Emerging Markets | Europe | Politics & Geopolitics
The divergence of monetary policy in Norway, Canada, and now possibly Sweden from that of the rest of the world over the last twelve months is stark. While almost every other central bank has turned dovish, the Norges bank has hiked four times since September last year while the Bank of Canada has hiked five times since mid-2017. And the Riskbank in its October meeting pretty much guaranteed a hike at its 19 December meeting. Looking strictly at economic activity, it’s questionable whether these hikes are warranted.
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Since the 2014 Ukrainian revolution, when Ukrainian President Yanukovych was ousted, Russia has been involved in a military conflict in eastern Ukraine. Pro-Russian separatists have been fighting the Ukrainian army for control of a sizeable area in Donbas, a province in eastern Ukraine that borders Russia. This has been a major geopolitical risk that has held back the performance of Ukrainian assets. Now seems to be some signs of this conflict easing, which could be positive for credit.
The Recent Signs of Reconciliation
In early September, Russia and Ukraine completed a prisoner exchange with 35 freed from either side – the first meaningful step towards resolving their ‘frozen’ conflict in Donbas. The next step was 1 October: during a meeting of a tri-partite conflict resolution group in the Belarusian capital of Minsk the sides approved an election process for the two Donbas regions of Donetsk and Luhansk controlled by pro-Russian separatists.
At the 1 October meeting, the parties sought to organise the first ever in-person meeting in the between the Russian and Ukrainian presidents Putin and Zelensky. This would be done in the so-called Normandy format, where the French President and German Chancellor would also participate. The date for the summit is likely to be 9 December.
However, as pre-conditions for the summit, the parties agreed that in two hotspots on the front line, Zolote and Petrivske, forces on both sides should withdraw symmetrically 1 km away from the contact line. Disengagement in the third hotspot, Stanitsia Luhanska, was completed back in June. On 8 November, Zelensky announced that the disengagement in Zolote was proceeding as scheduled (Interfax). On 12 November, international monitors reported success in Petrivske.
Zelensky Taking Heat
Talks with Russia are not without risks for Ukrainian President Zelensky. In October, after the local media spread news that the Ukrainian negotiators had agreed to special elections and laws for the Donbas region, nationalist parties organised protests in several Ukrainian cities, including Kyiv and Lviv. Opposition politicians argued that following the new process meant caving in to the demands of Russia and the Donbas separatists.
Finding a compromise on the wording of the Donbas law that would not stoke up domestic tensions is a serious test for Zelensky and his cabinet. His party, the Servant of the People (SOP, currently holds a majority of seats in the parliament, which should help to push any laws through parliament. According to a recent opinion poll, 62% of voters positively evaluate Zelensky and his team’s first steps. However, the controversy around the terms of the peace process in Donbas could weaken the support they currently enjoy.
Russia Shows Willing
Meanwhile, Russia has also taken steps to show that a compromise is on the cards. On 18 November, Ukraine confirmed Russia had returned the vessels it seized a year ago during the incident with Ukrainian sailors in the Kerch Strait. Russia is seeking to improve its relationship with Europe and its involvement in Donbas hinders this. Following five years of frozen conflict, Russia has probably calculated that there is more to gain than lose from making concessions on Donbas. And French President Macron’s pro-active position on mending ties with Russia is providing the reconciliation process with a new impetus.
The recent positive developments have increased the likelihood of the Donbas conflict ending soon. Although the date of the first Normandy-style summit may change, there are now more reasons to hope that the Russian and Ukrainian leaders could approve a new roadmap for resolving it.
Further Progress Would Likely Unlock Potential for Sovereign Upgrades for Both Russia and Ukraine.
On Friday 22 November, Moody’s changed its outlook on Ukraine’s sovereign debt from ‘stable’ to ‘positive’ (it has affirmed its rating of Caa1). Both Fitch and S&P recently upgraded its Ukraine sovereign ratings by one notch (to ‘B’). For years, rating agencies have listed high geopolitical risks, with ongoing military conflict in Donbas, among the main challenges for Ukraine’s sovereign credit. Therefore, the removal of this challenge would likely fuel a further rally in Ukraine’s Eurobonds.
Russia also needs peace with Ukraine to unlock potential for further sovereign upgrades. If Putin and Zelensky arrive at a new peace deal for Donbas, we expect further tightening of Russia’s Eurobond spreads in anticipation of positive reaction from the rating agencies.
Tatiana Orlova is a macroeconomist and strategist, and the founder of Emerginomics Research. She has been covering Emerging Markets since 2001, and has pursued various roles on the sell-side across RBS, Nomura, ING & Credit Suisse.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)