Collapse of the Western narrative
The gloomy sentiments of winter have transformed into a “we’ll cope with that” attitude. Ukrainian forces retreated from Avdiivka due to a shortage of ammunition, while the Russians employed new tactics of distant, massive barrages with guided aerial bombs. The retreat was painful, but the withdrawal from Avdiivka seems to have accelerated the EU's previously sluggish decision making process, resulting in the long-awaited replenishment of artillery shells.
The situation at the front is described as complex and unstable, yet there is a significantly positive trend in how Western decision makers perceive the war. This marks a tectonic shift in understanding Russia, and strategizing about how to deal with it. Recall that, over the last two years, the prevailing narrative framed the war as a “border conflict,” advocating for rationed supplies of weapons and ammunition to Ukraine and imposing reasonable sanctions on Russia to diminish its war capabilities. It was expected that both sides would eventually become exhausted over a reasonable period, and then agree to negotiate a peace deal. However, as the third year of the war begins, the fighting is only intensifying, with Russia expanding its military production and Ukrainians showing no intention of surrendering. Against this backdrop, Western decision makers are witnessing the collapse of their narrative. Especially following Donald Trump's threat to not protect the European Union from Russian aggression, they are now explicitly recognizing the existential nature of the war, and acknowledging that Russia will not stop at Ukraine if it succeeds. Better late than never. Hopefully, the next level of understanding will be the realization that the only way to end the war is to defeat Russia, which means forcing Russia to withdraw from sovereign Ukrainian territory.
Despite experiencing significant delays in external funding and military support from the West, the economic indicators remain positive. Exports via the Russia-free sea route have surged, with iron ore and metals finally rebounding after two years of transportation challenges. The exports recovery has helped alleviate pressure on the balance of payments, although gross international reserves still fell by 8.5% (or $3.5 billion) since December, reaching $37.1 billion by March, due to markedly reduced financial inflows from abroad. We're observing continued disinflation, with the CPI rising by just 0.3% m/m (+4.3% y/y) in February, leading to a +0.7% ytd increase for the first two months of the year — the smallest rise in the last four years. This significantly lower-than-expected consumer inflation prompted the NBU to cut the prime rate in March by 0.5 ppts to 14.5%, even though it had previously signaled its intention to keep the rate unchanged until H2 2024. Furthermore, net budget collection (excluding grants) nearly doubled in February, buoyed by early corporate tax and dividend deductions of state-owned enterprises. The Ministry of Finance is using hands-on management to boost revenue, in the face of delayed financial support. However, all these positive economic trends are predicated on the expectation that substantial financial support from both the European Union and the United States will materialize in the coming months.
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