Cables From The Diplomatic Frontlines - NATO's $100bn watershed moment: implications of proposed launch of a long-term support fund for Ukraine.

NATO’s $100bn fund to Trump-proof Ukraine Aid will create a number of game-changing dynamics.

• NATO is moving forward with a plan to launch a $100 billion military aid program for Ukraine over five years, aimed at securing long-term support against Russian aggression.

• Jens Stoltenberg, NATO's secretary-general, supports overhauling how aid is managed by transferring control of the US-founded Ramstein Group to NATO, and consequently, proposing to enhance the alliance's role in coordinating military aid from approximately 50 countries.

• While some NATO members, including Poland and the Baltic states, are in favor, others like (the expected culprit) Hungary express concerns about escalating the conflict.

• The US seeks further discussions on the proposal's details, focusing on potential overlaps with existing efforts and the risk of inadvertently escalating tensions (unfortunately, two years into this war, Biden admin is still mostly preoccupied with escalation worries).

• German Foreign Minister Annalena Baerbock highlighted the necessity of transforming ad hoc support mechanisms into sustainable, long-term structures.

• But it is unclear if this signals a shift in Germany's stance towards a more concrete support framework or if Baerbock is once again out of sync with the more dovish and perpetually hesitant Olaf Scholz.

• Despite the proposed changes, the US intends to keep leading the Ukraine Defence Contact Group.

• (side note: and it would be astonishingly bad signaling if it didn’t).

• We don’t have (for now) enough data points to judge whether this fund is likely to materialize - it really should, that should be our presumption, but there are already some worrying signs.

• There are countries like Hungary and Slovakia - the two are already demonstrating resistance.

• But there are also others like Spain that weirdly focus on the remote structural risks like the potential for the $100 billion initiative to overlap with existing financial aid efforts.

• Such concerns are easily dealt with however, and it is worrying that a country of Spain’s size and heft is already throwing around some procedural concerns - this could be a signal of further resistance to come.

• For now however, we shall presume that this NATO-centric program will pass.

• And if it does pass, there will certainly be some important strategic implications worth unpacking.

• Most obviously, there will be implications on the battlefield and Ukraine’s ability to sustain long-term war of attrition.

• And this would in turn affect Russia’s calculus in two contradictory ways:

• 1) On the one hand, Moscow will be incentivized to throw the kitchen sink right now, and maximize gains with lesser regard for the cost and casualties;

• 2) At the same time, once the program kicks into effect, Russia will be faced with an adversary better prepared for the long-term war of attrition.

• And at that point, the question of how this affects their policy would largely depend on a number of (non-exhaustive) factors;

• a) Overall geopolitical context.

• Who is the President of the US, and what is their policy/how is it different from what is happening right now?

• Is it Trump? And is true that he wants to give up Donbass and Crimea to Putin?

• Is it once again Biden?

• If so, is he more assertive given that it is his last term, or is he more constrained given the unfavorable composition of the Congress?

• What is going on in the EU, is there additional funding to supplement this NATO program? etc.

• b) What is the overall mood in the west?

• Is the Ukraine fatigue reversing?

• Now that Ukraine is once again facing mortal danger of a collapsing front?

• Or are citizens of the West tired and want this war to be stopped at all cost?

• c) Actual situation on the battlefield.

• Is it worth pushing on with attritional war?

• Is victory closer every day?

• Or will Ukraine’s frontline stabilize?

• Will Russia scale production of its 1,500kg and 3kg glide bombs?

• Will Ukraine have enough F-16s with AIM-120 AMRAAM missiles to destroy a few of these bombers and deter/deny space to the rest of them over the frontlines?

• (side note: as of now, that is unlikely. Ukraine is set to receive only six by mid-summer (though some reports say up to twelve). It is also unclear how many advanced air-to-air missiles like AIM-120s Ukraine will be able to secure for its F-16s. If we get stuck over ‘‘escalation concerns’’ once again (similar to ATACMS and Taurus debate) then that would be real bad news for Kyiv)

• How about the balance of power in essential fires? Artillery shells? FPV drones?

• What about air defense?

• Russia is currently on track to overwhelm Ukrainian air defense systems absent massive supply of interceptor missiles (like Patriots) arriving sometime soon.

• Manpower is another issue - Ukraine is (foolishly) only now lowering the age of its conscripts to 25 (and at this point, it should probably be much lower...)

• All of this is to say that even if geopolitical context was somehow still broadly favorable to Ukraine, and Kyiv somehow secured the desired funding from NATO/US/EU/G7, the battlefield dynamics have their own separate timeline and slow deliveries of essential weapons/ammo could impact the trajectory of the war in a way that incentivizes Putin to press for advantage even if most of other factors would suggest settlement as the prudent course for Russia.

• d) Impact on the economy.

• Two years into the Ukraine war, Russia has demonstrated a surprising level of resilience: the IMF expects Russia to see a GDP growth of 2.6% in 2024, which is notably higher than the forecasts for the UK (0.6%) and the EU (0.9%).

• This resilience is attributed in part to the measures implemented by Russia's strong, independent central bank, which has imposed significant interest rate hikes to control inflation, and government capital controls that restrict the outflow of money from the country.

• These measures have certainly helped to stabilize the ruble and maintain economic activity within Russia.

• Russia outright stealing foreign assets and assigning it to Putin cronies has also helped - if those western owned assets remained frozen/unproductive, the impact on the economy would have been more notable.

• In addition, Russia has a massive shadow fleet of oil tankers that sidestep G7 price cap on oil (set at $60 per barrel) by avoiding western insurance and logistics (a key measure enforcing the price cap is that any company that wants access to western credit/insurance/logistics markets for oil tankers/transportation must adhere to the price cap - in practice however, enforcement is also quite patchy even when parties decide to comply on the surface).

• And a number of third party export/import operations located at strategic countries (like the UAE/Hong Kong etc) have been instrumental in sourcing key components and rare semiconductors for Russia’s industry.

• With all that said however, the situation isn’t as rosy as Putin claims it to be.

• For a start, the very same IMF that projects strong growth this year has also published research that puts Russia’s GDP at around 7% lower than the pre-war forecast..

• In addition, what happens next is an open question - there are certainly signs that what has worked before will not necessarily work the same way in the future.

• Russia's GDP is around 7% lower than the pre-war forecast, according to the International Monetary Fund.

• Secondly, even though enforcement of the price cap has been far from ideal, the price caps did have a significant effect: Russia has had at least $36.8 billion less in its coffers from foregone export revenues due to the G7 price cap on the Russian crude oil.

• All that is money that wasn’t spent on purchasing missiles/shells/drones on scaling up domestic manufacturing bases.

• Thirdly, (thus far) incredibly competent (and relatively independent) Russian central bank will have to make much tougher decisions going forward: the trade-off between containing inflation and killing growth will become even more acute going forward.

• This is because Russia is now running a war economy: government spending is at unprecedented levels, with a significant portion allocated to military expenditure.

• Indeed, Russia's budget for 2024 includes a significant increase in military spending: a record 30% increase in military expenditures, totaling 36.6 trillion rubles (approximately $405 billion).

• This escalation in defense spending, which amounts to nearly 70% more than the previous year, will have a major economic impact.

• When military takes up 6% of your GDP, and the labor market is very tight at 2.8% unemployment rate as of March of this year (and this trend is not reversing anytime soon and would indeed get worse if Putin submits to public pressure and limits Central Asian immigration following the Moscow terrorist attacks (perpetrators were of Tajik origin)) you will run into major cost-push inflation unless Russia’s central bank hikes the interest rates much higher and inflicts some pain on consumers (especially those that rely on loans to make ends meet) and businesses.

• So, whether it is higher inflation or lower economic growth/dented living standards, the impact on Putin’s popularity may end up being quite unfavorable.

• Finally, it is also important to remember that the West has not embarked upon the toughest measures yet: it can freeze $300 billion of the Russian central bank's assets, impose widespread secondary sanctions - cutting off financial institutions and most businesses from doing business with Russia (similar sanctions have crippled Iran), and tighten blockade around technology imports - finally ensuring that Russian industry lacks access to crucial enabler technology like advanced semiconductors.

• (side note: the US did already impose secondary sanctions on Russia, authorized under Executive Order 14114 (December 2023), which broadens existing import restrictions on Russian goods and targets financial institutions involved in transactions supporting Russia's military efforts. The sanctions also focus on restricting Russia's revenue from key economic sectors by limiting its use of the international financial system​. With that said however, these secondary sanctions are still narrow - they can be expanded to copy those that inflicted enormous economic damage on Iran.)

• e) Allies.