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The end of the cold war after the disintegration of the Soviet Union in 1991 and the subsequent rapprochement between the West and Russia was responsible for the so called ‘peace dividend’ i.e. risk premia on a whole set of asset classes like equities, oil etc. coming down as it was believed that the resulting stability and détente between the two adversarial blocks would ensure that economic resources would not be frittered away majorly on defence but will be utilized for productive purposes. This lowering of risk premia was one of the major structural reasons underpinning the sustained outperformance of equities.
Crimea’s secession from Ukraine and likely accession to the Russian Federation marks a tectonic shift in this nearly two-and-a-half decade détente. The global equity and oil markets have shrugged-off the impact of this epochal event and are focusing on strengthening short-term monthly economic indicators in the US.
The West has imposed some minor sanctions on a few individuals by debarring them from travelling to the West and seizing their assets and has refrained from substantive punitive measures, especially because of European (Germany imports 35% of its gas from Russia, Italy 31%, Poland 70%, Bulgaria 90%, Romania 25%) fears of disruption in supply of gas & oil from Russia and its impact on their fragile economic recovery.
From the Western standpoint, the ‘annexation’ of Crimea by the Russian Federation raises concerns about its belligerent expansionist agenda which could encompass other regions in Russia’s ‘near abroad’ i.e. ex-members of the former Soviet Union and members of the erstwhile Warsaw Pact.
With significant Russian-speaking minorities in many of these countries like the Eastern part of Ukraine, the five Central Asian republics of Kazakhstan, Uzbekistan, Krygyzthan, Turkmenistan & Tajikistan as well as the Baltic states of Estonia, Latvia and Lithuania (which are members of the US and EU led NATO alliance), the fears are that Russia could use the same reasoning of ‘threat to Russian speaking minorities from far-right neo-Nazi & fascist forces’ to intervene and foment trouble.
The secession of two provinces, South Ossetia and Abkhazia, from Georgia in 2008 during President Bush’s tenure went unchallenged from the West emboldening Russia to attempt something similar in other countries in its periphery.
From Russia’s perspective, NATO & EU are continuing to spread their influence by including the Warsaw-pact countries (which were under the influence of Communist Soviet Union) in Eastern Europe like Poland, Hungary, Czech Republic, Slovakia & Romania, Bulgaria; Balkan States like Croatia, Slovenia and the three Baltic states of Estonia, Latvia & Lithuania that were part of the Soviet Union.
Trying to co-opt Ukraine (and previously Georgia) in the EU was perceived to be another provocation in EU’s attempt to encircle parts of Russia. The fight for dominance between the Eastward-expanding NATO & EU and Russia’s dogged efforts to form a rival Eurasian Economic Union (current members besides Russia are Belarus and Kazakhstan) will inject instability and have long-term ramifications in the geo-political and geo-economic affairs. A new ‘Great Game’ has started in earnest between Russia & the West.
With its strong position in global oil & gas markets, second largest nuclear & missile arsenal, a Veto in the UN Security Council and potential to create trouble for the West in many Geo-political theatres like Iran, Syria, North Korea etc, Russia’s adversarial stance has a strong potential to lead to a sudden spike in risk premium in equities and oil markets. The longstanding ‘Peace Dividend’ is fraying and markets better take note.
The author is Head - Investment Strategy & Advisory at Prabhudas Lilladher
