Ceasefire Process Brings Sanctions Risk Relief

By Chris Weafer, September 4, 2014

The escalation of fighting in eastern Ukraine immediately after the Minsk summit had raised the sanctions threat against Russia. The threats were expected to become even more pronounced in the days leading up to the NATO summit on 4-5 September.

The breaking news from Kiev (Wednesday morning) is that Russia and Ukraine have agreed to a permanent ceasefire in eastern Ukraine, later amended by President Poroshenko's office to state both sides had agreed to a ceasefire process. Despite Moscow sticking with its long held position that it is not party to the conflict and therefore is not formally part of the peace deal, the news will greatly add to the optimism that the worst of the crisis has now passed. If the agreement is seen to be put into effect then optimism that the existing sanctions against Russia, and the retaliatory actions taken by Moscow, may be removed at the first review date on 1 November.

In our recent note “Ukraine: What Comes Next?” we highlighted that the Kiev government is under much greater pressure than Moscow to end the fighting in the east. The Ukraine economy is now spiralling downwards faster and the government will need to ask for additional bailout cash from the west. More immediately the Rada elections have been set for 26 October and would be much more fractious if the fighting in the east was ongoing. (Chris Weafer is a senior partner at Moscow-based consulting firm Macro Advisory.)

The ruble and asset prices on the Russian and Ukraine bourses will undoubtedly react very positively to the news.

The appetite for further sanctions in Europe had already appeared weak as several country leaders spoke out against additional measures after Moscow’s food import ban retaliation.

The cease-fire, assuming it comes into effect and holds, will bring relief to foreign businesses in Russia. But the declining pace of economic growth will not be easily of quickly reversed. The legacy of sanctions and other economic problems, evident long before the Ukraine crisis started, will still take some time to resolve.

The Economy Ministry has cut its growth outlook and raised its inflation outlook for both 2014 and 2015, specifically blaming the accumulated impacted of sanctions and the declining level of consumer activity and investment.

The Central Bank had been expected to raise the Key Rate again at its September 12th meeting because of the recent pressure on the ruble and the high inflation rate. The rally in the ruble, which followed this morning’s peace deal news, may be enough to allow the Central Bank delay that rate decision.

Despite this morning’s rally we have cut our year-end ruble-dollar target to RUB37.5/US$. The price of Urals has again dipped just below $100 p/bbl and the Central Bank now seems content to let the ruble float more freely.

The ruble lost 4% against the US dollar in August and dropped a further 1% on 1 September (down 14% YTD ahead of this morning’s rally). Most of the weakness is a direct