Tim Ash comments on the blockade in the Donbas

2017/3/15 13:34:55

Ash: “Not sure that Moscow actually wants to add the cost of maintaining DPR and LPR, alongside the now long list of annexed and disputed territories including Crimea, South Ossetia, Abkhazia and Trans-Dniestr. Formal annexation of DPR/LPR would also further diminish Russian leverage in the rest of Ukraine which I tend to think was the primary reason for Russian intervention in the first place.”

 


LONDON, Mar 15, 2017 (UBO) – Responding to growing interest and concern regarding the blockade efforts in eastern Ukraine, Timothy Ash of Blueberry Asset Management offered the following comments at of 13:10, Mar 15, 2017:

 

The blockade is still proving challenging for the Poroshenko/Groysman administration to handle. On the one part they desperately want to lift it as:

 

a) It is proving damaging to the economy and the nascent economic recovery – which I guess PP sees as important for boosting his chances of re-election;

b) It leaves Ukraine exposed to accusations from Western allies of breaking the terms of the Minsk II process which includes commitments to work for the re-integration of DPR and LPR into Ukraine proper.

 

On the other, they recognise difficult politics around this, as the nationalists and others backing the blockade have hit a popular chord with the population who question why Ukrainian entities are still trading with DPR and LPR which are still continuing the conflict in the East. The message is that Ukraine should move away with trading with DPR and LPR and to fully put the cost of sustaining these regimes on Moscow’s lap. Moscow has kind of stirred the pot by announcing that Russia will accept DPR/LPR IDs and also making the rouble the sole legal tender in DPR and LPR. There has also been talk of DPR and LPR nationalising assets on their territory, but still technically in the ownership of Ukrainian entities. Not sure that Moscow actually wants to add the cost of maintaining DPR and LPR, alongside the now long list of annexed and disputed territories including Crimea, South Ossetia, Abkhazia and Trans-Dniestr. Formal annexation of DPR/LPR would also further diminish Russian leverage in the rest of Ukraine which I tend to think was the primary reason for Russian intervention in the first place.

 

The Ukrainian government has hence tried to manage the blockade with care – nervous about using heavy handed tactics for fear that these will get out of hand, provoking a larger popular backlash. But this week we have seen a varied strategy applied:

 

First, we have seen police, SBU forces move in to remove one of the blockade sites – arresting a couple of score of demonstrators. This proved relatively successful – while there were counter demonstrations across Ukraine, and in Kyiv, these have proven relatively muted, attended only by a few hundred demonstrators. Assuming no larger opposition, I think we could see police/SBU operatives move to try and break the rest of the blockades.

 

Second, the prosecutor general, Yuri Lutsenko, announced legal action against the Mayor of Lviv, Andrey Sadovy over alleged malpractice around the management of refuge dumps in Lviv – a fire recently saw a number of people killed, and the allegations are of some kind of liability by Sadovy. Sadovy is seen as a contender for the presidency in the 2019 elections, and his party Samopomich has been big backers of the blockade. Cynics might argue that the two events are linked – and all this is a warning to Sadovy to back off over the blockade.

 

Third, the government is promising a better regulation/restriction of trade with DPR and LPR. The assumption is that this still allows strategic supplies of coal/raw materials across to industrial facilities in the rest of Ukraine, but presumably some strategy to ween Ukraine away from the continued reliance, for example on anthracite coal from DPR and LPR. Critics would argue that this is just pandering to oligarchic interests in Ukraine.

 

Fourth, perhaps a sop to nationalists with questions being raised over the future of Russian bank operations in Ukraine. Nationalists have in recent days targeted Russian bank branches – even bricking up the entrances to a number of these. The NBU has threatened to sanction Russian banks for transacting with DPR and LPR entities and the NBU and the SBU are slated to have a discussion over the longer term future of Russian banks in Ukraine.

 

On the issue of Russian banks, the NBU has thus far been sanguine, even supportive of their continued operation/presence in Ukraine. Partially this reflected the prior weakness/vulnerability of the Ukrainian banking sector – there was nervousness about Russian banks’ early withdrawal (~USD20bn in assets at one point) and how destabilising this could have been for the wider sector, and also the potential cost to the sovereign balance sheet through likely needed action to take over these banks. Russian banks have actually behaved impeccably, cooperating with the NBU – recapitalising as required. I think partially this is in recognition that by handing back the keys they would automatically suffer a full loss on their assets, plus also they would be unlikely ever to be given banking licenses in Ukraine. And retaining even now skeleton operations in Ukraine gives Moscow some leverage, albeit declining. It now seems likely, given the political setting in Ukraine, that these entities will be sanctioned by the Ukrainian government for alleged transactions with DPR and LPR and this could see their eventual nationalisation by the Ukrainian state. Russian banks have significantly wound down their operations in Ukraine, and with the broader Ukrainian banking sector appearing in a healthier state, with public finances also in better order I don’t think this process will have much of a systemic impact on the Ukrainian banking sector or economy. But it seems likely that such action will be challenged by Russian entities in the courts – adding yet another lawsuit to the now many between Russia and Ukraine.

 

One big take out from the above though is the more nationalist mood/agenda in Ukraine, and I think this could also play out more broadly in Ukrainian politics – this could impact on the Groysman administration which is likely to suffer a no confidence motion in April/May, and even in a best case is likely to be significantly reshuffled. This process could be disruptive and the danger as I see it is that we see a much more Ukrainian-first agenda rolled out, which might be less IMF friendly –so less willingness to do some of the IMF-related reforms, including land reform, pension reform and furthering the anti-corruption agenda. Some might argue that any government reshuffle/change in Ukraine will ultimately be focused at stalling that anti-corruption agenda which has now reached a critical point but is now so important to Ukraine longer term growth and development.

 

** Please note that any views expressed herein are those of the author as of the date of publication and are subject to change at any time due to market or economic conditions. The views expressed do not reflect the opinions of all portfolio managers at BlueBay, or the views of the firm as a whole. In addition, these conclusions are speculative in nature, may not come to pass and are not intended to predict the future of any specific investment. No representation or warranty can be given with respect to the accuracy or completeness of the information. Charts and graphs provided herein are for illustrative purposes only.”

 

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