Russia Sanctions & Airliner Tragedy: How Much of a Game Changer?

By Chris Weafer, July 18, 2014

The possible consequences of yesterday’s Malaysian Airlines tragedy and the latest sanctions announcements from the US and EU must be considered while reflecting on the latest events. The air crash will sharply raise pressure. The finger of blame for the destruction of the Malaysian airliner is being widely pointed at pro-Moscow separatists using a sophisticated missile which, according to experts cited in the media, could only have come from a Russian source.

The separatists and Moscow are denying this and investigations are underway. If the allegation is confirmed, the pressure on Moscow will greatly intensify to much more clearly disassociate itself from the separatists and to be seen to try and close the border to prevent military equipment crossing into eastern Ukraine. If Russia does not take this verifiable action, Western political pressure will definitely intensify and, with it, the risk of moving into Stage 3 sanctions.

Tragedy has the potential to bring Stage 3 sanction closer. We have previously assumed that Stage 3 sanctions, especially from the EU, are unlikely and nothing we have heard from the US or EU earlier this week changes that. But the Malaysian Airliner tragedy is a potential game changer. The only question is how. Either the event will push Russia towards greater isolationism as a response to the broadly based global criticism, inevitable if the accusations are proven, or it will mark some sort of end, or the start of the end, of the most dangerous phase in the conflict in eastern Ukraine.

The potential for both outcomes is on the table right now. It means that investors will remain very nervous of Russia risk until there is some clarity. That means further short-term weakness in the ruble, in equities and in debt prices. It also potentially extends the period of self-sanctions by Western companies and banks. Much will depend on what can be proven, what is widely believed, and how Moscow responds. By any measure this is unchartered territory.

Bottom Line. If Moscow is seen to be pro-active in ending support for the separatists and looking for a resolution to the conflict in eastern Ukraine the risk of moving out of Stage 2 sanctions will be reduced and the ruble and equities will rally strongly. We will also be able to look at an unwinding of self-sanctions and have more confidence for a better economic performance and business/investment case for 2015 and beyond. If the opposite happens, i.e. greater belligerency from Moscow, then capital markets will likely quickly retrace the rally seen from mid-March and self-sanctions will worsen.

Hoping for meaningful dialogue

Two week window for discussions. Before news of the Malaysian Airlines crash hit the headlines, the market and media reaction to the latest US sanctions is understandable. We have now clearly entered the most dangerous phase of the crisis as the Ukraine military push to establish control in eastern Ukraine and the EU/US make clear their threat to move to more serious Stage 3 sanctions. Whether intentional or not the