A Baltic Backstop for Russian Blight

Russia’s propaganda and threats are spooking potential investors in the Baltic States. NATO members should offer a financial backstop to reassure them.

Source: Lithuanian Armed Forces

Russia’s hybrid warfare strategy aims to undermine the resilience of NATO’s northeastern region; methods such as propaganda campaigns, arson against high-profile targets, and aggressive diplomacy lay the foundations for the Kremlin’s ultimate aim — the reoccupation or subjugation of the Baltics (see here the Kremlin’s suggestion for withdrawal of NATO forces as a precondition for peace in Ukraine). 

The Baltic states are repeatedly painted as a possible military target for Russia, creating an environment of insecurity that deters investment and trade, and threatens to isolate and erode their economic foundations. Of course, NATO’s military forward-defense is vital, but it must be complemented by robust financial support to restore market confidence and demonstrate that Baltic security is non-negotiable. 

Since 2022, the Baltic economies have suffered a “perfect storm” of economic challenges influenced by the full-scale invasion of Ukraine and proximity to Russia. Bond yields rose in a way that could “only be explained by perceived geopolitical risk,” according to Mārtiņš Kazāks, then Governor of Latvia’s Central Bank.  

The credit ratings of all three Baltic states have been cut, with analysts blaming the Ukraine war and ongoing risks while noting negative perceptions among investors. The International Monetary Fund (IMF) and European Commission have both noted an erosion of competition and growth from “war-driven shock.” 

All three Baltic economies have suffered a fall in foreign direct investment and have been further weighed down by the loss of trade partnerships caused by stringent sanctions enforcement. They also suffered the effects of energy price volatility before the break with Russia’s electricity network in February.  

Without initiatives to counter the perceived “proximity risk,” economic consequences are at risk of worsening, especially in times of crisis. The three countries have already reached double the average EU inflation rate, despite strong fiscal policies, and all three countries are undergoing significant public spending cuts to cover budget deficits while significantly boosting defense spending.  

While their economies are currently trending upwards, as a switch from the Russian market aligns with positive foreign investor sentiment, the growth is fragile. Any signs of Russian escalation, through military exercises or other posturing, could trigger a cascade of capital flight.  

Under increased economic pressure, defense capacity would be at risk, and Russian disinformation campaigns could leverage economic hardship to push populist anti-Western narratives.  

These could include reasserting “cooperation agreements” between Putin’s ruling party and ethnic Russian parties, which appeal to at least a fifth of the inhabitants of Estonia and Latvia, and would risk repeating the past success of Russian influence networks in placing Kremlin agents in Baltic parliaments.  

A way to counter Russia’s economic hybrid warfare would be the creation of a guarantee facility — a robust backstop to restore investor confidence and shield Baltic economies from prolonged exposure to risk. Drawing on the model of the European Stability Mechanism (ESM), which assists eurozone countries in financial distress, it could provide targeted political risk insurance for investments in the Baltics and compensate any losses stemming from military intervention or hybrid warfare.  

While its initial focus would be limited to loans for critical infrastructure and defense-related projects, the facility could expand to cover other sectors. Funding would be pooled from NATO members, requiring only a minimal initial capital base, with the option to tap into NATO’s 1.5% resilience expenditure target, or attract co-investment from the EU or financial markets.  

To ensure sustainability, it could self-fund or even return dividends to members by operating an insurance premium model, much like the World Bank’s Multilateral Investment Guarantee Agency, which has proven effective in more than 120 countries. If necessary, it could also issue bonds, following the example of the ESM. 

The immediate effect would be to send a powerful signal of confidence in the security of the Baltic states. The so-called “bazooka” of the ESM — where the commitment to a collective financial backstop calmed eurozone markets — demonstrates the potential impact.  

Even a modest diversion of NATO member defense spending could have an exponential impact. The funding could be made through expanding the NATO security investment program to include insurance, or by a new funding vehicle, like the innovation fund, which has secured over €1bn in venture capital from over 24 member states. If the Baltic states, Poland, and Finland were to invest 1% of their defense spending, the facility would be worth over €500m. Such ideas would not only reduce risk premiums for the approximately 6 million people living in the Baltics but also directly challenge Russia’s narrative of Baltic vulnerability.  

Over the medium-to-long term, the guarantee facility would serve as a comprehensive NATO response to Russia’s hybrid warfare, including economic coercion, and would allow alliance members to contribute to Baltic security without having to invest in defense infrastructure, materiel, or soldiers.  

The backstop could be expanded to aid other member states under similar duress, such as other Eastern and Central European countries that have experienced a fall in foreign direct investment. If necessary, it could be adapted into a full war-risk insurance scheme, mirroring the European Bank for Reconstruction and Development’s (EBRD) approach in Ukraine.  

A NATO guarantee scheme is a necessary evolution in collective security as financial markets have made it clear they no longer see NATO membership as an adequate deterrent to invasion. If it were, the Baltic states would not be facing such elevated risk premiums.  

Establishing a dedicated facility would demonstrate awareness of the fears of market participants, while also showing solidarity by sharing exposure to geopolitical risk among alliance members.  

With upcoming elections in each of the Baltic states, it is important that defense spending is seen as a responsibility rather than a NATO-imposed burden. Given the uncertainty in economic forecasts in the West, NATO members must find more ways to mitigate risks that could create economic shocks and pressure across the globe.  

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By Ēriks Selga. Ēriks Selga is a Fellow with the Tech Policy Program at the Center for European Policy Analysis. He is a former Digital Innovation Baltic Fellow at CEPA and is currently a Council member of the Latvian Competition Council.  Article first time published on CEPA web page. Prepared for publication by volunteers from the Res Publica - The Center for Civil Resistance.