Relative pain in Ukraine

Events around Ukraine are clearly damaging the economies of both Russia and the western countries, in particular Europe and the United States.

Russian and Western political leaders put forward, however, different views on the size of the respective damage. In addition, economic motivations are assumed to influence policy decisions, particularly in the West. Thus the more determined attitude of the US with respect to the more hesitant one of Europe is attributed, at least partly, to the fact that Europe is economically more vulnerable to tensions with Russia. Even within Europe, policy differences are assumed to  derive from different exposure to the Russian economy.

President Putin put the economic consequences of the crisis in Ukraine, and specifically of the sanctions, as follows: “Sanctions tend to have a boomerang effect, and without any doubt in this case they are driving Russian-American relations to a dead end, they are causing very serious damage,”  “I am convinced that this is to the detriment of the long-term strategic national interests of the American government and the American people.” (Financial Times of July 18th).

Chancellor Merkel said: “Regarding sanctions against Russia, we have so far reached level two and we cannot rule out having to go further. (…) We will not stop looking for diplomatic solutions. But we are nowhere near where we want to be.” (NATO Conference, July 2nd)

While President Obama said:Both Angela and I have repeatedly said, we want to see a diplomatic resolution to the situation in Ukraine. But we’ve also been clear that if the Russian leadership does not change course, it will face increasing costs as well as growing isolation — diplomatic and economic. Already, the ruble has fallen to near all-time lows, Russian stocks this year have dropped sharply, and Russia has slipped into recession. Investors are fleeing, and it’s estimated that $100 billion in investment will exit Russia this year. Russian companies are finding it harder to access the capital they need, and Russia’s credit rating has been downgraded to just above “junk” status. In short, Russia’s actions in Ukraine are making an already weak Russian economy even weaker.”  (Remarks by President Obama and Chancellor Merkel in Joint Press Conference May 2nd)

Given these different assessments and to test the hypothesis that indeed political attitudes are influenced by economic factors, it is interesting to see what is the view of the market about the distribution of the damages between Russia, Europe and the United States.

The first step in the exercise was to identify salient events in the Ukrainian developments. These are reported in the table below.

Table 1. Selected events in Ukraine 

Date Comment
11-Mar-14 Crimean parliament declared Crimea independent from Ukraine; To hold referendum for joining Russia.
13-Mar-14 Pro- Kyiv vs Pro- Moscow protestors in Donetsk results in injuries and one death
14-Mar-14 Discussion of Secretary of State John Kerry with Russian Foreign Minister Sergei Lavrov in London yielded no result regarding crisis in Ukraine. Secretary Kerry : “after much discussion, the foreign minister made it clear that President Putin is not prepared to make any decision on Ukraine until after the referendum on Sunday.” The European Union is preparing to impose sanctions on Russian officials and businessmen following the Crimea referendum.
24-Mar-14 Intensified protests over the weekend; Russia Expelled from G8, with G7 threatening Additional Sanctions
7-Apr-14 People’s Republic of Donetsk:  In Donetsk pro-Russian activists demanded regional government to vote to authorize a referendum on allowing the “Donetsk Republic” to join Russia
23-Apr-14 President Turchynov renewed the offensive against separatists (whose activity is seen like an act of terrorism);
2-May-14 Between 30 and 45 pro-Russian activists died in Odessa. Reported as the deadliest day in Ukraine since the protests started
10-Jul-14 EU Diplomat  confirmed that new economic sanctions are imminent for 11 new individuals involved in the Ukrainian Crisis. Following this the US enforced the new sanctions as well.
17-Jul-14 Malaysian Airlines Flight Shot Down in Eastern Ukraine

Chart 1 shows the effect of these events on the Russian stock exchanges, giving a first visual evidence that indeed there were negative, albeit not permanent, repercussions for Russia.

Chart 1: MICEX index vs news related to the Ukrainian crisis


Source: Bloomberg

The most interesting message comes, however, from comparing what happened to the Russian stock exchange with the impact on the stocks of western economies. This is done in table 2.

Table 2. Stock exchange losses due to events in Ukraine, in per cent.

Date US(S&P) Russia Europe France Germany Italy
11-Mar-14 -0.51 -2.29 -0.01 -0.48 0.46 0.39
13-Mar-14 -1.17 -2.01 -1.50 -1.29 -1.86 -0.91
14-Mar-14 -0.28 -0.89 -0.49 -0.80 0.43 -1.19
24-Mar-14 -0.49 -0.72 -1.41 -1.36 -1.65 -1.65
7-Apr-14 -1.08 -2.36 -1.37 -1.08 -1.91 -0.84
23-Apr-14 -0.22 -0.49 -0.74 -0.74 -0.58 -1.18
2-May-14 -0.13 -0.09 -0.65 -0.65 -0.49 -0.01
10-Jul-14 -0.41 -1.22 -1.64 -1.34 -1.52 -1.90
17-Jul-14 -1.18 -2.31 -1.41 -1.21 -1.07 -2.21
Average -0.61 -1.38 -1.02 -1.00 -0.91 -1.06
Average relative to S&P average   2.26 1.68 1.64 1.50 1.74

Source: Bloomberg

The table shows that the impact of the selected events on the stock markets was generally negative in all markets concerned. However, as measured by the stock exchange, the Russian economy suffered more than twice as much (exactly 2.26 times, see last row) as the American one from events in Ukraine. The evidence about Europe confirms that the European economy is more vulnerable than the American one, but less than the Russian one, to events in Ukraine: for 1 unit of damage to the American economy, Europe had to bear a damage two thirds higher. Contrary to a wide held view, however, there is no significant difference within Europe as Germany, France and Italy do not show significantly different degrees of sensitivity to events in Ukraine,

In conclusion, while it is impossible to estimate the absolute size of the damage that the Ukrainian events are causing to the Russian, European and American economy, and it is thus also impossible to exclude that this damage could be very serious and even catastrophic, the reaction of the stock exchange market so far would indicate that indeed Russia suffers more than twice as much than the US, followed by Europe, with a loss two third higher than  the US. This can explain to some extent the different political attitudes of the three actors.

There is, however, another factor, much more difficult to measure, that impacts political reactions: the ability to bear economic pain. One reads in newspapers that this ability should be inversely proportional to the democratic vigour of the different countries: Russia, in this interpretation, should be capable of bearing more damage than the more vibrant democracies in the west. In my judgment, this is probably true in the short to medium term but not in the long one, where history shows that the superior resilience and strength of democracies eventually prevail. However, the period between the short to medium run and the long one can be rough, indeed very rough.

Post quoted in the Financial Times article of 27th of July by Wolfgang Münchau on “The west risks collateral damage by punishing Russia”


*** Madalina Norocea gave assistance in preparing this post.