Eglé Fredriksson of East Capital -

The Baltic states are very carefully watching events unfold in Ukraine. All three countries are strongly integrated with the West both economically and militarily, which leads to constant confrontation with Russia, who perceives the region's western orientation as one of the greatest threats to its national security. The Baltics' criticism of Russia's actions in Crimea and their call for the West to support Ukraine, stem strongly from their desire to see Ukraine more tightly integrated with the West, but also due to the fact that they want the West to reinforce its commitment to the security of the Baltics. However, the Baltics have little interest in seeing the clash between the West and Russia escalate.

Political and economic implications

Baltic ties to the West through membership in Nato, EU and the Eurozone are a concern for Russia, particularly since this brings the western military alliance close to Russia's heartland and directly borders Russia's access to the Baltic Sea. Despite their western alliances, the Baltic states are still vulnerable to Russian destabilization tactics: the Baltic states are largely dependent on Russian energy imports, and Russia remains an important trade partner for them.

On several occasions, Russia has temporarily cut off energy supplies or hindered imports from Baltic companies to inflict economic strain. While Russia can benefit from actions that in the short term create tensions between Baltic governments and business communities wanting stable ties to Russia, this strategy strengthens the Baltics' long-term determination to take measures that limit their exposure to Russia, specifically in terms of energy supplies and trade diversification outside Russia. The Baltic states are using liquefied natural gas (LNG) terminals, one will be operational soon and others are still in the planning stages, along with further electricity and natural gas links to weaken Russia's energy leverage over the coming years.

Russia could also use cultural and political ties to destabilize the Baltics. All three Baltic countries have strong political parties that are somewhat pro-Russian. These parties often are sidelined in the formation of national governments, but they still carry weight in domestic politics. More than 20 years after the breakup of the Soviet Union, the integration of ethnic Russians remains an issue, especially in Latvia. However, the Russians in the Baltics are not nearly as loyal to Moscow as those in Crimea. Moreover, the fact that the Baltics have Nato membership makes it very unlikely that Russia would be willing to directly engage in these countries militarily.

As the confrontation between the West and Russia over Ukraine drags on, the Baltic states will be affected more directly. The harder the West pushes against Russia, the more likely it is that Russia will react by destabilizing the Baltics economically, politically and socially, although Moscow's ability to greatly affect the Baltics is constrained.

Stock market implications

After a very strong start to the year, the Baltic stock market saw the first hit from the Ukrainian events in March only after the military intervention in Crimea. Since the beginning of March, the Baltic stock exchange index has dropped by 2.5%, but is still up year to date by 1.4%. Overall, the listed Baltic equities have a limited exposure towards Russian and Ukrainian markets, as their sales exposure is more domestic and exports are quite diversified. In terms of the direct impact, the Baltic market is affected due to a few export companies having a majority of their earnings generated in Russia and Ukraine, such as pharmacy producers Grindex and Olainfarm, lingerie producer Silvano and construction company Panevezio Statybos Trestas.

While East Capital is not presently invested in these companies, we do have investments in Lithuanian dairy companies Pieno Zvaigzdes, Zemaitijos Pienas and Rokiskio Suris as well as the facilities manager City Service with significant Russian sales. Dairy producers have already successfully resolved the latest export ban initiated by Russia last October and exports resumed two months ago. We also have a small stake in the Lithuanian gas importing company Lietuvos Dujos, which is co-owned by Russian gas monopoly Gazprom. Lithuania succeeded in negotiating a 20-25% lower gas price from Gazprom; however, due to political tensions these negotiations are likely to stall for the time being. We do not foresee a major gas supply disruption to the region for the time being.

Hence, when the dust from the Ukrainian crisis settles, we believe that the Baltic market should return to previous levels without a major negative fundamental impact.

Eglé Fredriksson is a senior adviser at East Capital.