Russo-Ukrainian Crisis: How It Might Hit The Global Markets?
By: Khaled A. BaRahma
Background
In November 2013, protests broke out in the Ukrainian capital, Kyiv. Thousands of Ukrainians protested against the rejection of a trade agreement with the European Union made by Ukrainian president Viktor Yanukovych. As a result of violent crackdowns by state security forces, more protesters were drawn into the conflict, which led to Yanukovych's departure in February 2014.
Crimea was annexed by the Russian Federation in a disputed referendum in March 2014 after Russian troops took control of the region. According to Vladimir Putin, Russians and Russian speakers in Crimea and southeast Ukraine have the right to be protected. Two months after the crisis erupted, Donetsk and Luhansk separatists declared independence from Ukraine.
According to conservative estimates, more than 10,300 people have been killed and almost 24,000 injured in eastern Ukraine since April 2014 due to violence between Russian-backed separatist forces and the Ukrainian military. Russia has denied that it is involved, but Ukraine and NATO have reported Russian troops gathering near Donetsk and Russian cross-border shelling.
When a Malaysian Airlines flight was shot down over Ukrainian airspace, all 298 passengers were killed, the situation in Ukraine escalated into an international crisis, putting the United States and the European Union (EU) at odds with Russia. In October 2015, Dutch air accident investigators found that a Russian built surface to air missile had shot down the plane. After the downing of the airplane, investigators concluded that the missile system had been provided by Russia, determining it had been moved into eastern Ukraine before returning to Russian territory.
Through the Minsk Accords, France, Germany, Russia, and Ukraine have been attempting to broker a cessation of violence since February 2015. According to the agreement, heavy weaponry will be withdrawn, the Ukrainian government will be in control throughout the conflict zone, and a cease-fire will take effect. There have, however, been no diplomatic settlements or satisfactory resolutions.
To deter possible future Russian aggression throughout Europe, specifically in the Baltics, NATO announced in April 2016 that it would deploy four battalions to Eastern Europe and rotate them through Estonia, Latvia, Lithuania, and Poland. As part of the alliance's deterrence presence, two US Army tank brigades deployed to Poland in September 2017 to reinforce these battalions.
Since 2014, Ukraine has been targeted by numerous cyberattacks. Ukraine lost power in December 2015 after an attack on a utility company, and parts of Kyiv experienced another blackout in December 2016. The NotPetya cyberattack hit the Ukrainian government and business computer systems in June 2017, spreading worldwide and causing billions in damages. The attack, attributed to Russia, caused significant damage to computer systems worldwide.
As the Donald Trump administration entered its second term, the United States increased its security assistance to Ukraine while also continuing to press Russia over its involvement in eastern Ukraine. Twenty-one individuals and nine companies have been sanctioned by the United States since January 2018, including several Russian officials. It was the first sale of lethal weaponry since the conflict began when the State Department approved the sale of anti-tank weapons to Ukraine in March 2018. Several large-scale air exercises were conducted in western Ukraine by the United States and a number of other NATO member states during October 2018. In September 2018, as part of its annual exercises, Russia held its largest since the fall of the Soviet Union.
The Economic Concerns
Several markets would be impacted by Russia's invasion of Ukraine, including wheat and energy prices, sovereign dollar bonds, and safe-haven assets. The following listed below are the top 5 potential escalations of tensions likely to affect global markets:
1. The Safe Haven:
In times of market turmoil, safe-haven investments are expected to hold their value or increase in value. As a result of multi-decade high inflation and upcoming interest rate hikes, bond markets had a bad month, with 10-year rates still hovering around 2% and German yields above 0% since 2019. However, a Russian Ukrainian conflict could change that.
In the aftermath of a major risk event, investors usually rush back to bonds, which are generally considered the safest investments. This time may not be any different, even if a Russian invasion of Ukraine risks further increasing oil prices.
As Swiss francs have traditionally been viewed by investors as a safe haven in forex markets, the euro/Swiss franc exchange rate is considered one of the largest indicators of geopolitical risk in the eurozone. Despite a widespread selloff on Wall Street, it hit its highest level since May 2015. In times of conflict or economic strife, gold also serves as a shelter.
2. Grains & Wheat:
In the aftermath of the COVID-19 pandemic, the halting of grain exports from the Black Sea region would likely have a major impact on prices and add to food inflation. A military action or sanctions against any of these four major exporters could disrupt grain shipping from ports in the Black Sea.
In the upcoming season, Ukraine is projected to rank third in corn exports and fourth in wheat exports, according to data from IGC - the International Grains Council -, while Russia tops the list as a wheat exporter. There have been increases in geopolitical risks in the Black Sea region recently, which could affect wheat prices in the future.
3. Natural Gas & Oil:
If tensions turn into conflict, energy markets may be affected. The main reason is that about 35% of Europe's natural gas comes from Russia, predominantly via pipelines that cross Belarus and Poland into Germany, Nord Stream 1 running directly into Germany, and others through Ukraine. As a result of lockdowns in 2020, volumes of Russian gas headed to Europe declined. Last year, consumption surged, sending prices to record heights, but volumes did not recover fully.
According to reports, Germany may halt the Nord Stream 2 pipeline if Russia invades Ukraine as part of possible sanctions should the invasion occur. By increasing Europe's gas imports, the pipeline also underscores the country's reliance on Russia for energy.
Bjarne Schieldrop, a commodities analyst at SEB, says markets should expect gas exports from Russia through Ukraine and Belarus to be substantially reduced if sanctions are implemented, and gas prices should return to Q4 levels.
Curbs or disruptions to the oil market could also affect the oil market since Ukraine transfers Russian oil to Slovakia, Hungary and the Czech Republic. S&P Global Platts reported that the amount of Russian crude transiting through Ukraine in 2020 was 12,3 million metric tons, down from 11.9 million metric tons in 2021.
In its report to investors, JPMorgan warned of a "material spike" in oil prices if tensions flared. It may rise to $150 a barrel. This, which would reduce global GDP growth by about 0.9% in the first half of this year and more than double inflation to over 7.2%.
4. Company Exposure:
Company Exposure is the amount an investor stands to lose in investment should the investment fail. An invasion by Russia would have consequences for listed western firms, but a surge in oil prices could somewhat offset any blow to revenues.
British Petroleum owns 19.75% of Rosneft and collaborates with Russia's largest oil company on a number of joint ventures.
A third of Russian LNG exports are coming from Sakhalin 2, Shell's first LNG facility. The company also has joint ventures with Gazprom, a company controlled by state energy giant Gazprom. In addition to Shell, Exxon (XOM.N) and India's Oil and Natural Gas Corp (ONGC.NS) also holds a stake in the Sakhalin-1 oil and gas project. Norwegian Equinor (EQNR.OL) operates in the country as well.
Based on calculations made by JPMorgan, Europe is the region with the greatest risk in the financial sector. RBIV.VI, from Austria, derives 39% of its estimated net profit from its Russian subsidiary, OTP, from Hungary, and UniCredit (CRDI.MI), from Italy. Societe Generale (SOGN.PA), meanwhile, generates 6% of its company net profits from its retail operations through Rosbank. According to JPMorgan figures, ING (INGA.AS) also has a presence in Russia, but the market accounts for less than 1% of its net profit.
With regards to the amount of loans made to Russia, French and Austrian banks have the most exposure, at $24.2 billion and $17.2 billion, respectively. According to the Bank for International Settlements (BIS), U.S. lenders accounted for 16 billion dollars, Japanese at 9.6 billion dollars, and German banks at $8.8 billion dollars.
Several sectors are affected as well. In contrast, 93 Russian stores of German brewery Metro AG (B4B.DE) generate 17% of its profits and 10% of its sales, while the Danish company Carlsberg (CARLb.CO) owns Baltika and has almost 40% of the brewer's market share.
5. Regional Dollar Bond and Currencies:
Potential military action will have the greatest impact on Russian and Ukrainian assets. As tensions between Washington (and its allies) and Moscow escalate, investors have reduced their exposure to both countries' dollar bonds recently.
Fixed income markets in Ukraine are primarily the domain of investors from emerging markets. Russian investors' standing on capital markets has declined in recent years because of sanctions and geopolitical tensions, thereby preventing contagion through those channels.
Rupees and hryvnias of other emerging-market currencies have also suffered losses, making them the worst performers so far this year. Chris Turner, global head of markets at ING, cited "substantial uncertainties" on the Ukraine-Russia border. Turner pointed out that when the Rouble plunged at the end of 2014, there were liquidity gaps and U.S. dollar hoarding to blame.
Concerns Regarding Discrimination Against Russian-Speakers in Ukraine
Ukrainian, a language written in the Cyrillic alphabet, is spoken by the vast majority of Ukrainians. The language – As a member of the East Slavic language family along with Russian and Belarusian – Russian and Polish share many similarities, as well as being closely related. A large number of Poles, Yiddish speakers, Rusyns, Belarusians, Romanians and Moldovans, Bulgarians, Crimean Turks, and Hungarians speak these languages. Russia dominates the minority languages in the country.
Local authorities were given the authority to formally recognize minority languages in 2012 via a law. The country's official language is continued to be Ukrainian. However, regional administrators have the option of conducting business according to the language spoken in their region. Russian and Crimean Tatar are the official languages of Crimea, which has an autonomous status within Ukraine and has a majority of Russian speakers. Moreover, in the other areas with substantial Russian minorities, educational institutes still use Russian as a medium of instruction. Following the ouster of pro-Russian President Yanukovych in February 2014, the Ukrainian parliament voted to repeal the minority language law. The bill was not signed into law by Alexander Turchynov.
In order to reflect the discrimination that Russia's citizens living in Ukraine experience in real-time, which is enshrined in law as Putin expressed on the last summit. Macron intended to discuss all security-related issues in Europe, including the discrimination of minority languages, as well as the anticipated conflict with the Ukrainian authorities following the summit.
