bne IntelliNews -

German Chancellor Angela Merkel has been talking tough on Russia, leading to a string of op-eds suggesting Germany has given up on Ostpolitik and Russia's biggest fan in western Europe is about to turn its back on the Kremlin.

The situation has been misread. Far from giving up, Germany wants to build closer business ties, and is even willing to set up a free trade agreement with Russia.

Germany is extremely keen for peace to return. The Russian economy is sinking and will probably slip into recession next year. German companies are heavily invested in Russia, which remains an extremely profitable market for them.

The problem is that both sides have dug their heels in over East Ukraine and the talks on what to do next are deadlocked. And so much trust has been destroyed on all sides by the debacle that any deal seems all but impossible to cut at the moment.

Merkel's four-hour tête-à-tête with Russian President Vladimir Putin at the G20 summit in Brisbane, Australia, in November was the first time the two leaders had met face to face since Russia annexed the Crimea in March.

Putin faced a chilly reception by the world's premiers. The host country's prime minister, Tony Abbott, almost threatened Putin with violence, saying he would "shirtfront" Putin on the Ukraine issue. In the end Putin decided to leave early, reportedly so that he could "catch up on sleep" on the long flight home.

But that was all for the cameras. The key meeting was Putin's conversation with Merkel. Afterwards she didn’t say anything explicitly about a change in policy direction, but she has made her position clearer.

While a trade deal between the European Union and Russia is not currently possible, Merkel believes some sort of free trade deal between the EU and the Russia-led Eurasian Economic Union (EEU), which comes into being in January, could be.

If Merkel's position was in any doubt, she made it explicit during her report to the Bundestag on her trip to the G20: “We are ready for talks between the Eurasian Union and the EU on trade issues,”  the Financial Times reported.

In theory this should not be difficult to organise, even though the actual negotiations would be hard. It also fits with Putin's vision of a "greater Europe" that stretches from Portugal to Vladivostok, in which Russia would obviously play an important role.

In effect what Merkel is trying to negotiate – and this is her forte, having cut her political teeth as a master builder of messy European Union agreements on divisive issues – is a European reset with Russia. She is trying to persuade Putin to step up and play the part of a true European partner that he always claims to be, putting aside his geopolitical ambitions.

Between March and the end of September Germany had deliberately tried to water down European's version of sanctions, which ended up being largely symbolic. There were even hopes at the beginning of November, before the G20 summit, that Europe, at Germany's behest, would withdraw the sanctions.

Merkel was giving Putin time to end the military confrontation in eastern Ukraine. Merkel had flown to Kyiv the weekend before the September 5 Minsk Summit between Putin and Ukrainian president Petro Poroshenko, and had clearly lent heavily on Kyiv to compromise. After the Minsk Summit ceasefire deal she expected to see an end to the hostilities.

However, as September wore on there was little abatement in the fighting in Ukraine's eastern districts; in the month after the Minsk "ceasefire" more than 1,000 people died, bringing the total of those who have lost their life to more than 4,000, according to the UN.

Now Germany has finally lost patience with Russia. Merkel is still offering some sort of EU-EEU FTA deal, but she is now also saying negotiation cannot begin until Russia completely withdraws from East Ukraine and sanctions will remain in place in the meantime for as long as necessary.

"The situation in [Ukraine's eastern cities of] Luhansk and Donetsk continues to be far away from a ceasefire. That's why economic sanctions are and remain unavoidable," she said. "We need patience and persistence in our efforts to overcome the crisis," she added, clearly implying that talks continue.

The impasse doesn’t mean Germany is going to sit back and wait for Russia's next move. The week after the G20, Germany's foreign minister Frank-Walter Steinmeier travelled to both Kyiv and Moscow to continue the negotiations Merkel had begun in Brisbane. But he was also clearly frustrated, telling reporters after his surprise invitation to dinner with Putin that "no breakthrough" was on the cards.

For his part Putin has constantly maintained that Russia's so-called pivot to Asia doesn’t represent an abandonment of its relations with the West, which he stresses remains Russia's "natural partner.” However, like Merkel, Putin has also dug his heels in.

"We call [on the West] to abandon the distorted logic of restrictions and threats and to search for mutually acceptable solutions to outstanding issues," Putin said in an interview with with Turkey's Anadolu news agency on November 28 ahead of a visit to Turkey. "Attempts to use the language of ultimatums and sanctions in talks with Russia are absolutely inadmissible and have no chance for success," the president said.

Putin will not withdraw from Ukraine until he gets a "100% guarantee" that Ukraine will not join Nato, and that Russia's commercial interests will be taken into account in any trade deal Ukraine signs with the EU.

Merkel's position is made even more difficult by the fact that the Ukrainians are unwilling to play ball. Not only is Kyiv a long way from promising to not ever join Nato, in his speech to the new post-election Rada that met on November 27, Poroshenko said that Ukraine's constitutional "non-bloc" status should be changed and the government will organise a referendum on joining Nato as soon as possible.

Merkel immediately slapped that idea down, reiterating that even if Ukraine applies to join it will be refused because, "decisions on membership are made by Alliance countries and not voters”.

“Nato membership for Ukraine isn’t on the agenda at this point,” Michael Grosse-Broemer, the parliamentary whip for Merkel’s Christian Democratic bloc told Bloomberg the same day, a point also repeated by Steinmeier hours later just in case the point was not being made emphatically enough.

But the mood in Kyiv is one of grim determination, especially in the face of the ever-rising death toll in the eastern parts of the country. No one is prepared to make any compromise with Russia on anything, reported Tim Ash, head of emerging markets research at Standard Bank, who was just in Kyiv to meet with local political and business leaders.

In his refusal to withdraw his forces Putin is hoping to manoeuvre Merkel into the roll of playing a middleman who will strong-arm the Ukrainians into a compromise. Putin doesn’t trust the Ukrainians, but it also seems that Germany's enthusiasm for playing Russia's gofer is fading.

Merkel lent on Poroshenko ahead of the Minsk summit, but maybe it is a trick she cannot pull off twice. Ukraine is clearly tiring of western "help” - the EU was widely ridiculed by the Euromaidan protestors at the start of this year for constantly sending messages of "grave concern" and little else.

Ukraine is again in desperate need, this time for money, but analysts have accused the West of "sleepwalking" in the crisis.  The EU offered to send just €500mn before the end of the year on November 27 and from funds already committed – far from the $10bn that analysts say the country needs to stave of total economic collapse.

That leaves Merkel in the middle with the extremely difficult task of finding some common ground between all sides. No wonder she is frustrated and talking tough.