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UKRAINE - IS THE TIDE TURNING AGAINST PUTIN, AGAIN?
Analysis & Commentary, By Timothy Ash
Bluebay Asset Manager
London, UK, August 4, 2022
LONDON......I thought it worth updating my thoughts on Ukraine, and particularly where this war is going as the duration and ultimate damage done by the conflict will be key to understanding the longer term economic story in Ukraine - the rebuild demands.
First point here is that it's clearly difficult to predict anything in a conflict. And we have seen the ebb and flow of this war with first Moscow's apparent blitzkrieg and most peoples’ assumption it would be all over in days with a Russian victory, but then the Ukrainian victory in the battle of Kyiv, then Russia refocusing on Donbas and victories in Severdonetsk and Lychachyansk, and in recent weeks what seems to be the momentum turning again through the provision of new Western military supplies (HIMARS) to Ukraine, with Russian momentum in Donbas stalled and the focus now turning to a looming battle for Kherson with Ukraine expected to go on the offensive.
Second, we know here that much depends on Putin ultimately, and the war will end when Putin decides to stop offensive actions - he might need to be beaten on the battlefield first though. And therein six months in, surely Putin must now be questioning whether he really can win this war? If that is the case, maybe he will push for a nearer term peace deal.
And therein I think what is now clear is that Russia does not have unlimited capacity to prolong this conflict unless that is Putin is prepared to put the Russian economy on to full scale, total war settings - think WW2 style general mobilisation and back to state planning of the economy.
I guess you could refer back to Iraq under Saddam and say, look he waged the Iran war for close to a decade. But back then Saddam was being financed and armed by the Gulf and the US. Russia currently has limited external sources of money or arms - albeit higher oil prices are helping.
But it is with arms and troops that Putin has the problem. By most accounts Russia has lost a huge amount of kit and troops in this conflict - likely half its combat capability. The kit is difficult to replace quickly. Russia is running out of supplies of high precision missiles, and they are difficult to manufacture given Western technology export bans to Russia. And China has not been willing to help Russia herein - albeit that could change with the idiotic Pelosi visit.
And on resupply, the HIMARS systems are now having a devastating effect - wreaking havoc on Russian supply chains which were already vulnerable. If Russia cannot get sufficient kit to the front line it cannot conduct war, simple as that.
And then there is the issue of troops and morale. Ukraine has said it can get 1 million troops in the field, and given its home advantage and now Western training (10k every 3 months being trained in the U.K.), manpower is not an issue for Ukraine. But it is for Russia. Russian casualties are likely tens of thousands already - some suggest KIA and MIA might be as many as 100,000, half the number of troops that initially started this campaign.
And unless Putin begins a general mobilisation, Russia just cannot get that many troops quickly into the field - actually also pointless if it cannot arm them anyway given resupply problems. Indeed we are seeing Russian forces having to be moved from different fronts, first from the north to Donbas, now to the South.
Meanwhile, for political reasons Putin seems reluctant to go to a general mobilisation - he seems happy to use troops drawn from poorer southern, largely Muslim, regions but not risk casualties from Western Russia, from Moscow and St Pete, et al. He is therefore obviously nervous about the domestic political setting in Russia itself.
Bottom line here is that Ukraine can mobilise close to 1 million men, and women, who are motivated to fight for their land. Putin is already close to depleting Russian regular forces and do Russians really want to fight for someone else’s land unless they really are totally brainwashed, or desperate (in the form of prisoners being freed to fight in Ukraine).
So it feels here as though Russia is reaching the peak of its capability to launch major offensive actions in Ukraine. It feels like Russia has got to the peak of its reach in Ukraine, so taking Crimea, much of Donbas and big chunks of Kherson and Zaporizhiya. And it feels to me now that the Kremlin agenda will be trying to consolidate these gains on the ground via some kind of diplomatic route.
Perhaps here we could see the recently reached grain deal as a start of that process - the deal made no sense from a Russian perspective, unless it was eyeing some bigger peace deal. Also note Schroeder's recent visit to Moscow and claims Russia wants a peace deal. We can debate whether Ukraine and Ukrainians are in any way inclined to accept anything of which Schroeder appeared to suggest.
From the Ukrainian side, they are only going to get stronger with more Western kit and financing arriving, and no shortage of motivated soldiers - surely Moscow realises now that time is not on its side. The longer it fights this war, the stronger Ukraine and the more impact that Western sanctions will have on its military capability. And remember on this latter front that for Putin the war in Ukraine is just part of the broader war with the West.
And we are now entering an arms race, with NATO set to go +2% of GDP spending on defence, and Russia simply cannot match that. Just do the maths, Western states now reigned against Russia have a combined GDP of what $40 trillion, 2% of that is $2 trillion, which is more than Russia’s entire GDP.
Putin needs now to replace half his military destroyed in Ukraine, and spend even more than pre-war just to maintain some kind of military parity with NATO. The longer he continues the war in Ukraine, the longer sanctions and the less able he will be to maintain any kind of military parity with the West - at least in conventional weapons, as nukes are a separate story.
Winning in Ukraine is important to Putin but would he want to jeopardise Russia’s broader security vis a vis the West by eroding its conventional military capability so much that it will struggle to counter possible NATO threats (not that I see them). And if Putin is going to try and maintain any kind of military parity with the West, surely this puts Russia back into a guns versus butter (or I-phones) scenario.
For Russia to keep pace with likely $2 trillion Western defence spending it will have to divert resources from consumption to defence, and this will raise fears about political stability. Russians will inevitably get much poorer, and will they still prize the capture of Donbas when they are to struggling to maintain living standards? I doubt it - as the star of Crimea has waned in Russia, post 2014.
So I think Putin has no other option here but to try and push some kind of peace deal, the sooner the better from his perspective. I think this winter. And what we are likely to see is the last big battle over the next month or so in Kherson, the gas crisis in Europe play out in the next few months, and at its peak, perhaps October-November, the Kremlin comes up with some peace plan.
At that point Ukraine will be under huge pressure from Europe to accept Moscow’s - opinion in Ukraine is set against a deal (polls show 90% against now giving territorial concessions to Russia as the price of peace), but let's see how that might change with the battle for Kherson. If the Ukrainians fail to recapture much territory, the mood in Kyiv might change. But I would expect Europe to try and bribe Ukraine big time to accept some kind of deal - ultimately a big reconstruction package would be good for Ukraine's growth/recovery story.
Not sure here though that the US, and it’s UK and Eastern European backers would be quite as enthusiastic as the appeasers in Germany and France. They are likely to be of the view that a real peace in Ukraine, and the security of Europe, can only be brought with a defeat for Putin, and the Ukrainians (backed by Western money and arms) are the best chance of achieving that. I don’t think Washington or London will be pushing Ukraine to agree a deal at any price. They will encourage Ukraine to negotiate hard, and hopefully from a position of new strength on the battlefield.
If Ukraine fails to accept peace, then I think we are in for a long grinding war, but at a much lower intensity - think back to Donbas 15-22, where the scale of the conflict is reduced significantly, we see various rounds of attempted peace talks which don't go very far. But in this scenario, Ukraine can still get back on with reconstruction.
Lots of money is still pumped in, and we see real GDP rebound from the low. Russia will remain weighed down by sanctions and hence in decline - whatever endgame in Ukraine, the arms race between the West and Russia will continue and hence the West has little real reason to relax sanctions.
The alternative is I guess that Putin is just hell bent on Ukraine's destruction, and likely with it that of Russia - perhaps the line on Ukraine could be “if I can’t have it, I will ensure trust you won’t want it”. He continues the attacks and as per the Iran- Iraq war both countries are grinded into the ground. But as with that conflict I don't see a win for either side. Neither has the capacity to win this war. That just seems like fact now - actually the more likely longer term winner would be Ukraine as I noted it has the troops and will get more Western kit and finance.
Now on the gas crisis, I think Putin plays that to full effect this winter, to get old Europe in a place where they are desperate to deal, and force Ukraine to deal.
Why this winter?
Because I think this is Putin's last chance to play this card. The longer he leaves it the more Russia will have been cut out of Europe's supply chains. And it will inevitably be cut out of supply chains for sure over the longer term as it has proven to be an unreliable supplier. So his card is now, this winter, not next year. If he is to play this card it is now. And the Kremlin will think they need to play it to bring this war to an end.
Just as an aside here on the energy crisis in Europe. Putin will play the gas card for sure, but he does have to be a bit careful. If he forces Europe, and the world, into recession as seems likely now he collapses global demand for energy and with it energy prices. He will then face the double whammy of lower export volumes and prices, so it will be ironic if only with peace comes the collapse of the Russian economy - guess you might say there it gives him an incentive to try and maintain tensions.
So summarising, my base case is a European energy crisis, brought on by Putin desperate now to get a Ukraine peace deal before year end. Big risk here is that Zelensky might not be able to sell that domestically - polls show 90% want the war to continue until all territory is regained - but lots of Western cash will be deployed to entice Ukraine to the table. But Ukraine will get big Western financing flows anyway, given the need now to build Ukraine as a defensive buffer state against Russia. And in the Schroeder peace offer, there is no way NATO would now accept a demilitarised Ukraine.
The good news for Ukraine in an early end to the war is that the economy is likely to bounce back quickly, as a result of the low base effect, the innovation shown in the war, and the huge Western financing likely to flow into Ukraine - we can debate the West’s willingness to write big checks for reconstruction but surely NATO now has a huge incentive to build the Ukrainian military into a supreme fighting force and buffer against Russia. And I use the State of Israel analogy here - like Israel, Ukraine fought this war as it had to to actually survive.
It will need to successfully rebuild its economy for the same reasons, to be economically powerful enough to be able to counter likely future Russian aggression. Important also to remember that whereas on February 24 we were debating whether Ukraine would exist, but we know now that despite Putin trying his best, a Ukraine with a significant part of its pre-Feb 24 land area, and access to ports, will exist. This is still a huge country, with a large, skilled population, which is absolutely viable as a state. It has fought and proven its right to exist.
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