,000 dead Russian troops), the Potemkin like a performance of the Russian military and kit, treasury - sanctions could well cost Russia up over a trillion dollars with sanctions and lost trade?
Putin might just use any short-term win from referenda in the captured territory as a base camp for further attacks in the months or years ahead. We could yet see further attacks and escalation with Ukraine and the West. We simply do not know.
But the first phase of the war failed (attempt to capture Kyiv) and now the offensive in Donbas seems to have also failed in its target of taking the whole of Donbas, indeed, the very little additional territory has been taken in recent weeks.
Q: Can Putin sell the limited territorial gains as a win at home?
Answer: Well in an authoritarian regime where the information space is controlled by the state, yes, at least in the short term. Putin can sell anything as a win. But while the regime still has some resources to insulate the population from sanctions - still $300bn plus in CBR reserves beyond the reach of sanctions - eventually sanctions will weigh, combined with the large number of body bags returning to Russia.
Families will see loved ones killed or injured and will likely see a marked drop in living standards, and opportunities for travel and international interaction (sports, culture) as this war has left Russia as an international pariah.
Eventually, people will surely ask, was it really worth it?
This could be months but more likely years. I think eventually it will bring regime change as after the Soviet Unions failed intervention in Afghanistan in the late 1970s, but that took another five years until Gorbachev and Perestroika. It might take that long in Russia now. But I do think this is as catastrophic a military defeat for Russia as was Afghanistan for the Soviet Union in the late 70s/80s. Putin has lost Ukraine to Russia, forever!
Q: Will sanctions impose an unbearable cost on the Russian economy?
Answer: I think it is now clear that sanctions are not a magic bullet, but they can be a useful tool to change the decision set of the aggressor, in this case, Russia.
They could come close to shutting the Russian economy down. But the aim always with sanctions is to ensure the cost to the target of sanctions is more than to those doing the sanctioning. So there is always a too and fro, and negotiation amongst those rolling out sanctions to ensure the maximum net hit to the sanctioned target but not risking unforeseen, systemic risks to those doing the sanctioning and to the global economy.
There is also a desire here to ensure unity in the West, recognizing that inevitably the costs of sanctions will not be evenly born across countries rolling out sanctions. Those most dependent on commodity exports from Russia are obviously most vulnerable, and not surprisingly they are typically less ambitious in agreeing to full energy or commodity boycotts, but eager to smooth the impact at home by securing longer transition periods. This is understandable.
But notwithstanding the above caveats, I think it is important to accept that where the West is now in terms of actual sanctions is far beyond where anyone expected the Western sanctions response to be.
No one expected CBR assets to be frozen - over $300bn put beyond the reach of the Russian state, sovereign debt sanctions so extreme that we are actually questioning when Russia will go into default, SWIFT sanctions rolled out on many banks, full blocking sanctions on many other banks.
One notable new development with Russia sanctions, unlike Iran perhaps, is the new phenomenon of self-sanctioning. International business is realizing that given the war crimes occurring in Ukraine, it is now morally reprehensible to do business with Russia.
Even international business with Russia, which does not fall under formal sanctions, is being closed down because companies do not want to be scarred by the stigma of doing business with the Putin regime. This is powerful. Russia is being shut down to global trade and shut off gradually from global markets. Russia will find it hard to sell products overseas and buy key imports.
And this is important when we think of the debate about an energy embargo. It seems unlikely at this stage that a full energy embargo will be imposed. But irrespective of that, self sanctioning is reducing global demand for Russian energy.
We can see that in the 30-40% discount now having to be offered by Russia to sell crude on international markets - in April 2022, the average price of Urals was $70 barrel, versus $107 for Brent. Meanwhile, Russian oil production dropped 9%, because demand for Russian energy is being reduced because of self-sanctioning but also due to the broader impacts of sanctions impacting on the willingness of insurance companies to provide cover for ships transporting it to global markets.
There is here an assumption that sanctions, by elevating global oil and commodity prices, are giving Russia a windfall gain, but the data in the discount on Russian Urals prices and Russian oil production - down by 1 mbd in recent months suggests something different.
Importantly though, irrespective of whether the West will impose an oil or full energy embargo this year or next, what is clear to the West now is that Russia is an unreliable energy supplier. And hence whatever happens now in the war in Ukraine, even if a peace deal is reached next week, the process of diversification away from reliance on Russian energy and commodities is inevitable.
The West will now inevitably cut Russia out of its energy and commodity supply chains.
And this represents a huge hit to Russia’s balance of payments over the medium term. It’s USD130bn energy business with the West will die, that’s the loss of 7-8% of GDP. A huge hit to Russia’s economy. And it cannot easily divert this energy business East, as particularly in the case of gas, it lacks pipelines, and likely as long as sanctions remain in place, will not be able to finance the construction of new energy infrastructure.
So I would say that Russia has some resources still to endure in the short term, but the hit to the Russian economy from sanctions will be enormous over the medium to longer term.
And I do not see sanctions easing off much as long as Putin remains in power. This means a massive reduction in trade turnover. Russia will remain isolated from international capital markets, in or close to default, and unable to finance investment. The economy is likely to see a recession of 8-10% this year, and thereafter sub par growth.
Capital and human flight and death of key imports will subdue potential growth - if it was just 1-2% before the conflict, it will be close to zero now because of this war. And Russia now faces a decade of isolation and economic stagnation and decline.
Q: Can you quantify the cost of the war so far to Russia?
Answer? Well, how do you quantify the loss in prestige and image?
But in terms of the economic costs, I have put the figure at something like $1.2 trillion, based on my back of the envelop calculations.
First, the Russian economy was $1.8 trillion before the war. Real GDP growth was expected to come in around 2-3% this year, but now people are assuming a fall of 8-10%. Let’s assume 10% loss versus trend, that’s a $180bn loss.
Second, asset freezes are coming in at something close to $400bn for the CBR and Russian entities. These assets may or may not be returned to Russia, as they could be used for Ukraine's war reparations.
Third, Russian asset markets are down by 50-80% depending on the asset. I make that a loss of something like $800bn, but I think around a quarter of that was held by foreigners. So that’s around a $600bn asset price loss to Russians.
Totaling that up we get to $1.2 trillion, give or take the odd $100bn! There is close to $8000 per capita. That is not a small change.
And this is not estimating the lost lives, the actual cost of the conflict in terms of destroyed military equipment, and likely future loss of Russian defense sales because Russian kit has performed so dismally - I mean who on earth would now want to buy Russian S400s, and Turkey must be asking did they buy duds?
But all told this is a huge one-off hit, and likely a continual hit to growth, perhaps as much as 1-2 percent points per year, which would represent $20-40bn in annual losses as long as relations with the West remain in the doldrums.
Q: What is your economic outlook now for Ukraine?
Answer: Well a lot depends on the end state in terms of territory. There were earlier fears that Russia would capture so much territory that what was left of “free” Ukraine would not really be sustainable. But actually, given that Russia has failed to capture much more territory following the initial invasion - even giving up most of the territory around Kyiv and the north, what is left is most of Ukraine.
And importantly, Russia failed to take Odesa and Mykolaiv, so Ukraine retains access to the sea - albeit the question is will it be able to use this accessor will Russia enforce a naval blockade?
But let’s assume the map stays close to the current situation. I actually think Ukraine has a great future.
Critically, it has fought for and proven its right to exist. What does not kill you makes you stronger, and I think that mantra will work for Ukraine. Putin has United the nation as never before, behind Zelensky. Ukrainians have won global hearts and minds, at least in the West.
They have shown unbelievable ingenuity and innovation in defeating the Russian Goliath. International business will want to do business in/with Ukraine, and harness the potential of this still huge country with a vigilant, dynamic and large population. The West is likely to want to ensure Ukraine is successful. It will pump billions into the country to ensure its and the West’s defense.
I can imagine a Marshall Plan-like program to help rebuild the country and to make it successful. Ukraine might end up losing a large swathe of territory in the south and east, but I think for Ukraine this will be like the Korean War, and it will end up like the successful South, with Russia unfortunately for it ending up like the sanctioned and economically backward North Korea.
Actually, I think this war will prove to be the “State of Israel” moment for Ukraine, it survived a near-death experience but now will be determined to be successful and there will be sufficient international goodwill to ensure it can be. It could end up with EU candidate member status, which would be a hugely important anchor to ensure its success.
Remember successful countries in emerging Europe needed candidate EU member status to really push on with the transition as it provided a straight jacket for reform, with clear KPIs. Ukraine has never had that, but it could now well get this key blueprint for reform.
Q: Can Ukraine avoid debt restructuring?
The answer, well yes, but I think in all likelihood there will have to be a debt restructuring.
Initially, the public sector debt burden was about $97bn, with a dollar GDP of around $155bn.
Dollar GDP is probably going to fall to something closer to $100bn, and pubic debts rise with Western credit disbursements.
This will take the debt/GDP ratio above 100%, beyond the level which saw the last debt restructuring in 2015. And Ukraine will need to receive tens if not hundreds of billions in credits and grants from the Western official sector. Against that backdrop, I just cannot imagine that the private sector will not be asked to contribute via debt restructuring. And if the debt/GDP ratio is above 100%, it’s hard to argue for the IMF et al that that is sustainable.
Ukraine is though likely to service its debt as long as the conflict lasts, as Western donors will be eager to show/prove its success, and will not want the added complication of a default/debt restructuring while a war is still in full swing. So I think the West will by hook or crook provide Ukraine with the $5-7bn it monthly needs to cover the public sector financing needs. But once the war ends debt will have to be restructured.
Answer: Well it might already be in default as I don’t think foreign holders of OFZ payments due in April have been able to get paid out in rubles and had these converted to FX. But on the external side, the MOF took it to the line last week and seemed to have paid the service due of just under $700m.
They blinked, and they showed that they did not want a default, as they understood the long-term consequences would be extremely damaging and long felt. The question now is whether OFAC will extend the general license for foreign debt service which expires on May 25. A view has been that it is beneficial for the US to allow Russia to draw down scarce FX liquidity beyond that frozen by the West.
But actually, I think the benefits of seeing this liquidity is drawn down very marginally with a few billion external debt services here and there pales into insignificance when thinking of the economic and PR hit to Russia of a sovereign default.
The Russians themselves revealed their own cost-benefit calculations by paying earlier this month - so the interests of OFAC surely now are the opposite. If OFAC extends the general license beyond May 25, this would be to the clear benefit of Russia, so why would they do that? It does not make sense.
A better question would be if OFAC fails to extend the general licenses, can Russia still avoid default by some legal fix?