Crisis: Post Crimea Referendum Scenarios

The Crimean authorities have scheduled a referendum on March 16 to determine whether the Autonomous Republic of Crimea will declare independence from Ukraine and join Russia. The EU and US have both strongly condemned the decision to push ahead with a referendum while Russian troops occupy Crimea, and argue that secession would be illegal under Ukraine's constitution, which requires a nationwide referendum first. Meanwhile, Russia has asserted that the ousting of Ukraine's government has effectively invalidated the validity of the constitution, implicitly suggesting it would recognise the outcome of the referendum.

The referendum ballot paper will contain two options for voters. The first question will ask voters whether they are in favour of the Autonomous Republic of Crimea reuniting with Russia as a constituent part of the Russian Federation, while the second asks whether they are in favour of restoring the Constitution of the Republic of Crimea of 1992 and of Crimea's status as part of Ukraine. The second question is somewhat misleading as the 1992 Constitution declares that Crimea is an independent state and not part of Ukraine. Thus restoring this constitution would mean that Crimea ceases to be part of Ukraine. There is no option to vote for Crimea to stay as an autonomous region of Ukraine.

While the Ukrainian crisis has so far played out largely in line with our core view, below we lay out a number of scenarios that could emerge after this weekend's referendum. We cautiously maintain our core view that there will be no further Russian intervention in Ukraine, but with troops amassing close to the eastern borders of Ukraine, there is a growing possibility that the situation will escalate.

Conflict Fears Pressuring Markets
Exchange Rate - UAH/USD

Crisis: Post Crimea Referendum Scenarios

The Crimean authorities have scheduled a referendum on March 16 to determine whether the Autonomous Republic of Crimea will declare independence from Ukraine and join Russia. The EU and US have both strongly condemned the decision to push ahead with a referendum while Russian troops occupy Crimea, and argue that secession would be illegal under Ukraine's constitution, which requires a nationwide referendum first. Meanwhile, Russia has asserted that the ousting of Ukraine's government has effectively invalidated the validity of the constitution, implicitly suggesting it would recognise the outcome of the referendum.

The referendum ballot paper will contain two options for voters. The first question will ask voters whether they are in favour of the Autonomous Republic of Crimea reuniting with Russia as a constituent part of the Russian Federation, while the second asks whether they are in favour of restoring the Constitution of the Republic of Crimea of 1992 and of Crimea's status as part of Ukraine. The second question is somewhat misleading as the 1992 Constitution declares that Crimea is an independent state and not part of Ukraine. Thus restoring this constitution would mean that Crimea ceases to be part of Ukraine. There is no option to vote for Crimea to stay as an autonomous region of Ukraine.

While the Ukrainian crisis has so far played out largely in line with our core view, below we lay out a number of scenarios that could emerge after this weekend's referendum. We cautiously maintain our core view that there will be no further Russian intervention in Ukraine, but with troops amassing close to the eastern borders of Ukraine, there is a growing possibility that the situation will escalate.

Conflict Fears Pressuring Markets
Exchange Rate - UAH/USD

Scenario I: Crimea Declares Independence, But Falls Short Of Full Annexation

Despite strong pro-Russian sentiment in Crimea, we note that a vote to join Russia is by no means guaranteed at the referendum. While there is no option to remain a part of Ukraine, a majority vote for independence, rather than full accession to Russia might occur. As both Ukraine and Western powers are unlikely to recognise the result of the vote, we expect a fair amount of tension would be expected in this situation, although ultimately we think Russia is unlikely to move troops out of Crimea anytime soon. Despite not officially integrating into Russia, under this scenario Crimea would likely share many economic and social attributes, including the adoption of the Russian rouble as the official currency, while Russia would maintain a strong military presence in the region through its existing military bases.

Market Impact: We would expect to see some volatility, particularly if tensions between pro-Russia and pro-Ukraine citizens escalate, but most of this has already been priced in. In fact, we think the recent sell off has already incorporated some probability of economic sanctions on Russia. Hence, if the market perceives the threat of sanctions to be receding in a de-escalation scenario, this would be market positive.

Scenario II: Russia Annexes Crimea

Market Impact: Major Negative For European Markets, Sector Specific Industries

Given that there is a strong chance that the voters in this weekend's referendum will vote for integration with Russia, this scenario would see Russia annex Crimea, but fall short of a military intervention in mainland (especially eastern) Ukraine. Having built up a considerable military presence across the eastern border of Ukraine, both the West and Ukraine will not intervene militarily to retake Crimea. However, we think that a scenario where Crimea was directly absorbed into Russia would trigger trade sanctions by the EU and the US on Russia, which would be extremely painful economically.

Market Impact: While markets have priced in a small probability of economic and financial sanctions being placed on Russia, we think most investors are adopting a wait and see attitude, suggesting further downside if and when sanctions are announced. Russian assets would be worst hit, but the damage would spread as far as German equities, while soft commodities and oil would benefit, along with typical safe haven assets such as USTs.

Scenario III: Russia Advances Into Eastern Regions

This represents the worst-case scenario, whereby Russian troops move into eastern Ukrainian regions, probably under similar pretexts to those used in Crimea as tensions between the ethnic Russian and Ukrainian populations flare into sporadic violence, or under the guise of provocation. Although the West would be reluctant to intervene militarily at first, there would almost certainly be severe economic and financial sanctions imposed on Russia, while the Ukrainian military may decide to launch a counteroffensive on Russian troops, escalating into a bloody and potentially protracted conflict.

Market Impact: This scenario would be catastrophic for markets. Regardless of the actual risk of Western military intervention in Ukraine, the outbreak of a military conflict on Europe's borders would probably trigger a fierce fire sale across all asset classes. Beyond market sentiment, a combination of sanctions and military action would probably bring logistical disruption, particularly affecting gas and grains, while growth concerns in economies reliant on Russian gas could lead to rising credit spreads.

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