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Mohamed A. El-Erian: Lifting the Ukrainian Cloud That Threatens Stocks

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Mohamed A. El-Erian is the former CEO and co-CIO of PIMCO. He is chief economic advisor to Allianz, chair of President Obama’s Global Development Council, and author of the NYT/WSJ bestseller “When Markets Collide.” Follow him on twitter, @elerianm.

What does it take to decisively lift the cloud of the Ukrainian crisis that hangs over global equity markets? Here are five key conditions. They are set out along a timeline that goes from the immediate to the longer-term.
 
First, Russia needs to refrain from any additional provocations, threats and, certainly, territorial incursions.
 
After annexing Crimea and amassing tens of thousands of troops on its Ukrainian border, Russia suddenly appears more open to a diplomatic dialogue. Following up on a reportedly more constructive phone call between Presidents Obama and Putin, U.S. Secretary of State John Kerry has stayed in Europe to hold talks with Sergey Lavrov, his Russian counterpart.
 
The hope is that this latest rounds of talks, which started yesterday, would be a more effective catalyst to meaningfully de-escalate tensions; and quickly before some disruptive border skirmish occurs, inadvertent or otherwise.
 
Second, Ukraine needs to mobilize within weeks (if not within days) tens of billions of dollars of exceptional funding from the international community.
 
Ukraine is sure to face considerable difficulties without the prompt infusion of such sizeable emergency financing into the economy, the budget and foreign reserves – in paying public sector employees (including the security forces), safeguarding supplies of basic necessities from abroad (including Russian gas), and meeting international debt service obligations. Such payments disruptions would also be accompanied by a damaging output collapse and the threat of hyper-inflation.
 
The International Monetary Fund has already indicated its intention to pursue a “standby arrangement” with Ukraine. In addition to the $18 billion that the IMF is said to be willing to lend, this would unlock tens of billions more from other multilateral institutions and supportive national governments.
 
It remains to be seen whether the Ukrainian government would be able to implement the policy actions negotiated with the IMF. There are also questions as to whether private creditors would ultimately face haircuts on their claims on Ukraine.
 
Third, Ukraine’s immediate financial stabilization phase would need to be supplemented with a broader policy response that places the economy of the path of higher medium-term growth.
 
At the minimum, this would require a meaningful set of structural reforms to reverse what has been a pronounced period of economic under-performance. (An often-cited comparison notes that Ukraine went from having a similar GDP per capita level to Poland’s in the 1990s to just one-third today. Moreover, according to this measure, average living standards in Ukraine actually declined.)
 
Fourth, the government in Kiev would need to secure broad-based backing from the population for its economic, political and social programs.
 
The outcome of the upcoming elections are critical given the transitory nature of the current government. Working with parliament, the newly-elected president and her/his cabinet would have to rapidly set about the challenging task of anchoring a durable social and political reconciliation process. They would also have to ensure considerable domestic ownership for the economic reforms supported by the IMF arrangement.
 
Finally, and more generally, the global economy would need to develop much better structures and mechanisms to deal with geo-political crises.
 
With the recent weakening of what, already, was a fragile multilateral governance system, there are few readily available circuit breakers to stop negative spillovers from the multiplying pockets of geo-political risks. To recap the “Gs” issues discussed here, neither the G-20 nor the G-8 are playing much of a role today. The G-7 is trying but faces challenges. It falls to the G-1 (U.S.) to take the lead in what increasingly is trending towards a G-0 world.
 
This is quite a list of conditions. It starts difficult and, unfortunately, gets harder as it looks beyond the immediate period ahead. And the market consequences go beyond the Ukrainian overhang. They also speak to the challenge markets face in better modeling and pricing geo-political risk.
 

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