What happens if Russia loses to Ukraine

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About the author: Tim Ash is the emerging markets senior sovereign strategist at BlueBay Asset Management.

Russia is losing the war in Ukraine. If President Vladimir Putin’s initial goals were to decapitate the government in Kyiv, impose his own regime therein, demilitarize the country, and stop its Western orientation, then eight months in, the invasion has clearly failed.

Putin subsequently fell back on more-limited stated goals of securing Donbas and a southern land corridor to Crimea. In September, Putin seemed to try to cement his limited gains by announcing the annexation of four partially occupied regions of Ukraine. However, recent military defeats in Kharkhiv and now around Kherson raise doubts as to whether even these objectives can be sustained.

Indeed, a total collapse of Russian forces in Ukraine now seems possible. The limits of Russian conventional military power have been brutally exposed. President Xi Jinping of China and Prime Minister Narendra Modi of India are now appearing to distance themselves from the Russian leader. Within Russia, opposition and unease are growing at the poor performance of the Russian military and state.

Ukraine, on the other hand, has united and mobilized against the Russian threat. Ukraine now has a capable military force, arguably a much greater threat to Russia than on the day of the invasion. The West is also now united around the common purpose of standing up to Russian aggression.

From here on out, Putin is faced with three limited options. Each would affect markets.

First, the wise thing for Putin to do would be to quickly sue for peace. One could argue that the halfhearted Russian attempt to force an energy crisis in Europe and the annexation and linked threats therein of the use of nuclear arms, are all meant to force Ukraine and the West to the negotiating table this fall and to concede to peace terms on Putin’s terms—he keeps what he occupied. But with Ukraine on the front foot, Kyiv seems in no mood to negotiate until it at least pushes Russia back to positions as of Feb. 23, invasion day.

In fact, at this stage, a full reversal of Russian gains seems the most likely outcome, as Russian forces in Ukraine collapse over the winter. But waiting for this eventuality would leave Putin vulnerable to domestic political fallout from what would then clearly be a devastating military defeat. An early withdrawal amid some kind of peace process might enable Putin to save some face, by limiting Russian casualties, and perhaps he could negotiate some sanctions moderation on the Russian economy.

A Ukraine win and early end to the war would obviously be well received by the market. Risk assets would rally, and commodity prices probably fall or moderate their rises, although much would depend on the political setup remaining in Russia. But lower commodity prices would help counter the global cost of living crisis, and might allow the U.S. Federal Reserve to pivot in terms of interest rates, again helping to turn the global mood.

If Putin stays, clearly, relations with the West will remain strained, and sanctions moderation would be limited. Arguably, markets would be waiting for the next flare-up. Perhaps we would see a relatively short but significant market rally.

Second, a much more optimistic scenario involves Ukraine winning, and Putin losing power, most likely via an internal coup. Less likely would be a popular uprising, although this could happen over time, especially if Putin tries to grind out a longer war. Obviously, there are concerns about who would follow Putin. The next person is likely to be currently within the inner Kremlin circle, but one who wants to stabilize the relationship with the West. If this happens, and Putin leaves power, sanctions will be moderated. Markets are likely to rally hard on any such outcome, as the prospect will reopen investments into Russia.

The third and obviously worst-case scenario is that Putin could carry out his nuclear threat. He may use tactical nuclear weapons to try to halt any Ukrainian offensives and again force the Ukrainian side to the negotiating table. However, as military specialists have highlighted, the use of tactical nuclear weapons is difficult in practice. They might not bring clear-cut military wins, they risk contamination of Russia and occupied territory, and they bring huge political costs to Russia. China may abandon Putin. It would risk military intervention by the North Atlantic Treaty Organization, and the prospect that China and NATO might reach the same conclusions that Putin needs to be removed.

An outcome that involves nuclear war is unlikely, but obviously a nuclear attack by Russia would be a huge security event globally, making the world instantly more uncertain and risky. If Russia turns to nuclear action, the global markets would probably be sent into a tailspin, with flight to quality assets. Commodity prices would probably rise massively, global growth would crater, and risk assets would suffer. Risks would be of a global systemic event, adding on to already elevated concerns around the global cost of living crisis, Fed tightening, and existing war concerns.

Which of these three options comes to pass, regrettably, rests almost entirely with Vladimir Putin.

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