Article

War, Russia and the investment outlook

Two years since Russia’s invasion of Ukraine, we take a wider look at the implications of the conflict.

| 10 min read

Two years ago on 24 February, Russian troops moved into Ukraine. Since then, there have been too many deaths and too much destruction, with thousands of human tragedies and many Ukrainians now living away from their homeland. We send our sympathy to all who have suffered in this conflict.

The Ukrainian forces surprised their invaders with stout resistance. The Ukrainian president, Volodymyr Zelenskyy, rallied his country to see off the main thrust of the invasion and to contain Russian troops to the corridor of land in the south east – from the Russian border through to Crimea.

President Zelenskyy received substantial financial and moral support from the US, NATO, the European Union (EU) and other leading advanced countries. Gradually, the countries friendly to Ukraine released some more sophisticated weapons to help the Ukrainian forces and committed to supply more ammunition and missiles to counter the strength of the Russian military.

The state of the war

Today, two large armies are dug-in to a heavily fortified trench system of defensive lines around the occupied south eastern corner of the country. It has some of the characteristics of a first world war extended battle. Both sides need large armies to control such a long frontier. Both exchange large numbers of shells from artillery against opposing positions. There are extensive minefields and other barriers to either side making gains, as well as pushing back the other. Occasional breakthroughs win modest amounts of territory. Losses are high.

At sea, Ukraine has had some success pushing back the Russian navy which sought to control the Black Sea and tried to prevent Ukrainian seaborne trade from its southern ports. Use of drones and smart weaponry has sunk some Russian ships and warned off others.

Ukraine urges the advanced countries to send more ammunition and weapons, and to keep the money flowing so it can afford to maintain its public spending against the background of a sharp loss of tax revenues. Many people have left to stay in safer countries. cutting national output and incomes. Much effort has been diverted into military action, and some parts of the productive economy have suffered from war damage.

The EU committed to supplying one million shells in a year but struggles to produce enough. Claims are made by both sides when a small success in shifting the lines takes place. Most military experts see the conflict continuing with neither side in a position to overwhelm the other. Russia has access to more troops with the larger population and the strength of the government. Ukraine may have access to more money and weaponry from the friendly counties if politics allows.

The Ukrainian president is currently considering extending conscription to swell the numbers of troops. All men between 18 and 60 must stay in the country and some are required to join the army. New legislation would lower the age of actual enlistment from 27 to 25. Russia has recruited prisoners and used patriotic appeals to increase its numbers. In Russia, all 18-27-year-olds are liable to serve for a compulsory one year in the army, but not all are called up. Both countries must tread carefully over the extent of conscription, preferring to raise and extend their armies through volunteers. President Zelenskyy wishes to increase his army of one million by 500,000.

The state of the allies

To date, the EU has been the most generous with money, and the US the most generous with arms. Between them, the US and EU account for most of the assistance, with the UK, Japan, Canada and some others also making useful contributions. The EU has just agreed further grants and loans up to €50bn for Ukraine. This is for the period up to 2027 which will not be nearly enough should the war grind on for a long time.

The US president is trying to get agreement to a further $60bn of assistance, but the Republicans in the House of Representatives are resisting. They detect a war weariness in their voters and wish to pile on pressure to get more done to protect the US southern border before consenting to more money for Ukraine.

Whilst President Joe Biden and the various presidents speaking for the EU remain robust in their verbal support for Ukraine, there is some feeling that in due course they would like a negotiated settlement of a damaging war. Some think it will be difficult for Ukraine to achieve its war aim of forcing Russia out of all Ukrainian territory. NATO, the US and EU would need to put in far more weaponry, ammunition and money to help bring about a quicker and total victory for Ukraine.

The wider impact of the conflict

Both sides have sought to damage and destabilise the trade and economic progress of the other. The advanced countries have put in a progressively more severe set of sanctions against Russian money, oil and gas and more general trade. Russia has retaliated against supplies of cheap gas to Europe.

Many Western assets in Russia have been badly devalued or are no longer available to their former owners. Russia has sought to cut Ukrainian sales of agricultural produce to the West. The US and its allies have tried to prevent the supply of microchips, digital capability, metals, engineering items and other supplies that are needed to feed the Russian war machine.

Russia has been forced into diverting more import and export trade to China, Turkey, India and other emerging market economies that do not enforce the same advanced country sanctions. Russian trade has been dented, but the country has found new sources of supply and new markets for sales.

In practice, it comes down to political judgements.

It is widely accepted that the West has immobilised around $300bn of the Russian central bank’s assets held in the Western system prior to the sanctions. Of this, €190bn has been identified as assets held in the Euroclear depository.

Typically, central banks keep holdings of foreign government bonds and bills, and currency deposits. The G7 moved to immobilise these assets, meaning they remain the assets of Russia, but the country cannot use them or repatriate them for the time being. Some are now arguing that the G7 should go to the next stage and confiscate these assets, passing them to Ukraine as reparations and money for the rebuilding of Ukraine following all the Russian-inflicted war damage. Some want to take money made as returns on the assets or impose some kind of a windfall tax on them. This would be a far smaller sum to contribute to Ukraine, but still poses some issues about the legality and wisdom of the move.

This has led to strong arguments between international lawyers over whether any of this could be made a lawful act. It has not happened before. It would require the advanced countries to make a case that it has or can enjoy the power to confiscate assets owned by another sovereign state in these extreme conditions, overriding the usual assumption of sovereign immunity. Both Canada and the EU have enacted some legislation but have fallen short of legislating to confiscate the sovereign assets and send them to Ukraine. The EU is concentrating on the returns on the assets. The issue of sovereign immunity has not been resolved, as any amount of national legislation cannot override sovereign immunity if international courts assert it in this case.

In practice, it comes down to political judgements. Whatever the international judges may say, the G7 countries can control this money and could expropriate some or all of it. They would need to ask themselves several important questions before doing do.

  • Would taking these assets lead other foreign countries that currently trust Western banks and financial institutions to withdraw their money, fearing that one day their assets could be taken?
  • What would happen if say China decided to support its friend Russia by deliberately and clumsily removing substantial Western assets in retaliation?
  • What future relationship does the G7 wish to have with Russia?
  • Would intensifying action against Russian assets lead to a fiercer and longer conflict rather than shortening it?
  • Could they lose in an international court despite legislating on this issue, leading to considerable embarrassment?

Christine Lagarde, the Head of the European Central Bank is one who thinks it would be too dangerous to take these assets and is worried about the impact it would have on the reputation and liquidity of the euro and of the Euroclear system. The G7 is likely to want to move together on any action against Russian assets to avoid splits in approach.

We have need to assume the war continues, and to forecast no early victory for either side. Both are digging into well-defended positions and considering how to expand their personnel and the ammunition available for the battles. We will explore the wider impact of wars on trade, energy and minerals in a later piece.

So far, the Russian economy has suffered some loss but still has sufficient resource to fight on. Ukraine depends on a continuing supply of money and military help from its allies. We expect the US to find some extra assistance and for the EU to continue its support, despite the political difficulties. The G7 does not yet want to confiscate the Russian money, though the total large sum would offset the costs to date incurred by Ukraine and its benefactors.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

War, Russia and the investment outlook

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