Ok, now I cannot avoid it any further. How can I claim a blog on Emerging Markets with no comments on the situation in Ukraine. So, here it goes.

First, let´s take a look on the main fixed income indicator of Ukraine – the cash price on the Ukrainian government bond (USD denominated) that matures in the beginning of June this year (the technical term is UKRAIN 7.95 06/04/14 $). The cash price was slightly above 100 in January. But, as the situation escalated with demonstrations that turned more and more violent, the fall of Viktor Yanukovych and the current situation in the Crimea, the price of the short dated bond has dropped to a current price of around 93. With a current price of 93 and less than 3 months to maturity, the bond yields 41 %.

The situation is so volatile and confusing to the market that the bond trades on headlines alone. Let me give you an example. Last week on March 5, the bond traded at a price of around 95 in the morning. At lunch time, reports were in the press from acting finance minister Oleksandr Shlapak that Ukraine was considering a debt restructuring. So, as the news hit the screen, the price on some broker screens dropped to 70. An hour later, it was confirmed that the acting finance minister was considering restructuring on domestic bonds only – and not foreign denominated bonds. So, the price of the bonds bounced back to the 92 area. Headlines in the press influence the price of the short dated bonds at the moment.

Picture from Bloomberg.

So, where is the international help? The IMF, EU and the US are together with the Ukrainian government negotiating an aid package at the moment. Rumors about a $15 billion USD bailout package have been around for some time. But, the trouble is, no one knows the extent of Ukraine´s financial problems. Will 15 billion USD be enough and for how long will that aid last? They are trying to find out at the moment. But they don’t have that much time because – as you know – a large USD denominated bond is about to mature in less than 3 month time.      

What is about to happen? Well, no one knows what Putin is considering next.

There will be a referendum about the future of Crimea this Sunday and - quite possibly - this will show that the majority will prefer to become part of Russia.  So, Russia will claim Crimea by the end of March. Now, the US has denied the legitimacy of this referendum and has promised – together with the EU - to retaliate financially.

But realistically, how can the EU and the US harm Russia financially right now? In a recent Wall Street Journal article, the dilemma is explained. Import and export relations with Russia have been rising steadily since the collapse of the Soviet Union and Russia now supplies around 30% of Europe´s natural gas consumption. So Europe is depending on Russia. 

But, the EU is able to shift energy supplier - over the medium term (if the EU can commit to it) - and this will be critical to Russia since energy export revenue covers about 50% of the federal budget revenues. So Russia is completely dependent on a high energy price and on “keeping customers happy” to cover the federal budget. Recently, we saw Gazprom cut prices to their European customers, because of pressure from cheap coal deliveries from the US. Obviously, coal is no perfect substitute to gas in a Europe that praises "green energy", and when Russia cut off the gas supplies to Ukraine and Europe back in 2009, reliable gas deliveries from Norway made up for the shortfall.  

So, who has the upper hand? Who will flinch first? I don’t see Russia backing down over Crimea. They have too much invested in this confrontation and will lose too much if they back down. If the result of the referendum turns out as expected, Russia will demand Crimea. The EU and the US will have to accept this but as a possible response, the EU will start looking for alternative suppliers of energy *). Over time, this will put additional pressure on the Russian federal budget and the ultimate looser will be Russia.

*) The EU will have to commit to this in the long run - but I must admit this assumes that Germany is able to commit to this "hard core" EU response as Germany has been the weak link in this game against Putin.