MOSCOW BLOG: UK PM May grapples with what's to be done about those who are to blame

MOSCOW BLOG: UK PM May grapples with what's to be done about those who are to blame
UK PM Theresa May ordered the expulsion of 23 Russian diplomats following the poisoning of Russian spy Sergei Skripal / Wikicommons
By Ben Aris in Moscow March 16, 2018

British Prime Minister Theresa May has expelled 23 Russian diplomats suspected of spying, claiming that the Russian government was “almost certainly culpable” for the poisoning of Russian double agent Sergei Skripal in Salisbury on March 4.

Russia watchers were underwhelmed by the measures; bne IntelliNews columnist Mark Galeotti tweeted that the UK response was “measured, conventional and moderate … None of which has any meaningful effect punishing or deterring #Russia”. May’s actions also failed to have an impact on markets, with Gazprom successfully issuing a €750mn Eurobond to strong demand the very same day. And as I write, the Russian ministry of finance is in the process of offering a $3bn bond, which had already raised $4.5bn of bids with several hours to go before the offer closes. 

May’s speech also included vague threats about seizing Russian state assets, and measures to annoy oligarchs like inspecting their private jets more thoroughly when they arrive in London. Notably she backed down over the idea of shuttering the state sponsored broadcaster RT UK (formerly Russia Today) after Russia’s foreign ministry made it clear it would kick the entire British press corps out of Russia in retribution.

"I can tell you right now that no British mass media outlet will be allowed to work in our country if [the UK authorities] close RT," Russian foreign ministry spokeswoman Maria Zakharova said in the 60 Minutes programme aired on Rossiya 1 television on March 13.

And May also ignored calls from the anti-Russia lobby, championed by activist investor turned Kremlin foe Bill Browder, to close London to Russia’s elite and seize their money and property there, which would be legally difficult to do to say the least.

Finally it is important to note that at the very start of the government reaction the British government said, “this is not an article five matter”, referring to the Nato clause that says an attack on one country is an attack on all. No one is going to go to war over an attempt on the life of a retired Russian spy. While some commentators see the Salisbuy incident as a chemical weapons attack on the British civilian population and the first use of chemical weapons in Europe since the end of WWII, the government is treating it for what it is — an assassination attempt on a former spy.

Are May’s actions weak? Yes and no.

As I wrote at the start of the week there are five big questions that need to be answered about Skripal’s death and, apart from more clarity on the origin of the nerve agent, little progress has been made on that front.

The main question still stands: now the nerve agent has been identified as Novichok, a Soviet-era military grade chemical weapon that reportedly only Russia can make, there can be no doubt that the attack originated in Russia. But that sheds no light on who used it.

Business vs. politics

What has become clearer is the dichotomy between the political relations between Russia and the UK (and the EU in general), and how investors see Russia. It's the age-old clash between politics and money.

On the same day as May announced her Russian punishments to parliament, state-owned gas monopolist Gazprom's €750mn Eurobond was three times oversubscribed and offered a low yield of only 2.5%. 70% of the bonds were bought by investors from continental Europe, including 38% from Germany, and 5% of the Gazprom bond buyers were from the UK. 

On March 16, Russia’s Ministry of Finance announced it was also pressing ahead with plans to issue a total of $7bn of new Eurobonds. That includes $3bn of bonds it has issued in each of the last two years since the sanctions were imposed following the annexation of Crimea in 2014, as well as an additional $4bn of bonds that will be swapped for the 2029 bonds that were largely held by the failed Financial Corporation Otkritie bank. The first $3bn of new sovereign bonds have a yield guidance of a low 4.75%, possibly due to anticipated high demand from investors, although Russia will still pay a premium due to the political tension, say analysts (at the moment estimated to be 30bp).

It is now crystal clear that May has to play to two constituencies: the public and the business community in general, and the City of London in particular.

What the bond prices mean is that investors have shrugged off fears that the west will impose real sanctions that will actually affect Russia’s economy or its ability to raise money on the international capital markets. Indeed, the spreads on Russia’s sovereign Eurobonds have been falling steadily over the last six months as yield-hungry investors snap up Russian paper. In March, spreads over the benchmark US treasury bills fell to a mere 180 basis points, its lowest level in years.

A similar story is being played out on the equity market where Russian stocks are now the second biggest overweight in the benchmark MSCI EM index, even if investors are concentred in a very short list of names led by state-owned retail banking giant Sberbank, which is now the second most valuable bank in Europe. Moreover, there were two IPOs in 2017 — shoe retailer Obuv Rossii and logistics firm Globaltrucks, both organised by up-and-coming broker/dealer BCS Global Markets — where foreign investors bought about half the issue, as well as a string of SPOs that show international interest in Russian stocks has reappeared. Several more IPOs and SPOs are on the docket for this year.

What to do about those who are to blame

That leaves the UK with a very Soviet problem to solve. In the run up to the October revolution Lenin wrote a famous pamphlet: “What’s to be done” and in the Soviet-era the most pertinent question was “Who is to blame” for the failures to meet the five-year plan goals. Today May has to decide what is to be done about those who are to blame for the attempt to kill Skripal. And it seems that she doesn't have answers to either question.

To recap: the main question is who is behind the poisoning. It remains entirely possible that this was a state-ordered hit. But if that is true then it would represent a significant scaling up for the Kremlin’s aggression and a departure from the previous policy of harrying the west and sabre rattling on the one hand, while trying to talk down the sanctions on the other. It would mean the Kremlin is giving up all hope of ever lifting sanctions and has resigned itself to a new and permanent full blown Cold War.

In Moscow, businesspeople are as confused as the British government as to who is behind the poisoning, but the consensus is that it was not Putin.

“I can’t imaging the Kremlin doing this,” BCS GM chief economist Vladimir Tikhomirov told bne IntelliNews in an interview. “There is no upside. And the Kremlin wouldn’t risk a boycott of the World Cup only a few months before it is due to start.”

Tikhomirov pointed out that during May’s speech the ruble dollar exchange rate barely budged, and after the speech the Russian currency even gained against the dollar. Real sanctions would have seen the ruble fall against the dollar.

If Putin has lost control over Russia’s chemical weapon stocks, as even May admitted could be possible, the attack is well timed as he can’t admit to that only a week before a presidential election without doing damage to himself at the polls.

Economies intertwined 

The bond issues show that Russia and the UK remain closely connected and interdependent thanks to business. May needed to make a symbolic gesture but she dare not attack Russian money in the bond or property markets. Several commentators have pointed out that if measures were taken to take back oligarchs’ London houses (many sales of London property to Russians flagrantly ignored mandatory money laundering checks) then the property market could collapse, which would have serious consequences for the UK economy.

Russian residents of “Londongrad” are not expecting serious repercussions. Businessman Andrei Yakunin, the son of former Russia Railways boss Vladimir Yakunin, told bne IntelliNews, “I hope this will not have a drastic impact. It’s all about perceptions as you can’t get into another man’s head. But I think the idea that the Kremlin ordered the attack is highly unlikely.”

May’s new punishments were a traditional response but underwhelming. She has found herself in a dilemma due to the realisation that some sort of workable relations with Russia are actually a lot more necessary than first appears.

The assumption amongst western politicians has been that Russia is a useful whipping boy: because of the lack of trade and investment by British companies in Russia (the UK has the least companies working in Russia of the big EU countries) you can badmouth Russia to make yourself look strong at no political cost. This habit was started by Gordon Brown after he took over as prime minister, and May was guilty too when she accused Russia of hacking the Brexit vote despite Facebook’s claim that Russians had spent just 73p on ads ahead of the referendum.

In reality there is a cost, as the British political and financial establishment have much deeper ties to Russian money than they care to admit. Moreover, the diplomatic inroads Russia has made in the Middle East plus its increasingly close relations with other emerging market powers, notably China, mean it is still a major player on the international stage. And, of course, there is still no resolution to the war in Europe’s backyard in Ukraine.

Russia is rising, even if it is still wobbly on its feet. The point is highlighted by Standard & Poor’s February decision to return Russia to investment grade, leaving Moody's as the only "big three" agency to keep Russia's sovereign assessment in the junk speculative category. By necessity all EM index-tracking funds have to take a position in Russian stocks and bonds as a result.

Now there is going to be another pause in the story as the Kremlin is demanding evidence of its culpability and will issue its retaliation decision in 10 days time. The expulsion of British diplomats from Moscow is a given, but all in all the Kremlin must be pleased with the leniency of May’s measures and its response is likely to be mild so that everyone can get back to business.

 

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