Russia-Ukraine’s Brooding Border Clashes

Russia and Ukraine stock market relative outperformance on the respective MSCI core and frontier indices was in play as a naval confrontation in Crimea sparked international condemnation and Kiev’s martial law declaration in border provinces already reeling from Moscow’s port grab. The Russian Foreign Ministry blamed stray ship provocation after forcibly boarding it and arresting sailors, while the US and Europe convened a UN Security Council session to criticize the action and threat further commercial and diplomatic sanctions. The incident preceded the annual G20 summit in Argentina with Presidents Putin and Trump in attendance and focused regional attention on the civil war in Eastern Ukraine with its heavy economic and humanitarian toll. Russian-supported rebels have taken over factories and declared their own government, while tens of thousands have been killed or fled the area 5 years after the Minsk agreement outlined a peace framework, according to outside monitors. GDP growth is set at 1.5% this year with oil above the budget’s $40/ barrel breakeven price, but sovereign borrowing continued in the wake of the latest Crimea events to close a slight deficit after VAT and pension changes. Geopolitical friction further weakened the ruble and the stock market’s valuation discount, and could send inflation toward 5% into next year prompting modest central bank tightening. State-owned Sberbank and VTB earnings were healthy in the latest reports with strong moves into infrastructure and technology to support domestic franchises, aided by depositor flight from ailing and shuttered private rivals under tougher supervision. Leading officials and executives have tried to encourage de-dollarization, with foreign reserves in the currency to be phased out in a challenge to Washington as Moscow also allies with Iran, North Korea and Venezuela.

Ukraine’s reaction was magnified by a bruising presidential contest with the incumbent Poroshenko running behind former holder of the post Tymoshenko, as both called for a harsh response. They are also dueling over a successor 1-year $4 billion IMF program after an October staff agreement was reached. Kiev passed energy price and tax hikes to keep the budget deficit below 3% of GDP and enable release of a first tranche in early 2019, but Tymoshenko’s and other candidates’ platforms oppose Fund austerity demands and pledge to roll back fuel cost increases. The fiscal package is also negative for securities markets with a 15% dividends levy, and could generate 10% inflation also due to currency depreciation with the meager less than three months imports’ reserve coverage. The 4% of GDP current account gap lingers despite a record $12 billion in remittances this year, and another Eurobond issue to ensure external financing is likely off the table until poll results are in, analysts believe. The EBRD predicts 3% growth in 2019, with both domestic consumption and investment stymied by high interest rates and political doubts. Successful privatization could boost confidence, with utility Centrenergo going on the block mid-December, but agriculture and metal exports are the mainstays drawing private equity and strategic investor interest. Eyes are also on next door Poland’s general elections at the end of 2019 which hosts the Ukrainian worker influx, with the populist ruling party still favored but experiencing an opposition incursion in recent local contests.

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