One year after Russia’s invasion of Ukraine, we fear the prospects of peace remain remote and that the conflict is likely to drag on for quarters, if not years. An analysis of relative strategic and economic positioning drives our assessment.
The strategic initiative remains with Russia. Despite some recent successes, Ukraine has failed to fully eject Russian forces. While the provision of tanks is a significant escalation of Western support, the tanks are not expected to materialize on the battlefield for at least two months. Many are now watching for Russian President Vladimir Putin’s reaction, which may include weapons of mass destruction. In this sense, the overall strategic dynamic of the world watching for Putin’s next move persists, and ironically the Western tank decision may have only reinforced it.
Russia retains significant gains consistent with our original assessment of Kremlin aims. We expected a Russian campaign aimed at partitioning Ukraine in a manner driving dependency and killing prospects of an economically viable independent Ukraine outside Moscow’s sphere of influence. Despite setbacks, Moscow maintains de facto control over Ukraine’s industrial heartland and has effectively landlocked the country. The result has been a rump Ukraine ruled from Kyiv on life support underwritten by Western aid.
We believe talk of Ukrainian victory is premature. The initial invasion and subsequent Russian campaign decimated Ukraine’s economy. Beyond the hit to growth on the order of around one third of GDP in 2022, the destruction of the country’s capital stock and Moscow’s stranglehold on the seaborne export routes has been suffocating. In our view, late 2022 International Monetary Fund (IMF) estimates of Ukrainian gross external financing needs of $3 to $5 billion almost certainly understate reality.
Ukraine’s reaction function tilts strongly in favor of escalation. Ukrainian President Volodymyr Zelensky’s political efforts translated into Western support critical to Ukrainian defenses, which nevertheless fell short of guaranteeing Ukrainian victory. Meanwhile, Kyiv’s declared war aims have escalated to returning to the lines of 2014 rather than 2022. The former would require the reconquest of the Crimean peninsula—a mountainous region saturated with Russian forces—as well as territories in the Donbas that Russia has controlled for nearly a decade. While we may understand Kyiv’s efforts, the extent of Western support, disposition of forces on the ground, and significant advantages Russia currently holds make us doubt the prospects of a swift end to hostilities.
Despite notable setbacks, Russia remains resilient... Russia’s economy and political system have been resilient to both the conflict and Western sanctions. Market forecasts of double-digit GDP declines issued in early 2022 proved overly pessimistic, and the IMF recently increased its 2023 Russian growth forecast from a contraction to a mild expansion. Inflation has slowed, enabling the central bank to markedly ease policy. While fiscal pressures are more evident after Western price caps on energy exports, Russia entered the conflict with strong fiscal and external positions. Belligerents in wartime typically experience considerable fiscal and current account deficits. Neither was in evidence in Russia over the last year, helping to give the country a buffer if dynamics turn more pernicious.
…even militarily. Despite some significant failures, Russia retains immense strategic gains, and could now benefit from the advantages that typically accrue to the defender on the battlefield. There are also signs of incremental improvements in the Russian military. This pattern of gross failure followed by battlefield learning and improving results is a long-running theme in Russian military history, echoing back to 1812, the Civil War and the 1940s.
The Kremlin’s will to fight has not waned. With an atomized opposition, a resilient economy and a military evidently competent enough to hold significant swaths of Ukrainian territory, Moscow has an incentive to retain a hard line in Ukraine. The West’s decision to send tanks, and more recent flirtatious talk of fighter jets will likely play to hawks in Moscow, not least for fear of losing a window to snuff out an independent Ukraine, in our opinion. Furthermore, while the West benefited from a surprisingly warm winter, key vulnerabilities on the energy front remain. Europe still depends largely on imported hydrocarbons, and remains vulnerable to gas shortages in particular in the event of an adverse turn in the weather. Domestically, predicting regime change precisely is impossible, but we continue to see it as a Western fantasy, which if realized, is not guaranteed to result in an outcome favorable to those wishing for it.
We expect the conflict to escalate in the coming months and reiterate our view that it is likely to continue for several quarters if not years. Both parties have strong incentives to push on instead of suing for peace. The likely result is more fighting with little sign of resolution. To the extent the situation persists into 2024, Moscow’s leverage over Western energy vulnerabilities will likely increase. In our view, the recent Western tariffs on aluminum and other metals underscore how little the Kremlin has exploited its asymmetric leverage over global supply chains.
We believe the war is a significant risk to markets more generally, especially as a tax on growth and a source of chronic inflationary pressure.
Past market experience is no guarantee of future results.
Markets are extremely fluid and change frequently.
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