Wednesday, May 21, 2014

Putin's motives and next steps

Recently Sam Zell, a major US investor, made some comments on the dangers of Vladimir Putin's unpredictable behavior and Russia's aggressive foreign policy. Zell's point was that investors are simply not paying enough attention to Putin's dangerous ambitions, which could further raise geopolitical risks and adversely impact asset valuations.

Perhaps. But let's take a closer look at Vladimir Putin and what ultimately drives him. It's important to point out that the Russian leader sees almost no opposing views within the nation's government. From Russia's parliament to its central bank to the country's mainstream media, when Putin says "jump", the answer is always "how high?". The risk of course is that without any opposing views he could put the country on a dangerous path. We've seen this before with popular authoritarian leaders around the world. But there is one potentially opposing voice that Putin does listen to. It's his domestic popular support.

Vladimir Putin is driven by power. But he is also keenly aware that power requires popular support and after running the country for such a long time, popular support is not a given. The Orange Revolution in Kiev is just a reminder of how much a significant loss of popularity could cost an authoritarian ruler. In fact, prior to the takeover of Crimea, Putin's popularity was on the decline, and the annexation of the region improved his standing dramatically. It wasn't just one of Russia's favorite vacation spots where scores of wealthy Russians own property that made that decision popular. It solidified Russia's control over the strategically important port as well as the massive oil and gas reserves in the Black Sea (which Ukraine has now lost).

As discussed before (see post), Russia is not concerned about any serious economic sanctions, making Crimea well worth damaging the relations with the West - for now. Eastern Ukraine is another story however. While the majority of Russians supported the Crimea move, there is far less appetite among the population to move into other regions of Ukraine. And the inhabitants of eastern Ukraine may not be as welcoming as those in Crimea - in spite of all the pro-Russian activism in the area. For a shrewd survivor like Putin, that matters. We therefore see Russia taking a much more cautious approach in eastern Ukraine.

Moreover, the longer the impasse with the West lasts, the more precarious Russia's economic situation becomes. Both foreign and domestic investment has slowed and confidence took a beating. A tighter monetary stance (higher rates) instituted to support the ruble has not helped. In fact Goldman's leading index is now showing Russia's economy beginning to contact. And for a BRIC nation accustomed to years of growth, this is a big deal. In the intermediate term this slowdown is bad news for Putin, as his post-Crimea popularity will soon start to fade.

That is why we see Mr. Putin taking a trip to Beijing. Closing the $400bn natural gas deal with China is a sure way to help the economy at home. Getting some support from China on the Ukraine situation is also helpful. All this puts "points on the board" for the Russian leader at home.

Fairly soon we should see Russia pull back the troops from the eastern Ukrainian border. Putin has plenty of operatives on the ground in Ukraine to know exactly what's going on, giving him the ability to tactically redeploy troops as needed. Moreover, in months ahead he will reach out to Western Europe through unofficial channels and try to engineer some sort of an agreement with the goal of normalizing relations. If Europe goes for it, the US will have to follow. Putin's goal will be to restore investor confidence in order to keep the economy from slipping into a recession and damaging his popular support. In spite of Sam Zell's warnings, further Russian aggression in the near-term is therefore unlikely.

Having said this, it is important to understand that the Russians view the Ukraine territory (as well as Belarus) as a their "western buffer". Based on Russian history (whether it was 1812 or 1941), the need for that buffer, combined with the mistrust of the West, is ingrained in the Russian psyche. That's why when the idea of Ukraine joining NATO was brought up several years ago at a conference, it panicked some Russian generals. Western leaders should therefore understand that the thought of Ukraine joining the EU is a highly sensitive issue for the Russians, in spite of the new leadership in Kiev pushing to accelerate the process. And any sudden moves in that direction in the near-term could escalate tensions with Russia.
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