What to Expect from Yanukovich's Visit to Moscow

George Friedman at Stratfor reminds us that Ukraine literally means "on the edge" and it has been earning its name recently.  President Yanukovich is in Moscow today and does not want to go home empty handed.  Over the apparent objections of large parts of the country, Yanukovich is seeking Russia's assistance over the IMF.  Yet it remains on the edge.  

Ukraine has an estimated $17 bln funding gap for 2014 2015.  The EU recently offered less than $1 bln in assistance, but promised its help to secure IMF, World Bank and other financing.  The impression was a half-hearted gesture by an aid weary Europe that is focused on its internal economic challenges.  

Reports suggest that Yanukovich could secure a $15 bln line from Russia, with fewer conditions, and received $3-$5 bln up front.  Yanukovich also hopes to secure a discount on natural gas (10%-15%, though some talk of 25% discount) .

The IMF would insist on painful austerity.  Russia is likely to be less demanding.  However, the risk is that it will have to pay the ultimate price--the erosion of sovereignty.  The Ukraine has been independent for 18 years, the longest in centuries. 

Simply put, Russia wants the Ukraine in its camp more than the EU apparently does.  For Russia, it is vital to its national security.  It is not only a buffer, but it also allows Russia to project power into Europe and the Middle East, through the Black Sea and Mediterranean.  Russia has already "lost" Georgia.  It is losing Moldova.   It cannot lose the Ukraine and has raised the stakes commensurately.  

The next step, which Russia has tactically pulled away from, is have Ukraine join Russia's customs union.  Membership is the last  card for Yanukovich.  Once his bridge is thoroughly burnt with Europe, Yanukovich's bargaining position with Russia will deteriorate. 

Ukraine's central bank has been intervening to support the hryvnia and this is draining reserves, which fell 9% in November to its lowest level since 2006 just below $19 bln.   Reserves have been slashed in half over the past 2.5 years. 

The country's 10-year bond yields has fallen from 10.7% on Dec 9 to just below 10.0% today.   The 3-year yield finished yesterday near 11.67%, which is 126 bp below the last week's high water mark.  The 5-year credit default swap, the price of insurance, slipped to 10.42% today, off about 28 bp on the day.  This puts it close to Venezuela (11.22%) and Argentina (~17.42%).  

Financial aid is helpful, but some of the structural reforms that the IMF would have insisted upon could help in the medium-to-longer term.  Russia is unlikely to exert much pressure in this direction.    At the same time, a deal with Russia risks greater social unrest.    The EU apparently wants a regime change.  It is possible that another new Orange Revolution is at hand.  Yet, the ability and willingness of resort to ruthless tactics by Yanukovich and Russia's Putin should not be under-estimated.  

As the year draws to a close, both Russia and China appear to be probing the US and Europe appetite for confrontation.  President Obama is perceived to be weak on international stage, hampered by a divided government, and his domestic agenda appears to be exhausting his political capital.  Europe is also more focused on internal events.  

Japan is more aggressive and, just today, announced a new beefed up national security strategy and a further increase in defense spending.  Prime Minister Abe was struggling to build strong support for his nationalistic agenda, which includes changing the pacifistic constitution.  China is unintentionally aiding his effort arguably more than any Japanese.