Russia may opt for institutional combat strategy; Eurobond conflict looms

Six weeks out from local elections, political maneuvers – the exit of a minor coalition partner and rumours of a merger between heavyweight parties – speak volumes in the headlines but are strategically insignificant. The parliamentary coalition remains well capable of continuing to enact reforms. And although the pace of reforms continues to underperform lofty expectations, there can be no question that the administration is moving the ship in the right direction. Meanwhile, the conflict with Russia is not going anywhere. Both Ukraine and Russia are preparing for a court battle over the contentious USD 3bln Eurobond due in December, and for now, our base case sees Russia pursuing a strategy of institutional combat as a way of derailing Ukraine from its current positive trajectory.

Reforms lag lofty expectations but are definitely moving in the right direction

IMF Managing Director Christine Lagarde last week visited Ukraine and praised the administration's reforms efforts, calling them "nothing but astonishing." We laud the fund's praise (carrots have a place alongside well-intentioned sticks), but the truth is somewhat less enthusiastic, although still definitely positive. Over the summer, Ukraine continued its "good enough" reforms effort, implementing a number of strong reform-oriented measures, but still failing to meet lofty expectations and doing less than it is capable of.

Conflict looming over Russia Eurobond

With a preliminary debt restructuring agreement in place the focus now turns to the contentious USD 3bln Russia Eurobond that comes due in December. Ukraine has shown its deep commitment to honour its international debt obligations, but we believe Ukraine will seek to invoke force majeure clauses and legal precedents to not pay the debt back to Russia, and to do so in accordance with international law and legal precedents and without triggering any default.

Poroshenko and Yatseniuk mull party merger ahead of local elections

The local elections in October will be an important milestone for Ukraine, both as a bellwether of public opinion and discontent and as a gauge of the country's view on the role the Donbas can play in an independent Ukraine. In the most recent public opinion poll (June 2015), PM Yatseniuk's party sank to dismal low single-digit territory (see chart on the left and full chart on page 3), which is driving rumoured talks of a possible merger between the Petro Poroshenko Bloc and Yatseniuk's People's Front.

Coalition changes do little to affect parliament's legislative capacity

Oleh Lyashko's coalition exit leaves the pro-government parliamentary coalition numbering at least 275, well above the 226 needed to pass laws. At this time we see no real risk of parliamentary discord that would endanger the institution's legislative capacity or bring up the spectre of new elections. Nevertheless, the upcoming final vote on proposed constitutional changes could pose a fresh stumbling point – something to keep on the radar.

Entrenched institutional combat as the next phase of Russia's hybrid war

Putin's possible next steps continue to be the main intrigue of the Ukrainian situation. For now, our base scenario sees Russia waging institutional combat: seeking mechanisms by which to sabotage efforts at economic reform and at kickstarting economic growth, sowing domestic political chaos, undermining the support of the international community, and denying attempts at integration with Euro-Atlantic institutions.

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