As the worst standoff between the West and Russia since the Cold War escalates, the crisis is unnerving investors who are unsure of what will happen next.
Hopes of a resolution were dashed when Ukraine declared an end to the so-called Easter truce earlier this week. U.S. President Barack Obama said on Friday that he would talk to European leaders later in the day about the crisis, and about the possibility of imposing further sanctions on Russia.
On Friday, Reuters reported that a Ukrainian military helicopter had been hit by gunfire at an airfield near the rebel-held eastern city of Slaviansk. Meanwhile, Russia warned Kiev it would face justice for killing up to five pro-Russian rebels a day earlier.
As concerns of all-out violence heighten, here’s a look at three possible outcomes to the crisis, and what each could mean for investors.
Tensions continue to escalate
For weeks now, armed rebels have occupied government buildings across eastern Ukraine and most show no sign of backing down.
There has also been much political posturing between both the West and Russia – each blaming the other for not adhering to a deal in which Ukraine, Russia, the U.S. and European Union agreed to de-escalate the conflict.
“In the short term, the most likely outcome of the Ukraine crisis is more of the same,” David Dalton, eastern Europe editor at the Economist Intelligence Unit, told CNBC.
“The high level of political risk and the bout of financial turbulence triggered by Russia’s annexation of Crimea in March has already started to impinge on investors’ decisions, as they hold back on investment plans until both the economic and political outlook becomes clearer.”
Nicholas Spiro, managing director of Spiro Sovereign Strategy, told CNBC he agreed that a continuation of the current state of affairs was what most investors were pricing in – but he warned that this was a risky strategy.
“We have already gone from the annexation of Crimea to military operations in eastern Ukraine in the space of just several weeks,” he told CNBC.
“Eastern Ukraine is a higher-stakes and more dangerous battleground, with ample scope for things to spiral out of control. Investors banking on a ‘tense but manageable’ scenario are underpricing the risks.”
The crisis has already taken its toll on Russia and Ukraine’s markets – and further unrest will only hit the countries harder.
Russia’s MICEX index is down around 13 percent year-to-date, and the dollar has gained 8.5 percent against the rouble over the same period.
Ukraine’s currency has also floundered, despite interest rate hikes by its central bank. The dollar has risen around 35 percent against the Ukrainian hryvnia year-to-date.
Permanent peace agreement
This is the least likely scenario, according to Spiro, and one the markets are assigning a very low probability to. “That the Geneva accord collapsed in a matter of days shows how difficult it is to meaningfully de-escalate tensions,” he said.
Even if there is a deal between Ukraine and Russia, Kiev is unlikely to come out on top, Dalton warned. Agreement between the countries could come in the form of a new Ukrainian constitution – which could include a decentralization of the country’s political structure, and the acceptance of Crimea’s annexation.
This would “severely diminish Ukraine’s standing as a sovereign state,” Dalton said. “If Ukraine is, in effect, reduced to something like a satellite of Russia, then the Westernizing reform plans of the interim government could come to nothing, and the planned improvements in the investment environment fail to materialize,” he added.
As Ukraine boosts its offensive against pro-Moscow separatists, and Russia begins military drills on the border, fears of a Russian invasion have heightened.
Spiro called this the “nightmare scenario,” which would be the “straw that breaks the camel’s back, as far as east-west relations are concerned.”
It would certainly hit markets hard. “If the situation were to tip over to war, this would trigger another bout of capital flight and currency weakening, as investors anticipated both further economic deterioration and the imposition of stronger Western sanctions,” Dalton said.
The U.S. and EU have already imposed travel bans and asset freezes on a number of Ukrainian and Russian officials, with Moscow retaliating by imposing sanctions of its own. On Thursday, U.S. President Barack Obama warned that additional penalties were being prepared, and would be implemented if Russia failed to back off.
But more extreme sanctions – such as those targeting trade or the financial sector – would likely push the economies of Russia, and perhaps even the European Union, into recession, Dalton warned.
It could also have a significant on the gas markets, given that Russia supplies around a third of Europe’s natural gas – and some of that supply is delivered through pipelines running through Ukraine.
Gas giant Gazprom – in which the Kremlin owns a majority stake – claims that Ukraine owes it more than $2.2 billion, and has already hinted that it could reduce supply if the debts are not paid. Russia has also hiked gas prices for Ukraine from $268 to $485 per 1,000 cubic meter, scrapping previous discounts, since the start of the unrest.
“A cut in gas supplies to the EU across Ukraine—either by Russia, or by Ukraine—would deliver a supply shock to many Western firms, but would also do significant damage to Russia’s budget inflows,” Dalton warned.