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The Big Picture

Russia's Sharp Escalation

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  • Moscow’s decision to partially mobilize Russia’s military reservists marks the biggest escalation in the Ukraine conflict since it began.
  • Russia’s economy is holding up better than many expected, but hydrocarbon revenues are threatened by escalating Western sanctions later this year.
  • Prospects of a peaceful resolution to the conflict, already dim, appear to be receding further.

Russia has withstood the barrage of Western sanctions better than its adversaries had hoped. But some cracks are starting to appear. Russia's partial mobilization, announced on Wednesday, and plan to hold hasty referendums on four occupied Ukrainian territories joining Russia have been interpreted in the West as evidence that Moscow's war effort is being credibly challenged by Ukraine’s Nato-backed military. The energy war is also entering a critical phase: Russia’s “war premium” from higher oil and gas revenues is eroding, and pressure will increase with the planned introduction of EU oil sanctions from December. Western leaders keen to see the tide turn against Moscow have seized on these developments for encouragement.

The view from Moscow is somewhat different. Calls to intensify its military operations have grown louder since the Ukrainian army launched its eastern counter-offensive earlier this month. President Vladimir Putin says Russian forces are now fighting "the whole military machine" of the West. But he insists partial mobilization — a move that could undermine his strong popularity ratings at home — "is fully adequate to the threats" Russia faces. He will likely draw some comfort from his meetings last week with China’s leader Xi Jinping and India’s Prime Minister Narendra Modi, key allies in his efforts to withstand the West’s assault on Russian oil exports, and from Europe's own vulnerabilities in the face of spiraling energy prices.

Putin’s remarks to Xi, at the Shanghai Cooperation Organization (SCO) summit in Uzbekistan, that he understood Beijing’s "questions and concern" about the Ukraine crisis triggered a wave of Western commentary about the de facto limits of their “no-limits” friendship. This was no surprise. Russia’s alliance with China is pivotal in its confrontation with the US and Europe, and especially so in the escalating energy war. But Chinese state media did not report Putin’s remarks, and the foreign ministry stressed that Beijing would work with Russia to help inject “stability into a world of change and disorder.” Tensions between the US and China over Taiwan could push Beijing closer to Moscow. Meanwhile, Modi’s comment to Putin that “this is not an era of war” was spun differently in Russia than in the West.

Raising the Stakes

What's clear, however, is that any annexation of the four Russian-controlled areas of Ukraine where referendums are due in the coming days — Luhansk, Donetsk, Zaporizhzhia and Kherson — will sharply raise the stakes. Western leaders have dismissed the move as meaningless — “parody” plebiscites. But for the Kremlin, annexing these regions would cement its advances, make any future territorial compromise difficult, and present the West with the threat of a more serious conflict between Nato-backed forces and Russian forces defending “Russian territory.”

Tensions are also being stoked by developments in former Soviet states. Kazakhstan’s President Kassym-Zhomart reportedly angered Putin back in June by saying he wouldn’t recognize the independence of the Luhansk and Donetsk. Then, clashes last week in the Caucasus and Central Asia raised questions about Moscow’s ability to defuse tensions in its traditional sphere of influence while mired in the Ukraine conflict. The fighting between former Soviet states Azerbaijan and Armenia was the worst violence since their full-blown conflict in 2002, and Russia suspects a destabilizing hand at work. The clashes broke out two days before the SCO summit, fueling those suspicions, especially given the visit to the Armenian capital on Sunday by US House Speaker Nancy Pelosi, who became the highest-ranking US official to visit since its independence in 1991.

Economic Pressure

Russia’s oil exports have proven remarkably resilient so far, essentially holding up to prewar levels. But the outlook is starting to darken somewhat: Oil and gas revenues that spiked at the start of the conflict are now softening, due to lower exports of gas and refined product, and the $30/bbl fall in benchmark oil prices since June. This has seen the oil income “war premium” that Moscow enjoyed in the second quarter disappear in the third quarter, according to Energy Intelligence’s estimate — although this year's total should still comfortably exceed last year's.

While market uncertainties abound, the economic pressure could intensify when the EU embargo, parallel shipping sanctions and planned G7 price cap on Russian oil come into force in December. Russian media report that the government is looking at budget cuts and could turn to the oil and gas sector next year for additional taxes. Emissions monitoring firm Kayrros says it has observed an unseasonably sharp fall in cement output in the past two weeks, in what it sees as a fairly clear indication of slowing economic activity. Western sanctions and export controls have hit key industries, including auto production, shipbuilding, metallurgy and defense.

US officials say these constraints have translated into real problems for the Russian army in Ukraine. “[Russia] has had to cannibalize its domestic industry in order to manufacture battlefield equipment it cannot procure on the international market,” says Liz Rosenberg, assistant secretary at the US Treasury. “It's also compelled to look to international pariahs [like] Iran and North Korea in order to source some of its military equipment.”

Friends in Asia

How China and India respond to the new oil sanctions will be a critical test of their relationship with Russia — and of the effectiveness of the West’s efforts to squeeze Russian oil revenues. Despite its tensions with Washington, China has tended to play by the rules of Western sanctions. Kremlin spokesman Dmitry Peskov acknowledged on Sunday that the threat of secondary sanctions had a negative impact on bilateral cooperation. But, as he also noted, the overall trend is marked by growth. The consensus view among analysts is that, as Russia’s close ally, China won’t accept the price cap but may use it to negotiate bigger discounts on its purchases of Russian oil.

There is also a level of concern in Russia about becoming too dependent on China. But the SCO summit, for all the critical Western coverage, was seen as a success in Russia. Moscow can also point to real success in its efforts to diversify its non-Western alliances, boosting trade ties with India and certain Mideast and African countries.

Heading into the winter, Russia has calculated that the pain in Europe from spiraling energy costs and reduced gas supplies will be greater than it own sanctions pain and will weaken the EU’s resolve on Ukraine. Good relations with China, India and others will help ease the pressure on Russia, both economically and geopolitically. The mobilization and referendums can be viewed as a sign of weakness. But they could also be seen as a move to stare down the West through escalation.

Topics:
Sanctions, Military Conflict, Trade, Macroeconomics , Ukraine Crisis
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