Strategy Note /

Russia-Ukraine conflict de-escalates from here

  • Russia has recognised Donetsk and Luhansk in east Ukraine as separatist republics and deployed military forces

  • Extending its buffer and protecting Russian-speaking population is in its interest, occupation of western Ukraine is not

  • Unless sanctions derail Nord Stream 2, which Germany does not want, then the conflict should de-escalate from here

Russia-Ukraine conflict de-escalates from here
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
22 February 2022
Published byTellimer Research

Russian equities are down 15% this week and the currency is down 3% after President Putin recognised Donetsk and Luhansk in east Ukraine as separatist republics and deployed regular military forces there (special forces have been present for years, although of course this is denied by Russia).

The Minsk agreements of 2014 and 2015, which attempted to end the separatist conflict in these regions, appear even more irretrievable. But the overall conflict between Russia and Ukraine may well have peaked.

Stationing its troops in these separatist regions is consistent with Russia's interests and capabilities whereas full blown invasion and occupation of western Ukraine is not. Russia is calculating and aggressive but not irrational and reckless.

The western sanctions that follow Russia's actions to date should be manageable given its fiscal strength (fiscal balance and gross government debt of 0% and under 20%, respectively, in 2022, according to IMF forecasts), particularly during the current period of high oil prices.

Despite public posturing, the US and EU can also likely live with these separatist regions (just as they have with South Ossetia and Abkhazia in Georgia), as long as Russia goes no further in Ukraine, and be satisfied that new sanctions impose a cost on Russia without having to test the strength of US and EU unity and commit US and EU troops in direct combat.

And at a time of high oil, gas, and other commodity prices, and accelerating inflation in the US and EU, there is a limit to how swingeing sanctions will be on key Russian commodity exports before they inflict unacceptable self-harm.

The risk to this view is the Nord Stream 2 gas pipeline. Should sanctions include NS2 or should Germany extend its halt to a permanent block, then that may be a red line crossed for Russia which leads it to over-reach in Ukraine. Sanctions on – or permanent mothballing of – NS2 are not in the interests of Germany, which is reliant on Russian gas imports, particularly as it transitions away from coal and nuclear, and this should mitigate this risk.

Russian equities (MoEx index) are valued on a forward PE of close to 4x, a 35% discount to the 5-year median and back to troughs seen during previous global shocks (2008 financial crisis and 2014 oil price crash) and local geopolitical disruption (2008 Georgia war, 2014 Crimea annexation).

Russia equities back to previous trough valuation

Russia's realistic buffer strategy in Ukraine

Extending its geographic buffer and protecting Russian-speaking populations is in its interest, a full invasion and subsequent occupation of west Ukraine is neither in its interest nor its capability.

The encirclement of Ukraine with two hundred thousand troops has successfully projected Russia's threat of full invasion and achieved an outcome similar to that seen in Georgia in 2008, with Russian-backed statelets of South Ossetia and Abkhazia.

A full-blown invasion is far too costly for Russia and likely beyond its capability and priorities. Consider the following factors:

  • The flat geography of Ukraine makes for a very difficult terrain to retain once invaded.

  • The non-Russian speaking composition of the western Ukrainian population will resist.

  • The sheer size of the population (over 40mn in non-Donbas Ukraine, compared to under 4mn for Georgia in 2008).

  • Arms supplied by the US and EU to the Ukrainian government (which makes it still inferior to Russia's entire military, but significantly stronger than during the 2014 annexation of Crimea).

  • The lack of a youthful demographic in Russia to keep replenishing its supply of troops (median age is 40).

  • The remaining and much more challenging geographic buffers to position for in the longer-term — NATO members Lithuania, Latvia, Estonia, and Poland.

SWOT analysis of Russia 's power projection in buffer states

Related reading

Russia equities are back to trough valuation levels, Feb 2022

Russia and its security buffer, Jan 2022

Munich Security: Global division on Covid, Climate, and now Russia, Feb 2022