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Maybe Putin Did Blink on Ukraine?

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What gives with the latest Ukraine deal? It makes no sense to think that Russia is playing for time since momentum is all on Moscow's side.

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Investors reacted cautiously to Russia's sudden lurch toward peace, if not love and understanding, with Ukraine after multilateral talks in Geneva last Thursday. The MICEX shares index in Moscow rose 2%, not a sharp jump by emerging market standards and still leaving it with a 10% loss since Ukrainian president Viktor Yanukovych fled his post in late February.  Western markets, which host most of the trading in major Russian stocks, were closed on Friday.

Caution certainly seems appropriate for one of the weirdest foreign policy turnabouts in memory. All systems seemed to be go for the 40,000 Russian troops massed on Ukraine's border to roll into the country's restive Eastern regions. Local discontents, perhaps abetted by undercover Russian operatives, had seized government buildings in a dozen different towns, emerging picturesquely masked and armed to the teeth for the cameras. The Ukrainian government's counterstrike looked a model of futility. One armored vehicle got stuck telegenically in a ditch, while half a dozen others either defected or were captured by the rebels. 

Even as Russian foreign minister Sergei Lavrov jetted to Switzerland to meet counterparts from Ukraine, the US, and the European Union, President Vladimir Putin spoke bellicosely at one of his periodic national call-in shows. "I want to remind you that the Federation Council has given the president the right to use armed force in Ukraine," he bristled. Putin elaborated that a large swathe of present-day Ukraine had been known as "Little Russia" before the 1917 revolution, and "God knows" why Vladimir Lenin had decided to part with it.

Yet hours later, Lavrov emerged from his parley with a lamb-like demeanor, declaring Russia's determination to "de-escalate" the crisis. The core principle: "All illegal armed groups in Ukraine should be disarmed, all administrative buildings returned to their legal owners."  Lavrov ceded the lead role in monitoring this process to the Organization for Security and Cooperation in Europe, a do-gooder group more famous for observing elections in dicey polities. Sending troops into Ukraine "contradicts the core interests of Russia," which wants Ukraine to be "a strong state and a link between East and West," he continued. Lavrov did not invite John Kerry onto the stage to share a chorus of "Kumbaya," but he well might have.

So what gives? Western observers, starting with Kerry's boss Barack Obama, understandably feared that Russia was playing a trick. But no one could say what sort of trick and why. It makes no sense to think that Russia is playing for time. Momentum is all on Moscow's side, and time can only help the Ukrainians organize their response a little more effectively.

Putin and Lavrov could be playing a more subtle game, assuming that the Kiev authorities will be unable to rein in the "illegal armed groups" on their side of the barricades, including the Right Sector proto-militia that helped overthrow Yanukovych and subsequently became the bête noir of Russian claims that Ukraine had fallen into "fascist" hands. That would in turn legitimize Moscow's backing for the "Donetsk People's Republic," as the Eastern protestors have dubbed themselves.

But all that would greatly complicate an objective -- making parts of Ukraine ungovernable and justifying intervention -- that Russia could have achieved simply and right now. Inviting the OSCE in also provides a credible neutral referee and slows everything down sufficiently for Ukraine to hold its presidential election on May 25, ushering in a legitimate successor to Yanukovych. It seemed like Russia was working hard to undermine that process. The Donetsk Republic, which has attracted limited public support and is despised by the establishment even in its own region, will wither in time without the threat of Russian violence behind it.

So the balance of speculation has to be on Putin genuinely tacking toward peace. While formal Western sanctions against Russia have been largely symbolic so far, Moscow's Ukraine policy is hardly without cost. Capital flight has diminished the Russian economy's 2014 growth expectations from more than 2% to lucky-to-avoid-recession. The ruble has slumped by more than 7% against the dollar this year while other emerging markets currencies advanced. The central bank had to hike its key interest rate from 5.5 % to 7%, crunching credit across the economy.

Against that background, a credible threat of substantive sanctions, say constricting the $600 billion-plus flow of capital from Western banks and bondholders to Russia's private sector, might just have swayed Putin to quit, or de-escalate anyway, while he is ahead in Ukraine. Or the Western powers perhaps found ways to damage his or his friends' financial interests directly. We probably won't know exactly for some time.

Assuming the diplomatic reversal is genuine, some Russian-linked securities could be in for a de-escalation dividend. Within Russia those would be companies that investors generally like but suffered heavily in the political crossfire. Dominant state bank Sberbank (OTCMKTS:SBRCY) and internet supremo Yandex (NASDAQ:YNDX) fall into this category. Both have lost about a quarter of their value since Feb. 22.  An intriguing Russia play outside Russia is Austria-based Raiffeisen Bank International (VIE:RBI). The largest foreign lender in both Russia and Ukraine, Raiffeisen has sunk by 15% since the crisis erupted.

Place all bets carefully, however. A state that is effectively governed by one man on an emotional high, like Russia, can easily change its mind again. 
No positions in stocks mentioned.

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