Ukraine- Russia Crisis and it’s effect on financial markets globally

According to Capital Economics “The crisis in Ukraine has the potential to have a further significant and prolonged impact on global financial markets, even though our current judgement is that the fallout is likely to be short-lived.”

Europe is heavily dependent on supplies of Russian energy and oil prices have already jumped. The financial burden of supporting any new Ukrainian government also looks set to fall mainly on the US and on the EU, especially if Ukraine is given a fast-track to EU membership (not likely, but possible).

Over the weekend, Russia began to annex Ukraine’s Crimean peninsula. Russia’s moves have been strongly condemned by the international community, although the response of the major Western powers is likely to focus on diplomatic and economic sanctions.

Russia and Georgia fought a brief war in August 2008 over the disputed territory of South Ossetia, which has many similarities with recent developments in Ukraine. The key point is that the conflict was short-lived and ended by an EU-sponsored ceasefire. Russian forces still occupy South Ossetia which has now declared independence from Georgia, a position that very few other countries officially recognise but no-one can realistically do anything about. A similar outcome in Crimea would soon drop out of the daily headlines.

Second, though, Ukraine is roughly ten times larger than Georgia, in terms of population (45 million vs.5 million) and GDP ($180 bn vs. $16 bn). Ukraine’s financial markets and external debts are correspondingly much greater and it is a more credible candidate for EU membership in due course. Indeed, unlike Georgia, Ukraine shares borders with four current EU members. Third, regional turmoil could also have a major impact on the Russian economy itself and on its trade, particularly in energy, with the rest of the world. The country’s financial markets and currency have already been hit hard, prompting an emergency rate hike this morning in an attempt to stem capital outflows.

Two specific risks are worth dwelling on; one is the possibility of the disruption to the supply of Russian energy to the European Union, whether as a result of Western sanctions or Russian manipulation. Russia is of course a major supplier of oil to Germany and the Netherlands in particular and of natural gas to Western Europe generally. However, disruption to energy trade would be in neither side’s interest, especially Russia’s as it would simply encourage EU customers to seek more secure supplies elsewhere. We suspect that any Western sanctions will only target individuals and political and cultural links, rather than trade.

The other issue is the financial burden of supporting Ukraine. The country needs around $25bn soon to refinance debt and pay other bills for goods and services. Over the longer-term, the cost of supporting the transition could run into the hundreds of billions of dollars. These are not particularly large sums when measured against the combined resources of the IMF and the major advanced economies that might be willing to offer bilateral support. Nonetheless, every dollar spent on Ukraine is a dollar not available to finance bailouts elsewhere, including the weaker economies of the euro-zone.

In the meantime, the escalating tensions and risk of a wider military conflict, however small, could continue to boost demand for safe havens, including government bonds, gold and the yen, while undermining equity prices. German and other European equity markets whose companies are most dependent on Russian energy supplies may be hit hardest. But Japanese equities are also particularly vulnerable, given the close correlation between yen strength and Nikkei weakness.

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2 thoughts on “Ukraine- Russia Crisis and it’s effect on financial markets globally

  1. Pingback: Ukraine: Russia sanctions fallout and Latvian measures | Financial Crime Asia

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