The Russian invasion of Ukraine on February 24th sent shockwaves through the global economy, as disruption to two of the most instrumental energy and grain exporters created significant headwinds for global supply chains. As Ukraine’s shipping ports fell under Russian siege and Western sanctions limiting Russian energy exports were imposed, Europe’s dependence on Russian supply chains was soon realised. These headwinds have not only fuelled global inflationary pressures, casting further uncertainty over the economic outlook for developed economies, but have severely impacted key imports to emerging markets and sparked fears of a food crisis. Over seven months on from the start of the conflict, the narrative has begun to shift, with Ukraine having success in retaking previously occupied territory, leaving Putin exposed to mounting discontent in Moscow. As the stunning counteroffensive is met with a mobilisation of 300,000 Russian reservists, and renewed threats of destruction, will faltering support for the president mark the beginning of the end for Putin’s efforts to capture Ukrainian territory, or more severely, his time in power?
Pending Economic Slowdown
Russia’s position as a key commodity exporter allowed the accumulation of significant of sovereign wealth, driven by $119 billion from oil and gas revenues alone in 2021. The invasion has highlighted the importance of Russia to the global energy market, and the commodity price volatility seen since has led to predictions that Russian revenues from energy will jump to $337 billion in 2022 as oil prices remain elevated and natural gas prices surge amid ongoing supply concerns.
Despite an increase in revenue from energy exports, the Russian economy is facing huge levels of uncertainty, with the International Monetary Fund forecasting a year-on-year contraction in GDP of 6% in 2022, far below the original expectations for 5% growth. Putin’s efforts to ensure economic stability have resulted in the mobilisation of factories with the intent to increase military goods output. Workers involved in defence manufacturing have switched to a 12-hour day, helping ‘finished metal goods’ production surge 30% in July from a year earlier. Imports to Russia have declined over 50% this year, consumer spending has plummeted and with Putin currently running a budget deficit, it is becoming clear that the Russian economy faces massive repercussions from the ongoing conflict, despite the Kremlin’s efforts to paint a false picture of economic stability and strength in unity.
Growing Military Discontent
In recent weeks, the deteriorating economic outlook has been mirrored by a weakening military position in Ukraine, as Kyiv’s troops continue to launch counter-offensives which have resulted in the recapture of 6000sq km of land. Growing discontent amongst Russian forces, an apparent lack of clear strategy and embarrassing defeats have increased pressure on Putin, with his leadership being brought into question. The discontent no longer remains solely within anti-Kremlin circles, with one of Putin’s most vocal allies, Ramzan Kadyrov, now openly criticising the Russian Army’s performance in Ukraine. The question remains, where next for Putin?
In a chilling response last month, Putin issued a rare state TV address to Russia, in which he outlined plans to mobilise 300,000 reservists, the first partial mobilisation since WWII. Many are becoming sceptical that this can be achieved as a result of faltering support for the Kremlin and in response, anti-war protestors have taken to the streets in Moscow and St. Petersburg, resulting in around 2,400 arrests at the time of writing. Finland have also reported increasing queues at the border as Russian citizens look to flee in the face of receiving draft papers. In addition to the mobilisation announcement, Putin also renewed threats towards the west, accusing NATO members of engaging in “nuclear blackmail”, whilst renewing nuclear threats of his own. Markets have largely shrugged off these comments, and commodities have remained somewhat muted against the threat of escalation. Many have also come to believe that deteriorating support could lead to officers refusing to obey commands, should Putin order the unthinkable.
Western allies remain hopeful that further resistance from Kyiv and the ongoing discontent from Russian forces will result in the withdrawal of Russian troops from Ukraine and the ultimate removal of Putin from power. Should this unlikely scenario play out, the economic sanctions placed on Russia would likely remain in place, with the normalisation of energy exports improbable. One window of opportunity would be for Ukraine to ramp up their own commodity exports with a simultaneous easing of supply chains allowing food prices to fall to pre-conflict levels with wheat, corn and fertiliser prices dropping to more normalised levels.
In September, President Putin met with Chinese President Xi Jinping for the first time since the invasion. Whilst the two leaders share a similar world view, it appears their relationship has come under pressure. Xi raised concerns over Putin’s actions in Ukraine, to which Putin acknowledged China’s concerns and expressed his support for the strategic partnership and ongoing friendship between both countries. Despite the invasion causing a slight fracture between the two, Putin continued to advocate the “One China” principle, condemning the US’s visit to Taiwan whilst supporting China’s military exercises in response, further fuelling geopolitical tensions with the west.
Annexation of Eastern Regions
On 30th September 2022, Putin signed the formal annexation of four areas of Ukraine, claiming they were now Russian territory. The annexation comes on the back of so-called ‘referendums’ which were Kremlin-controlled, with Western allies labelling the move illegal under international law. The declaration from President Putin comes at a time where Ukrainian troops were having some success in their counter-offensive in the north with troops encircling a city in Donetsk, close to a region which has just been declared ‘Russian’. It is likely that the West will react to this move by Putin with further sanctions, with the EU already drafting plans to target Russian exports and impose a price cap on Russian Oil. Sanctions are likely to cause knock-on effects on the Russian economy, driving further public unrest across the country.
A Military Withdrawal and a Commodity Price Retreat
Any significant withdrawal of Russian troops would likely lead to an easing of global food prices, as further clarity surrounding natural gas supplies will reduce the upside pressures on headline inflation levels. With food and energy costs remaining key drivers of inflation, cooling price pressures will allow central banks room to manoeuvre as they look to tame inflation which has reached highs not seen in decades in many nations across Europe. A shift in monetary policy tightening to a dovish outlook would boost risk asset prices, relieving pressure on the consumer during the current cost-of-living crisis.
Any withdrawal based on growing discontent surrounding Putin remains unlikely given the number of previous predictions of his demise. The end-of-Putin rhetoric is nothing new, with predictions of his downfall being present for almost the entirety of his rule, predominantly in 2008, as the invasion of Georgia, the global financial crisis and a collapse in oil prices wiped out $1 trillion in Russian stocks, leading to an 8% contraction in GDP. Once again, the rhetoric ratcheted up as a full-scale invasion led many to believe this would finally be the end of Putin. Instead, the Kremlin has attempted to shift the focus towards national identity in order to increase support and open the door to a potential full mobilisation of troops.
What Next?
It is our view that any immediate withdrawal of troops from Ukraine remains extremely unlikely, presenting further challenges for global supply chains and the European energy transition in the short term. Headwinds remain for the global economy with natural gas flows into Europe running at around 10% capacity, increasing pressure on consumer finances as governments look to offset further price hikes with fiscal support packages, despite central banks attempting to tame multi-decade high inflation. Sustained supply chain disruption and increased fiscal spending may push the Bank of England interest rate expectations higher as policymakers look to prevent further weakening in the pound and bring inflation down towards its 2% target.
Whilst it is almost impossible to predict movements from Putin as he becomes increasingly isolated from even his most vocal allies, the recent escalation we have seen highlights the unlikelihood of a withdrawal at this time. It remains our view that Putin will hold on to power, but the cost will likely be high. In the face of a failing invasion, it is reasonable to expect Putin to consider annexation as a Russian win, as they did in 2014 with Crimea. Given the recent state address and Putin’s unpredictability, we cannot yet rule out further escalation moving into the winter months, and markets will be watching the evolving situation closely in the coming months as the conflict rumbles on.
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