Ironhorse Tanks Can't Stop 'Ukraine Variable' From Hurting Banks
A year ago, Ukraine was about as exciting as Uzbekistan. Now, it’s a market driver.
The Market Vectors Russia exchange traded fund (RSX) is on its way to the teens unless rivals Vladimir Putin and Petro Poroshenko, Ukraine’s president, can hug it out mighty quick. Seeing how this is an unlikely scenario in the near term, markets are betting on the bear case.
Risk aversion continues to consume global financial markets as the equity weakness in Europe has extended to the U.S. The S&P 500 and Dow dropped over 1.3% on Wednesday. The main Russia ETF fell 1.87%.
Not surprisingly, the negative news flow out of Ukraine continues to hurt Russian and European equities as investors cherry pick which countries and companies will be hardest hit by sanctions.
Concerns are growing that peace between the Ukrainian government and pro-Russia separatists in Eastern Ukraine is not in the cards. The Kiev government currently claims that rebels attempted to storm the Donetsk airport overnight. Russian media is full of stories of human rights abuses by the Ukrainian military.
Meanwhile, officials in the German government are now signaling that even more sanctions may be applied against the Russian economy if the rebels make territorial gains beyond the regions of Donbass and Luhansk. German officials are specifically concerned about a takeover of the Donetsk Airport or even the city of Mariupol, a new city added to this list of uprisings this week.
Donetsk rebel leader Alexander Zakharchenko said in the local press on Wednesday that, “In two or three days, we will take control of the Donetsk airport.”
The market is treating this as a negative for Ukrainian debt, sending credit default swaps through the roof during the day today.
Moreover, even as debt default risk increases for Ukrainian lenders, the direct impact of the West’s sanctions on Western companies is beginning to emerge. For instance, violations of sanctions on Syria and Iran have already cost BNP Paribas more than $8 billion, Reuters reported in June.
Germany’s Commerzbank is reportedly being probed by U.S. regulators over violations of Iran sanctions that may end up costing the bank more than $700 million.
“No company wants to run afoul of these sanctions,” said Andrey Goltsblat, head of the Moscow lawfirm Goltsblat BLP, a division of U.K. international law firm Berwin Leighton Paisner. “Washington wanted to put these sanctions in place and it will impose them at will if it has to,” he said.
The sanctions wedge for any business dealings between U.S., European and Russian firms is widening. One of the more prominent is the Russian sanctions against agribusiness firms in both markets. At the Moscow Food Fair last month, representatives of food companies from sources without a foothold in the Russian market tried to muscle in on traditional suppliers.
“They’re coming from everywhere now to replace our European partners,” said Stefan Kuehr, general manager at the Radisson Royal Hotel in Moscow.
When it comes to economic might, food is not as sexy as oil. ExxonMobil’s $700 million deal to drill for hydrocarbons in the Kara Sea in northern Russia faces threats similar to BNP and Commerzbank. Bloomberg reported on Sept. 12 that the deal could be stopped before it’s finished. Sanctions this summer outlawed doing oil and gas partnerships in exploration and development, which is right in Exxon’s wheelhouse.
Militarily, though, there does not appear much that the West is willing to do to save nearly insolvent Ukraine from military defeat. ‘Ironhorse’ tanks being sent by the U.S. into the Baltics, while certainly raising the American flag over historic Russian real estate, will “not affect the outcome in the battle for the Donetsk Airport or Mariupol,” said Bretton Woods Research’s global economist Vladimir Signorelli. In fact, it will likely empower the pro-Russians to act out instead.
For Ukraine, this is becoming a Lincolnesque lesson in “divided we fall.”
On Tuesday, Poroshenko rejected that federalization is even possible for Ukraine, with Kiev being the recognized command center. Instead, he has been promoting a Polish model, which would decentralize Ukraine by introducing counties and municipalities, but this is not what the rebels want. They want an autonomous region, like Hong Kong is to China, or better yet, like Crimea was to Ukraine…before Russia annexed it on March 16.
Meanwhile, Ukraine’s economic situation remains grim given Prime Minister Arseniy Yatsenyuk’s faithful toeing of the International Monetary Fund’s austerity measures. One look at the credit default swaps market — which measures debt risk — and one can see that speculators are pricing a 69% likelihood of default over the next few years. This might not happen, but the risk means higher lending costs for Ukraine, which needs as much money as it can get. Financing growth will be painful, especially in dollar or euro-denominated debt. The Russians surely are’t going to come running to save them. Since president Viktor Yanukovych’s ouster on February 22, the Ukrainian currency has fallen nearly 60% against the dollar. Yatsenyuk said that 30% would be okay. He got double his base case scenario.
“Yes, to some extent there are grounds for concern. But we are not alone. All investment banks around the world are worried,” said Olga Podoinitsyna, member of the board at VTB Capital.
“If the West wanted the Ukraine to join the E.U. as a stable and prosperous member, it would have put an economic growth policy in place, not this austerian mess,” said Signorelli. “It’s impossible to imagine how we would have won the Cold War if these policies were heaped on West Germany following WWII.”
The economic demise of Ukraine will almost certainly lead to continued, political fracturing of the country. And that means more civil unrest in the east. So long as the West is convinced that Russia is fighting a proxy war by aiding the anti-Kiev rebels, more sanctions are coming.
If you would like to receive our legal alerts and updates highlighting current legal issues relevant to your areas of interest and providing expert commentary by our lawyers, please click on "Sign Up" and fill out the form.