Focus Ukraine: Attacking Russia's Economic Potential and Undermining Russians' Confidence in Their Own Security Are Elements of Ukraine's Current Strategy

Ihor Petrenko, Dmytro Levus, Petro Oleshchuk, Oleksiy Kushch

18 mins - 19 de Marzo de 2024, 07:00

Agenda Pública and United Ukraine Think Tank present Focus Ukraine, a weekly article series analysing how the military conflict in Ukraine and the political and economic situation in the country will evolve. The articles are written by Ihor Petrenko, Dmytro Levus, Petro Oleshchuk and Oleksiy Kushch, experts of the United Ukraine Think Tank.

Russia is trying to strike as hard as possible at Ukraine in order to destroy its infrastructure and terrorize the civilian population. At the same time, Ukraine responds with accurate strikes on oil refineries, and the actions of Russian volunteers who have entered the Russian border regions from Ukraine make Russian propaganda nervous about another demonstration of the government's helplessness against the backdrop of a non-alternative presidential election
In the course of the Russian-Ukrainian war, the trends that were previously outlined, but due to insufficient information, might have seemed to remain a kind of side and exotic direction of the war, have finally become clearly visible. Thus, the events of the past week have shown that the Ukrainian command has managed to turn strikes on Russia's oil refining sector into a real analog of strategic bombing with a successful result so far. Moreover, it is obvious that Ukraine has the appropriate equipment in the form of drones capable of overcoming air defense, carrying a powerful warhead and delivering precise, effective strikes at a distance of over a thousand kilometers, has an up-to-date target bank and a clear understanding of the main task. Russia's oil refining sector must be destroyed to the extent that it ceases to be an effective means for Russia to obtain funds to continue the war and to form the budget of the aggressor country. 

During the week, there were several such significant damage to refineries. This happened to the largest oil refinery in the Kaluga region ("Pervyi Zavod" LLC), which processes 1.2 million tons of oil per year. It specializes in petroleum solvents, jet fuel, and fuel oil. It was planned to modernize it for $650 million by the end of the year. In 2023, the plant was already repaired, and last year there was an attack on this plant, but unfortunately, an empty tank was hit. The drone attack on the Russian oil refining industry on March 12-13 targeted enterprises that account for 12 percent of the aggressor country's oil refining. For example, a drone attack on Rosneft's Ryazan refinery on March 13 led to a fire at two primary oil refining units, which account for 70 percent of the plant's capacity. This refinery is one of the largest in central Russia and is the main supplier of fuel for the Moscow region. The attack on March 12 on the refinery in Kstovo, Nizhny Novgorod Oblast, 1,150 km from the estimated location of the drone launch in Ukraine, resulted in a prolonged shutdown. There are many videos online showing the refinery's equipment on fire. The piquancy of the situation is that this equipment is made in the United States and it is problematic to repair it under sanctions, to put it mildly. This refinery produced 5% of Russia's annual oil refining, 17 million tons. The Novoshakhtinsky refinery in the Rostov region, which was used to supply fuel to the invading group in Ukraine, was also put out of commission. The Kirishi oil refinery in St. Petersburg was also hit. On the morning of March 16, it became known that Ukrainian drones attacked three oil refineries at once in the Samara region of the Russian Federation, 800-900 km from the Ukrainian border, meaning that the drones had to fly over 1000 kilometers before they successfully destroyed the refinery facilities. In particular, the Syzran refinery was hit, which is one of the twenty largest in Russia. Minus 7 million tons of oil refining per year. The Novokuibyshevsk and Kuibyshev refineries were also attacked. They process 25 million tons or 10% of Russian oil refining. 

The redistribution of fuel flows in Russia has already created logistical problems, especially as it prepares for the sowing campaign and the need to supply the front line. Russia is forced to withdraw air defense systems from the front to cover the refineries. According to official Russian reports alone, there has already been a drop in oil production by at least 6%.

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At the same time, Russia is trying to inflict the most damaging strikes on Ukraine possible, precisely to destroy infrastructure and terrorize civilians, including attacks on defense facilities. It is obvious that the border and frontline regions in this Russian plan should turn into scorched earth. Attacks with guided aerial bombs and artillery, converted S-300 anti-aircraft missiles, continue there. Myrnohrad, Pokrovsk, Nikopol and other towns have been repeatedly hit. People are massively evacuating from the border and frontline regions. However, this does not mean that such strikes have become a priority and that Russia has given up terrorizing the entire territory of Ukraine. On March 12, Russia fired missiles at Kryvyi Rih. A direct hit destroys a nine-story building. The roof of a five-story building was hit. The rescue operation ended at night. Four people were immediately reported dead and at least 43 injured, including 12 children. Later, a Russian Shahed UAV struck a five-story building in Sumy. Fifteen apartments were completely destroyed, and the same number were severely damaged. 10 people were rescued from the rubble, and it is unclear how many people were killed. It is obvious that Russian generals and politicians deliberately choose such targets. And they are supported by the Russians. From time to time, there are massive attacks by Shahed UAVs on the rear areas of Ukraine, but with uncertain results for the Russians. While on March 12, attacks by enemy Shahed UAVs damaged an infrastructure facility in Ternopil region, causing a fire that the State Emergency Service extinguished with 19 units of equipment within hours, on March 15, all 27 Shaheds were shot down by Ukraine's air defense. On March 15, Russia fired several ballistic missiles at Odesa from the occupied Crimea. Russia, as a terrorist state that professes the same terrorist ideology of the "Russian world," is true to itself. Among the dead are a medic and a rescuer who arrived at the place of the attack. And the Russian terrorists sent a second missile there, knowing full well that a rescue operation was underway. The next day, another rescuer died in the hospital. In total, 21 people were killed and about 70 wounded.

On the land front, the main news of the week was the events on the Russian-Ukrainian border. The Russian Federation is experiencing firsthand what ground warfare is like. The Russian armed opposition, united in the Russian Volunteer Corps, the Russian Freedom Legion and the Siberian Battalion, which is fighting alongside the Ukrainian Defense Forces against the Russian invaders, made another offensive into Russian territory in the Belgorod and Kursk regions. Before leaving, they recorded an appeal calling for the fight against Putin's regime. The fighting took place near Shebekino, Graivoron, Tiotkino, Spodarushino, Kozynka and other settlements. There is confirmed destruction of equipment, control points and ammunition depots of the Russian occupiers, and there are Russian captives. The forces of the FSB, border guards and the Russian Guard are obviously lacking, and paratroopers and motorized rifle units have been deployed. Explosions are heard in Bryansk, Kursk, and Belgorod regions. Subsequently, the Russian Volunteer Corps, the Russian Freedom Legion, and the Siberian Battalion warned the population of Belgorod and Kursk regions of the need to evacuate, as Russia's aggressive shelling of Ukrainian cities and villages leads to the need to destroy the aggressor's facilities through artillery and drone strikes. The real-life Russian opposition is armed not only with small arms but also with tanks. Russian citizens living in the combat zone have posted videos of tanks under the blue flags of the opposition. The Russians, who are fooled by propaganda and think that they are at war with the entire West, decided in discussions that it was either the British flag or the "LGBT flag." The reaction to these battles by both Russian propaganda and Russian dictator Putin himself is indicative. It shows the vulnerability of the Russian Federation to hostilities on its territory. Russian propaganda looks very ridiculous when it tries to hide the fact that Russian "security forces" are fighting with armed opposition groups from the Russian Volunteer Corps, the Russian Freedom Legion and the Siberian Battalion, calling them "Ukrainian saboteurs" and "subversive groups". The name "saboteurs" looks especially ridiculous when we talk about the tanks and artillery that the invaders are fighting with in broad daylight, now in the Russian Federation itself. Russian sources say that a certain number of fighters allegedly landed from helicopters near the village of Kozynka in the rear of Russian troops. Explosions are heard in Grayvoron, the regional center of Belgorod, and other localities. At the same time, there is reason to believe that the authorities of the aggressor country, the Russian Federation, not only did not facilitate the departure of its civilians from the danger zone, but also blocked it, ignoring the requests of the RDC, LSR and SibBat to evacuate civilians, turning the residents into human shields. However, it is obvious that many residents of Hraivoron and Bilhorod are trying to leave their cities. The war has returned to where it started. It was inevitable. 

Putin has reacted very tellingly to the actions of the military formations of the part of the Russian opposition that is fighting against him with arms in hand, side by side with the Ukrainians. He says that these are insignificant events. Moreover, he believes that this may be a seizure of territories in order to have an argument in negotiations with Russia, to put pressure on it, to force it to give up some of the seized Ukrainian territories. It is symptomatic that this "strategist" has suddenly begun to suggest such a possibility. He also links the situation to the so-called "presidential elections in Russia," a farce taking place in Russia. He said that's how Ukraine is trying to disrupt them.  Obviously, this event is not an election, Russia has long been without democracy, and the fact that Russia is holding these so-called "elections" in the temporarily occupied territories of Ukraine is a reason to believe that Putin, who will undoubtedly be "elected," is an illegitimate leader of the aggressor country. In any case, the fighting on the territory of the Russian Federation is important as evidence that there is a Russian political opposition that is effectively fighting the regime with arms in hand, and that Russians who support their government's actions are visibly convinced that they are not invulnerable. Finally, Belgorod region, where the main fighting is taking place, is very important for the Russian economy. Any instability in it negatively affects the level of agricultural production. 

March 14 is Volunteer Day in Ukraine. Ten years ago, the first 500 volunteers of the Maidan Self-Defense arrived at the training ground in Novi Petrivtsi near Kyiv to form a volunteer battalion of the National Guard of Ukraine. The emergence of a mass volunteer movement both in 2014 and in 2022 was a factor that the Kremlin did not consider when it was making plans to seize Ukraine. The volunteer movement is a phenomenon of Ukrainian society, its superpower and pride. These are people who were not military men by profession, but at a critical moment for the state, without summons or coercion, they voluntarily "paused" their previous lives and took up arms to defend the country. Ukraine exists and will continue to exist thanks to volunteers. In addition, volunteers from many countries came to defend Ukraine and help in the just struggle.

Ukraine effectively complements international sanctions against Russia with its strategy of reducing the flow of Russian petrodollars
The issue of Ukraine's strikes on Russian refineries, which took place just a week before the pseudo-presidential election in Russia, is coming to the fore. In particular, after the "elections" began, the SBU, together with the SSO and the Unmanned Systems Forces of the Armed Forces of Ukraine, conducted drone strikes on another refinery, Slovianskyi. The SBU continues to implement a strategy to undermine Russia's economic potential and reduce the flow of oil dollars that the enemy sends to the war. In total, SBU drones have recently successfully attacked 12 oil refineries in Russia. At the same time, the hostilities continue to move to the territory of the Russian Federation itself. In particular, the military operations of the Russian Volunteer Corps and the Freedom of Russia Legion in the Belgorod region should be considered in this context. On the eve of the "electoral procedure" in Russia, which should reaffirm Putin's power for the next years, all these actions demonstrate the weakness of the Russian repressive regime. And in this case, it is not only about the fighting spirit of Ukrainians who continue to defend their homeland, but also about the undermining of the situation inside Russia. All of this together outlines Ukraine's strategy in the war against Russia for the near future: undermining Russia's ability to wage aggressive war by attacking its economic potential and the very foundations of the Russian regime. At the moment, the Russian regime demonstrates its ability to continue the war against Ukraine due to the fact that Western sanctions have failed to cut off money for energy resources, and the inflow of money allows it to buy weapons from "third countries" (Iran, DPRK) and to constantly recruit mercenaries from among both Russian citizens and foreigners. Attacks on the most profitable sectors of Russia's economy could strategically undermine this potential.

A crucial task for the Ukrainian government is to maintain a delicate balance between the needs of the economy, the demands of the front line, and the public's sense of fair distribution of risks and resources
The more the country sinks into the mire of war, the more questions society raises about the new format of confrontation with Russia, given that the Western world is actually divided on the issue of providing Ukraine with the necessary assistance.

While the EU has approved its plan to provide €50 billion in financial assistance to Ukraine over 5 years, the US has made a tactical pause in providing the relevant support.

During the war, Ukraine needs to look for new approaches to finding "new gunpowder" that can change the situation on the front line.

For example, the creation of a "digital street of masters" at the Ministry of Defense to develop startups in the defense industry. It would include an interactive and dialogic mode, engineering support for the authors of ideas, testing of finished industrial designs at the front, and a scoring system for users. The goal is to select effective ideas through horizontal competition and, with the help of government orders, to help them survive in vertical competition with major players in this market. A kind of competitive "cross": horizontally and vertically. To give the Ministry of Defense the right to finance ideas, to create its own analog of the US Agency for Defense Innovation (DARPA). So far, only a closed military hub for financing innovations has been created in Ukraine. Nothing is known about the results of its activities so far, although there may be a factor of secrecy. 

But a military hub is not a massive "street of masters" format that can generate the cumulative effect of the energy of thousands of startups. 

In this context, more and more questions arise in society about the need to use the free resources of the Ukrainian banking system, which has a liquidity surplus of approximately UAH 400 billion or EUR 10 billion.

On March 14, the NBU again cut the key policy rate from 15% to 14.5%, i.e. by 0.5 percentage points. 

At the same time, the rate on deposit certificates is 17.5% (reduced by 1.5 percentage points), which is higher than the discount rate. The bank refinancing rate is 19.5%

Thus, the real discount rate is now not the prime rate, but the yield on the NBU's certificates of deposit (the amount of income that the NBU pays to commercial banks on their funds placed with it). 

From the perspective of the value of money in the economy, it is the rate on certificates of deposit that becomes the benchmark for money prices. 

Banks will always decide where to invest their resources: in NBU certificates of deposit at 17.5% or to provide loans to businesses at 25-30% or to individuals at 35-40%. 

And this is all against the backdrop of 4.3% inflation in February (core inflation was 4.5%). Thus, our real interest rate is also positive, but it is now +13% (if we compare core inflation with the rate on deposit certificates). Extremely tight monetary policy. 

It is clear that, in addition to the anti-inflationary effect, Ukraine's tight monetary policy compensates for the cumulative toxicity in the form of a set of war risks. The EU has no such risks. 

Tight monetary policy in developing countries is a response to the risks of capital outflows abroad and domestic liquidity flows in local currency to the dollar or euro. Therefore, central bank rates should be kept high. 

But now these risks are partially managed in Ukraine: capital outflows abroad have almost stopped, large foreign currency purchases are limited, and the cash currency market is low-liquid and easily compensated by the NBU's reserves. 

The dilemma facing the NBU now is something like this: to keep inflation low, i.e. to fulfill its number one mandate, and to do so, keep its key policy rate as high as possible by any means necessary. 

At the same time, during the war, banks have been extremely profitable. 

In 2023, banks earned UAH 86.5 billion in net profit, four times more than in 2022 and 12% higher than in pre-war 2021. 

The NBU recognizes that interest income was the driver of banks' profitability last year, and that allocations to reserves from excess income amounted to only UAH 17 billion. Overall, banks have never earned as much as they did during this war. As of January 1, 2024, the return on bank capital amounted to 31.6%, although in 2022 this figure was 9.7%. 

What should industry do under these conditions, when credit resources are used for financial transactions but not for the real economy?

So, in the near future, Ukraine will have to find its own balance between the stability of the banking system and the needs of the real economy in the face of limited external resources. Without this, it will not be possible to launch its "digital street of masters."

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