Ukraine Politics: Dangerous Escalation

Ukraine looks for a strong response from the West after Mariupol attacks

The week ahead is a decisive one for the EU and the West. The shocking attack on Mariupol over the weekend has been condemned by NATO, the OSCE, and scores of EU leaders, yet only a serious strengthening of the sanctions regime following a planned meeting of EU foreign ministers this Thursday will actually slow or deter Putin from further moves, in our view. We, however, are not optimistic on Europe's resolve; at this time we believe any new sanctions that may be adopted will be largely toothless, which does not bode well for a near-term stabilization of the situation in Ukraine.

The timing of the most recent escalation of fighting is not insignificant – that it coincided with both the gathering of the global elite in Davos and Ukraine's Unity Day on January 22 is no simple twist of fate. The calculated move by Putin was timed to ensure the media spotlight was on Davos rather than on Ukraine. He also knew his message would get through to European and Western leaders – a big middle finger to the sanctions regime, a nod to the doves that continue to stall more serious and more unified efforts to confront Russia, and an attempt to dissuade foreign donors and funders (notably the IMF) from putting together a financial package for Ukraine.

Surely this weekend's shelling of residential neighborhoods in Mariupol and the 30+ civilian deaths will swing the balance of power in Europe back towards the hawks. After the relative lull in fighting over the holidays, the doves, led by the EU's foreign affairs chief Frederica Mogherini, had in recent weeks started a push to scale back sanctions and restart a dialogue with Russia. The attacks on Mariupol have changed that, in our view, and a weakening of the sanctions regime is simply not on the table any longer.

EU foreign ministers will meet on Thursday to consider a response. In our view, despite the shocking nature of the attacks, the EU is still not prepared to adopt truly isolationist measures such as cutting Russia off from the SWIFT network of financial institutions. The foreign ministers will most certainly issue a sharp, albeit meaningless statement, but if they adopt new sanctions we believe they will be largely toothless.

Given our view that sanctions, for now, are unlikely to be strengthened or widened, the price of oil will remain a key determinant of Russian economic strength – or rather weakness – and its continued geopolitical moves. It is noteworthy, then, that immediately following last week's ascension to the throne, the new King of Saudi Arabia Salman pledged to maintain current crude oil production levels. That said, we believe the causative economic consequences of low oil prices on Putin's further moves in Ukraine could take significantly longer to take hold than the precipitous plunge in oil prices since May would suggest.

In short, the Mariupol attacks look like an attempt by Putin to gauge the West's nerves and its willingness to continue to appease his foray into Ukraine. Should Thursday's meeting of EU foreign ministers not deliver a negative shock to Putin, we believe it will embolden him for further moves.

On the more positive side, the IMF looks ready to approve a financing package for Ukraine aimed at macroeconomic stabilization and long-term reforms. We expect progress on the new request for financing, although it could take several weeks or even months to approve the request. The request requires approval from the IMF's executive board, and at the moment, the board is not scheduled to meet within the next 7 days.