German summary:

According to political decision-makers, the likelihood of Russian military intervention in Ukraine is growing. With his parallel and ultimate demands, President Putin wants to force the West to make massive and unilateral changes to the internationally agreed set of rules in Russia's favor. Should it come to a military confrontation, it can be assumed that the Western community of states will react with massive sanctions in the economic and financial sector and that the German government would support this. The West is prepared to accept considerable consequences for the global economy. At the same time, it is assumed that the damage to the Russian economic and financial sector would be much more dramatic. The West is thus creating considerable preventative leverage: a collapse in the Russian economy and substantial losses in state revenue could pose an existential threat to President Puti's power base.

Possible steps

• Cessation of trading in Russian government bonds.
• Exclusion of Russia from SWIFT ('Iran scenario')
• Restrictions on relations in the area of energy supplies (even if as a Russian countermeasure)
• No operating license for Nord Stream 2
• Sanctions against Russian state-owned companies and leading figures in the regime

Possible consequences

• It is clear in Western capitals that such steps would have a massive impact on the global economy, including further increases in energy prices.
• According to the predominant assessment, the Western economies could compensate for such slumps in the medium term - with considerable losses.
• The effects in Russia would be far more dramatic. More than 50% of Russian state revenue comes from the export of fossil fuels. Although Western Europe obtains over 40% of its gas from Russia, Russia sells 70% of its gas to Western Europe, and the proportion is even higher for other raw materials. Without SWIFT, Russia would be excluded from international payment transactions. The Russian leadership would not be able to continue to buy the approval of an already often dissatisfied population. 

Result

In the event of military escalation, the West refrains from responding to violence with counter-violence, but its reaction is aimed at the Achilles heel of the Russian regime: The structural deficits of the Russian economy and the nature of a system of rule that holds on to power essentially through the instruments of repression and bought consent

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Original text of the BGA Client Memo in English

Executive Summary

Further escalation of Russian-Ukrainian tensions into a military conflict is a scenario political decision-makers in Europe and the United States are taking into consideration more and more seriously. President Putin has extended his ultimatum beyond good behavior of Ukraine: Should the West not respond to his virtually unfulfillable security demands he does not rule out military action.

Corresponding risks to the European and global economy are increasing.

The pretext of a Russian attack on Ukraine would most likely be a situation (created) in which Russia 'would have come to the assistance of beleaguered fellow countrymen'. Alternatively, he 'could be forced to respond' to the West not yielding to his political ultimata. Yet the primary goal of the Russian leadership at present seems to be to test the West and to enforce an international situation more favorable to Russia.

The further development will largely depend on the unity and resolve of the West. Possible sanctions could target energy exports / Nordstream2, trade in Russian government bonds, Russia's participation in SWIFT and individual persons and companies. The new German government is likely to back such measures.

Berlin, Brussels and Washington are aware that severe sanctions could have a considerable impact on the world economy but calculate that the damage to Russia would be far more dramatic and that the threat will have a deterring effect on Moscow. Correspondently, it can be assumed that the willingness of the Western community to act has been clearly communicated to the Russian side.  

Current situation

• The Russian leadership has deployed probably more than 100,000 troops at the Ukrainian border. Ukraine and Western countries fear an invasion of Ukraine. Russia denies any such intentions.
• In the video summit on December 8 President Biden related to President Putin, that Russia would have to fear massive consequences in case of war, indicating the West would resort to means discussed since 2014 and not applied yet. Assistant secretary of state Karen Donfried has followed this up with talks in Moscow.
• NATO and EU have rallied behind the US.
• President Putin ultimately demands a status quo ante NATO's eastward extension in 1997: no deployment of NATO forces in ex-soviet-republics, definite renouncement on any further enlargement, particularly by Ukraine, no Western interference in Ukraine. Russia has also alluded to Finland's situation since.
• NATO has refuted the Russian demands but declared its readiness for "a meaningful dialogue with Russia" and that it is "aware of Russia's recent European security proposals."
• The Russian leadership creates a sense of urgency that would from her side justify further action. President Putin has stated that Russia "will respond with adequate military-technical measures and react harshly" in case the West continued its rather aggressive line" as he sees it.
• Stepping up the tonality President Putin has added since that Russia's answer would depend "on the proposals that our military experts will submit to me", should his proposals for binding security guarantees be rejected by the West.
• US talks with Russia on the overall security situation are likely to start early in 2022. High level talks are also planned between German and Russian senior officials.

Background:

• NATO-Russia relations are guided by the "NATO-Russia founding act" of 1997 which i.a. regulates the deployment of forces near each other's borders. NATO sees the act violated by Russian annexation of Crimea and fueling war in the Donbas yet maintains to always have stuck to the agreement.
• In 2008 NATO in principle opened the perspective for Ukraine and Georgia to one day become NATO members yet postponed any further concrete steps indefinitely.
• Military advisers from NATO countries help Ukraine to strengthen its forces, Ukraine has bought military hardware in the West, most notably capable drones from Turkey.

Possible Russian motives

• Russia does not ultimately exclude a military conflict but primarily - in a traditional manner - tries to test the West through escalation. Bringing the US to the table (instead of just the Europeans) is seen as a success already.
• The West shall accept Russia's concept as the dominant power in the post-Soviet space with the right to have a special say in the fate of other successor states (except for the Baltic states being NATO members already). Russia thereby wants to create its idea of a buffer zone consisting of Ukraine and Belarus - and eventually Finland - between NATO and itself.

• The Russian leadership perceives the trends of global politics not to be in its favor. The US and China having become the two supreme global powers, Russia wants to consolidate its own position.
• Dissatisfied with the stalemate of the conflict with Ukraine, Russia also aims at converting the current status quo into a lasting situation in its own favor. The already creeping annexation of the Donbas shall be accepted.
• The Russian leadership considers the current situation to be favorable to advance its own objectives: the US being largely absorbed by the challenge put by China and by upcoming elections, the Europeans (also thanks to Russian hybrid diversion) being split and lacking a clear leadership on Russia politics with the departure of A. Merkel.  

Possible further development

• An openly aggressive attack on Ukraine would not be in the tradition of Russian politics - a situation (created by Russia) in which it 'would have to come to the assistance of beleaguered fellow-Russians abroad' seems increasingly likely.
• President Putin could furthermore declare the West's refusal to accept his proposals (presented at gunpoint) to be a justification for military action.
• Military experts reckon, both Russia and Ukraine would incur massive losses in any conflict but see a clear upper hand on the Russian side to enforce any goal.
• Military engagement of NATO in such a conflict at present is not conceivable. President Biden has once again underlined this.
• Clear messaging from the West will be crucial. Russia must know the price tag for possible aggressive behavior beforehand. Responding to classical zero-sum thinking, further Russian action also in the past largely depended on the unity and resolve of the West.
• The Russian president is ready to take high risks and acts in a different rational than the West does. Yet in the end he, too, is a man of realpolitik. Beyond an incalculable military confrontation, he fears for his own power base. This could be threatened by a dramatic loss of revenues and a major economic crisis with ensuing social upheaval as consequences of forceful sanctions.
• The West cannot except that agreed rules of international affairs including the right to choose alliances are dictated and changed by force.
• Besides sanctions and dialogue, the West must take the Russian perception and concerns for real. There are fora enough to discuss security issues: The NATO-Russia dialogue, the OSCE, the UN, disarmament talks. Common interests can also be addressed in other spheres: climate change, fighting terrorism, encountering pandemic, international trade, energy transition, technical innovation.

• Any serious escalation of the current conflict would have major repercussions for the world economy.
• Western countries could impose sanctions on Russian energy exports, or the Russian leadership could do so reacting to Western sanctions in other spheres. This would have massive consequences - for both sides. But Russia clearly is more dependent: European countries buy more than 40% of their gas from Russia, Russia sells 70% of its gas to Europe. Targeting the yet unfinished Nord Stream 2 pipeline would have a symbolic effect, targeting other sources of Russian energy exports would have a more direct effect.
• The financial sector offers a set of powerful sanction tools yet unused. A ban on trading Russian government bonds would affect Russia severely but also the already nervous financial markets due to the prevalence of these securities in Western portfolios.
• Excluding Russia from SWIFT is a sanction being openly discussed again. It was the tool, bringing Iran back to the negotiating table. Russia's payments with the rest of the world would be disrupted while in turn this also would have substantial repercussions for the West and the global economy.
• Targeted sanctions would be very likely on individual actors or companies as has been the case in recent years.
• Western governments are clearly resolved to react massively in case of Russian military aggression and are ready to bear consequences for their economies. Energy prices would go up significantly further, yet there are - at high costs - alternate providers on the world market. Analysts in capitals are clearly inclined to believe that problems arising could be offset this way in the medium term.
• The Russian economy would suffer to an extent that could very seriously threaten the power base of the current regime. Dramatic losses of revenues could not be compensated for an extended period.

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About the authors:

Rüdiger von Fritsch is a BGA partner with 35 years of experience in diplomacy and government affairs. He was German Ambassador to Russia for five years until 2019. Prior to that, he was German Ambassador to Poland for four years and Director General of the Department of Economic Affairs at the Federal Foreign Office, where he was responsible for foreign trade, export promotion and control, energy, climate, research and technology. In this function, he was also Germany's deputy G8 Sherpa. During his career, he was Vice President of the Federal Intelligence Service (BND), Head of Political Planning for the Federal President and Advisor for European Affairs at the German Representation to the EU (German Antici). In October 2020, von Fritsch published his new book "Russia's Way" with many reflections on his time as German ambassador to Russia and on President Putin's power games. 

Alexander Dergay is an analyst at Berlin Global Advisors. Before joining BGA, he completed a dual Master's degree in Global Studies at the London School of Economics and Political Science and at the University of Vienna. Alexander gained his first professional experience in an international context in the European Parliament in the office of Prof. Dr. Sven Simon (CDU), in the Representative Office of the State of North Rhine-Westphalia in Moscow and in the Eastern Europe Dialogue of the Friedrich Ebert Foundation in Kiev. Most recently, he completed an internship in the EU delegation to the OSCE. Due to his interest in Eurasian political and economic issues, he spent extended periods as a visiting scholar in Beijing and Moscow. In addition to his native languages German and Russian, he is fluent in English and can communicate in Spanish and Mandarin.  

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