Ukraine could be on the brink of a wide-scale conflict that threatens to destabilize the region and worsen relations between Russia and the West.
Ukraine is going through the worst political crisis since the country gained independence after the dissolution of the Soviet Union in 1991. The first protest, which started in November over President Viktor Yanukovich’s last-minute refusal to sign the negotiated Trade Agreement with the European Union, recently turned into a full-scale violent clash between pro-European protesters and the authorities.
The storm that started on 17 February effectively resulted Yanukovich being deposed on 22 February and the forthcoming establishment of a new, most likely pro-Western government. The deal signed on 21 February between Yanukovich and the opposition leaders ended the violence,but it did not help the embattled leader regain control over the country.
Reportedly having fled to Russia, Yanukovich issued a statement Thursday insisting that he remains Ukraine’s legitimate leader. This affirmation stands in contrast to the situation on the ground. Olexander Turchinov, speaker of the Ukrainian parliament and a close ally of recently freed opposition leader Yulia Timoshenko, has been appointed interim president until the presidential elections in May.
Months of continued protests have already affected Ukraine’s fragile economy . Given recent events, the potential of the country to default on its debt is much higher. A default would affect the entire Central and Eastern Europe region. Reflecting the uncertain conditions, Standard & Poor’s cut Ukraine’s credit rating for the second time in three weeks. At the moment, investors are still betting against the worst-case civil war and default scenario, and taking advantage of the high yields and plunging bond prices.
Since 17 February, currencies in neighbouring countries, including Poland’s zloty, Hungary’s forint, Romania’s leu and Russia’s rouble, have dropped against both the euro and the US dollar. At the same time, yields on Ukrainian dollar-denominated government bonds maturing in June soared to 42 percent on 19 February, compared to 6 percent in January, and the price of 10-year bonds maturing in 2023 plunged by 15 percent.
Russia, which in December 2013 agreed to bail out Ukraine with a $15 billion loan, hinted it would end payments until the country elects a new government and the situation in the country stabilizes. The Russian budget might also suffer from the disruption in natural gas supplies going through western parts of Ukraine via the Dhruzba pipeline to Eastern Europe, which depends almost completely on Russian gas for its energy needs. This could recreate the 2009 situation when Europe experienced gas shortages as a result of the Russia-Ukraine gas war.
The long positive trend in attracting foreign direct investments had already started to slow down in late 2013, and if the political instability continues, large investment projects, primarily in the oil and gas sector, will almost certainly be put on hold. Last year, Ukraine signed production sharing agreements worth $4 billion with the investment consortium led by Italy’s ENI to explore offshore unconventional hydrocarbons in the Black Sea. This was in addition to $10 billion deals with Chevron, Shell and Exxon Mobile.
The continuing crisis will inevitably cause another stir between the West and Russia. After the latest bloodshed, moderate diplomatic tones from the West and Moscow have been replaced with more overt criticism between the two. However, neither Moscow nor the West wants to see the country fall into a bloody conflict or split up.
Although the country’s breakup is unlikely at the moment, events could take a sudden turn in any direction. Following Yunukovich’s deposition, the country now finds itself at a crossroads. But with the opposition movement gaining the upper hand, Washington and Europe will have to engage more, both economically and politically.
At the same time, the Kremlin will most certainly try to exert its influence over future events and keep Ukraine within its sphere of influence. Russia has enormous economic leverage, and it will surely use it if necessary. Equally important is the position of the large Russian minority in eastern and southern parts of Ukraine that openly defies the authority of the now opposition-led parliament in Kiev. This is most prominent in the Crimean region, home to the Russian Black Sea fleet.
Ukraine is still on the brink of a civil conflict and the state of the country’s economy remains dire, with high default potential on its debts in the short-term. We can expect intensive diplomatic activity between the European capitals, Washington and Moscow to prevent the political situation from deteriorating.
Once the crisis subsides, and with the stakes surrounding the country’s future orientation raised, the situation in Ukraine may increasingly resemble a classic Cold War proxy conflict.
