A Ukrainian newspaper reported that President Putin is preparing for his first meeting with President Trump by instructing his intel apparatchiks to develop a psychological profile, specifically to “figure out how to crack Trump at the first meeting.” This meeting could be the most important event of Trump’s first year in office, with ramifications for his entire presidency. It will be just as important for Putin. Russia will press to have sanctions dropped, and Ukraine fears that Trump will acquiesce.
We have a different take on the situation. In our view, Russia is complicit in the sanctions by engaging in military adventures that elicited a predictable response from the West. To understand why, you’ll need to know something about Russia’s economy and political climate, and a little about the Kremlin mindset. Consider that if Putin was successful in annexing Crimea, he’d acquire a prosperous industrial region and warm-water winter port. If he wasn’t, he’d have distracted a restless populace and quelled political dissent. He couldn’t lose and, so far, hasn’t.
The Russian-media-dubbed “Ukraine Crisis” came to a head in fall 2013. The Kremlin was pressuring then President Yanukovych to reject a trade deal with the EU, a move that eventually caused Yanukovych’s ouster. Russia was offering Ukraine, already over-burdened by external debt, more US dollar credits to purchase Russia’s natural gas, forcing it into a record trade deficit. These two simultaneous crises, political and economic, crushed Ukraine.
We see the “Ukraine Crisis” was a subterfuge. Putin was embroiled in his own political and economic crises, which became the motivation for aggressing against Ukraine. Putin was caught in a vise of two slow-moving events. In early 2013, his Levada approval rating had dropped to an all-time low of 24 points, in contrast to a high of 76 in 2007, a time of economic boom. Another crisis was brewing: ever diminishing economic growth and severe loss of competitiveness, aka “Dutch disease.” In early 2013, a meeting of economic insiders was held by newly re-elected President Putin. Then Economic Development Minister, now economic advisor to Putin, Andrey Belousov, explained that the “economic slowdown … job losses … were due to domestic issues: costs, and [the] ruble’s real increase.”
Stalling in 2012–13, and confronted with widely expected rate hikes by the US Fed, Russia’s oil-dependent and uncompetitive economy was at risk of a severe downtown. To fix both crises—boost low approval ratings and prepare for the inevitable macro adjustment—Putin resorted to aggression against “near abroad” nations. The first was Ukraine, seen as a convenient and easy target.
The Crimea annexation and military incursion into Eastern Ukraine, as well as the military build-up on borders with NATO members, were taken by Putin to bolster his popularity. That aim succeeded—Putin’s Levada approval rating soared back into the 70–80 range despite the collapsing economy. He was able to blame the West for the inevitable macro adjustment of the Russian economy and resultant sharp contraction in public consumption. That aim succeeded, too, with Finance Minister Anton Siluanov proclaiming that “Dutch disease is over.” As telling, Vladimir Mau, top economist and head of Russia’s Presidential Academy, said , “After 25 years of inflation, there is no Dutch disease.”
From late 2013 and throughout 2015, Russian authorities switched to a free-floating currency regime to combat Dutch disease. From the outset, this was a policy decision, not a response to market conditions.
Russia has actively sought to destabilize Ukraine and neighbouring countries. It was a deliberate strategy to bring Western sanctions on itself. Sanctions have been useful to lay blame for domestic issues on the West. But with 2018 presidential elections and the World Cup fast approaching, they’re becoming a burden.
We expect a shift in the Kremlin’s stance leading up to elections in 2018. Their strategy will be “70/70”: they want 70% of the electorate to vote and 70% of the votes to go to Putin. Despite controlling the media, Russian leadership does care about the legitimacy of power. A Putin re-election in 2018 is nearly certain, but there is a vital need for the Kremlin to portray Russia as a strong player, especially when dealing with the G7 nations on issues like nuclear weapons and terrorism.
The Kremlin manages by crisis, and they create problems as a counter-measure to true crises. The West should study the Kremlin mindset if they are to effectively negotiate with a very wily adversary.
Mr. Valchyshen is the Head of Research and Member of the Investment Committee of Investment Capital Ukraine. He was formerly head of Macro/Fixed Income Research for ING in Ukraine and a senior manager at Ukrsotsbank and Prominvestbank. He has a masters degree in Electrical Engineering from the State Polytechnic Institute of Ukraine and a masters degree in Banking from the Interregional Academy of Personnel Management.
ICU is a Kiev-based financial-services group that provides investment banking, securities trading and asset management for private and institutional investors. ICU manages the largest bond fund in Ukraine In 2014, ICU’s Chairman, Valeria Gontareva, became the Governor of Ukraine’s central bank.
