Russia Invades Ukraine: What’s Next?
Mar 1, 2022
by Harmen Overdijk

Russia launched a full-scale attack on Ukraine last week. After five days of heavy fighting whereby Russia initially focused on military targets, the attacks seem to have broadened.

Perhaps Russia was expecting that its army would be able to take most major cities quickly and be able to dispose of the government within days. However, the willingness of ordinary Ukrainian citizens to take up arms alongside the military has slowed Russia’s progress. International sentiment has sided with Ukraine in part due to the country’s use of social media to document the events.

The problem is that Russia cannot afford to not win this phase of the war. If they don’t overthrow the current government, the result will be a country that not only gets major economic and military support from the U.S. and EU but wants to distance itself even further from its neighbor. This would make Ukraine an even bigger threat to Russia’s security than before.

Russia’s objective is most likely to make Ukraine a vassal state, which would create a bigger buffer between Russia and NATO countries like Poland, the Baltic states, and Hungary. Russia invaded Ukraine to prevent it from becoming a defense partner of the U.S. and its allies. It is not likely to attack NATO members directly, who share a mutual defense treaty.

Will Economic Sanctions Work?

The U.S. and EU are imposing sweeping sanctions, including cutting off access to the SWIFT international payments system for the largest Russian banks. This will cause significant economic pain. On top of that, the sanctions specifically target the Russian Central Bank’s foreign currency reserves. Basically, the central bank lost access to half of its USD 600bln reserves. This could mean Russia will eventually have trouble financing the war, which is estimated to cost them USD 15 billion a day. On the other hand, high energy prices and a weaker ruble are helping Russia with domestic costs.

At the moment, we think it is unlikely that Europe will halt Russian energy exports, as that would cause energy prices to explode higher and this could lead to a recession in Europe. However, it is possible that the escalation of European sanctions will lead to Russia cutting off Europe’s energy, which could produce a large energy price shock. 

However, Putin might have underestimated Europe’s willingness to suffer economic pain to punish Russia for its aggression. I am originally from the Netherlands, and my family and friends back home have been stocking up on electric heaters and electric stoves over the weekend as they are prepared for Russia to turn off the gas.

Another unexpected development was that Germany’s Centre-left coalition government announced over the weekend they will basically triple their 2022 military budget from circa USD 55 billion to 165 billion. This is a significant change in mindset – it will be the first year in decades that Germany achieves 2% of GDP spend on defense, a NATO requirement. This will likely lead other European governments to follow suit. Ironically, Putin’s desire to put distance between Russia and NATO may have reinvigorated NATO overall. To put this in perspective, Russia defense’s budget was USD 62 billion in 2020.

Therefore, Putin’s strategy will likely not last forever. Ukraine will mark another case of Russian strategic overreach that will generate a social and political backlash in the coming years. While Putin has sufficient support among older, more Soviet-minded Russians for his Ukraine adventure, he lacks support among the younger people who will have to live with the negative economic consequences. 

From a broader, geopolitical point of view, Russia’s invasion of Ukraine drives another nail into the coffin of globalization. Russia is further distancing itself from the western economy. The U.S. and its allies are imposing export controls on critical technologies such as semiconductors against Russia to cripple any attempts at modernization.

The U.S. is already restricting China’s access to semiconductors and from now on it will try to enforce these export controls via secondary sanctions, giving rise to proxy battles in countries that Russia and China use to circumvent the sanctions.

Russia will be forced to link its resource-driven economy to the Chinese economy. Hence a major new geopolitical realignment is taking place between the U.S., Russia, and China.

However, China is also careful not to alienate its western partners too much. The West is more important for China economically than Russia will ever be.
Another complication for China is that it actually does more trade with Ukraine than it does with Russia. China imports a lot of food from Ukraine.

That is a key reason why the Chinese government is calling for a ceasefire. It also explicitly warned Russia not to expect China to bail them out after the U.S. and EU cut off Russia’s largest banks from the SWIFT international payments system.

Impact on Markets

Notwithstanding the human catastrophe, the economic impact of both Ukraine and Russia on the global economy is relatively small.

The recent correction in global equity markets was mostly caused by rising inflation and anxiety about how aggressive the Fed will be in its monetary policy. But for sure the geopolitical tension was adding oil to the fire. In recent months we already repositioned our portfolios to a more defensive tilt by adding commodities and increasing the weight in value and quality stocks.

We currently believe the Ukraine conflict will not lead to a global recession and therefore we favor staying invested in a diversified global portfolio of risk assets.
Let’s not forget that inflation is still high, and this conflict will add to inflationary pressure. Holding cash is not really an option in an inflationary environment.

Rest assured we are following the latest developments closely and are assessing their impact on the global economy, on long-term market expectations, and on your portfolio constantly.


DISCLAIMERS & DEFINITIONS

This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.

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