We ignore Ukraine crisis at our peril

Almost 100 years ago, many of our grandparents and great grandparents went to war, often never to return.

Is Europe on the verge of another conflict as the Crimea gets ready to rejoin Russia and parts of Eastern Ukraine teeter on the edge of anarchy? In The Washington Post, earlier this week, former US national security advisor, Zbigniew Brzezinski, warned of a threat to the security of Poland, Romania and the Baltic States and advised that the US military get ready for an immediate airlift of US airborne units to Europe.

Elsewhere, the mood has been less apocalyptic, or perhaps less realistic, depending on one’s point of view.

On Thursday, the Standard & Poor’s Index closed at record levels on the back of strong US employment data, while Goldman Sachs pronounced that investors are “sanguine on the Ukraine”.

In Moscow, the economic mood is more sombre. The local Micex stock index was down from 1,520 to just under 1,300 by mid week, while yields on Russian sovereign paper have jumped by 2%. The cost of insuring Russian debt has also jumped sharply, though it has yet to reach levels achieved last summer.

In Dublin, last week, Europe’s right of centre political leaders gathered under the banner of the EPP (European Peoples’ Party) . The mood at this pre-election rally was apparently complacent.

A cautionary note on the situation in Ukraine was provided by Hungary’s prime minister, Viktor Orban: “Europe will never be a respected actor in world politics until it can act as an equal partner in this crisis.”

However, the EU has good reason to fear a breakdown in economic relations with Moscow. The Russians appear to hold a strong hand of cards — at least in the short run — via its grip on Europe’s energy market.

It has the largest natural gas reserves in the world, the second largest coal reserves and eighth largest oil reserves. It is also excessively dependent on the export of raw materials — up to 80% dependent.

While it has paid off its foreign debt and has reserves of around €500bn, the commodity cycle has turned sharply as China and much of Asia have shifted, in part, from investment-led to consumer-led growth. So far, however, energy prices have been largely unaffected by this shift.

Putin is propped up by high oil and gas prices, allowing him to buy off his people. But his hand is less strong than it was five years ago, as alternative energy supply sources are developed.

That said, the EU is also a lot more vulnerable. In truth, both parties risk being like gentlemen preparing for a duel in which each could end up mortally wounding the other.

Germany, for example, imports more than one third of its natural gas and oil from Russia.

According to German weekly magazine Der Spiegel: “There is plenty of bluster and aggressive rhetoric in Europe, but many EU members are skittish about the potential dangers of imposing punitive economic measures on Moscow.”

With some relish, the Germans point to the picture of a classified document, taken as it was being brought into No 10 Downing Street by an official. The briefing paper for Prime Minister Cameron stipulated that the UK should not, for now, support trade sanctions or close London’s financial centre to Russians. “The message is clear — the British economy, which profits immensely from wealthy Russians, should be protected from potential fallout.”

BBC business editor Robert Peston points out that the UK enjoyed a current account surplus of almost £3bn (€3.62bn) in 2012 on the back of its huge investments, largely energy-related, in Russia.

These assets generated almost £5bn, more than making up for a £1.8bn deficit in goods and services trade. Some of these assets have been written down in value, but the message is clear: freezing assets held in the West may hurt Russian oligarchs and Putin cronies, but UK-based investors stand to lose even more in any tit-for-tat reaction.

Russia is all too willing to exert pressure, most notably in Ukraine, which is close to defaulting on its debt following the extraction of more than €50bn from its national treasury by the spectacularly corrupt former president Yanukovich.

The EU leaders have indicated that they will pump in more than €10bn to prop up the new Kiev administration in what amounts to a reversal of their previous stance.

The secretary general of NATO, Anders Fogh Rasmussen may have hit the nail on the head when he said: “Defence comes at a cost, but insecurity is much more expensive.”

Neglect of the simmering situation in the Ukraine looks set to prove costly indeed. The real concern for Europe’s leaders is that the Ukraine could turn out to be a bottomless pit for funds as well as a trigger for economic ripple effects across other vulnerable East European economies.

That said, Russia’s grip on energy markets may not be quite as strong as it appears, at first sight.

Norway and Qatar are viable alternative suppliers, though at a higher cost.

A prolonged crisis is likely, all the same, to bring a substantial strengthening on oil and gas prices. Stockbrokers anticipate that a flight to safe haven sovereigns and stocks is also in prospect. Longer term, there have to be real concerns for the European banking system if the crisis were to persist, given the exposure of banks; particularly French, Italian, and to a lesser extent German, to Russia and the Ukraine.

Ireland has modest direct exposure. Exports to Russia exceeded €600m in 2012 and have been growing fast. Per capita income in Russia is around €18,000 and appetite for Irish food and drink products is growing. Irish investment in Russia has been largely property related and this form of investment largely dried up following the crash in 2007-8.

However, construction service firms have carved out a profitable trade there.

Ireland has yet to benefit from the huge wave of Russian property investment sweeping over London, but the wife of Yuri Luzkhov, former Mayor of Moscow, Yelena Baturina, acquired the Morrison Hotel, carrying out an extensive refurbishment.

Clearly, the impacts on this country from a prolonged crisis will be indirect, but deep for all that.

Any disruption to trade and to business confidence across a continent which is only beginning to emerge from its long crisis can only be a negative.

It would pitch central banks back into crisis mode, ensuring that ‘tapering’ off of quantitative easing, is back on the backburner.

It is likely to retard the gradual move away from risk adversity in business and banking, thereby prolonging the jobs crisis.

It really is time to get talking. Let’s hope, the leaders at the end of the line will be interested in picking up the phone.