A war in Ukraine would raise country risk for others too

A ceremony in tribute to fallen defenders of Ukraine takes place against the backdrop of the Russian military build-up. Photo: Reuters

The threat of a Russian invasion and/or of more cyberwarfare, financial pressure and political meddling in Ukraine are making analysts more uncertain over global risk prospects at the start of the year after a couple of years of pandemic-related fallout.

Ukraine is already a high-risk option for investors, ranking 107^th in Euromoney’s global risk rankings and mired in the fourth of five risk categories on a par with other risky options including Côte d’Ivoire, Mauritania, Rwanda and Pakistan.

Its risk score improved last year though, on the back of continuing support from the IMF in the form of an extended Stand-By Arrangement to the end of June 2022.

GDP growth returned following a sharp decline in 2020 due to the pandemic, and there was some progress on the reforms and macroeconomic targeting the IMF had requested, albeit with warnings attached that it could do more.

Meanwhile, analysts routinely shrugged off the lack of democracy and the sanctions tarnishing Russia’s reputation.

The country’s strengthening macroeconomic fundamentals piggybacking higher commodity prices improved its total risk score, resulting in a rise to 74^th in the rankings, to keep Russia within tier 3 and making it a similar option to Bulgaria, Seychelles, Ghana and Bhutan.

Winds of change

Yet that looks as if it might be about to change, as analysts weigh up the consequences of Russia’s unprecedented military build-up. Ukraine too is beefing up its defences.

Regional expert Lilit Gevorgyan, senior economist and country risk analyst at IHS Markit, believes that militarization has not only made war highly likely, but it has also increased the cost of the geopolitical and economic fallout.

This also makes a diplomatic climbdown with limited military clashes along the Line of Contact possible, which could involve the recognition of independence by Russia of Donetsk and Luhansk, two self-declared states.

One regional risk expert confiding in Euromoney anonymously mentioned that war is not inevitable.

It should not be forgotten, he said, that the de facto "hybrid" Russian invasion of Ukraine – both the occupation of Crimea and the war in Donbas – has been a reality since 2014.

It was pointed out that Russia also has an arsenal of other tools at its disposal, including cyberattacks, sabotaging infrastructure facilities and acts of terrorism, such as the use of poisonous substances.

The de facto "hybrid" Russian invasion of Ukraine – both the occupation of Crimea and the war in Donbas – has been a reality since 2014

Owais Arshad, global economic sanctions expert at RBC, adds that one option could be a limited strike, for example, by seizing a land bridge to Crimea.

“Such a move would further consolidate Russia's hold over the territory," says Arshad. "It would also alleviate the chronic water shortages Crimea has faced after Kyiv throttled access to a strategic canal.”

Gevorgyan, meanwhile, states that, regardless of the outcome, the conflict is not going to be resolved anytime soon and that both Russian and Ukrainian risk scores will see big adjustments as a result; both countries are likely to become riskier options.

Other experts have mentioned there are grounds for lowering some indicators for both countries, such as "monetary policy/currency stability", given that both the hryvnia and rouble have already experienced volatility.

Other indicators, such as banking or institutional stability, macroeconomics, infrastructure and so on may be affected, depending not only on whether there will be a war, but also on how it develops.

Arshad says that his scores for bank stability risk, the economic outlook, government stability, institutional risk, access to capital markets and government finances would all be downgraded. Concerning the latter, he notes that Ukraine would likely lose energy transit fees.

Yet if war occurs it will also have material consequences for the risks in other former Soviet states, including Belarus, as well as across the EU.

Panayotis Gavras, head of policy and strategy at the Black Sea Trade and Development Bank, argues that should warfare occur – which he would not predict either way – it would not only lead to a spike in oil and gas prices.

Ukraine and Russia are both big grain exporters, he notes, and at relatively competitive prices to emerging markets such as Egypt, which is possibly the biggest client, but by no means the only one.

“If conflict blocks grain exports, we could see a spike in prices for such essential foodstuffs," says Gavras, "and that could have political repercussions in countries that depend on food imports from Russia and/or Ukraine.”

It should be borne in mind that the Arab Spring began with rising food prices.

While Gavras believes that perhaps food exporters such as Argentina, Australia and Canada might benefit, this would come at great cost to regional actors, with no gains in Eastern Europe or the eastern Mediterranean.

Russian fallout

Russia is the source of nearly 50% of the EU’s gas imports. Arshad says that tighter sanctions could prompt Russia to use its "energy weapon" to disrupt energy markets, but this would also hurt Russia itself as the EU is a lucrative source of foreign exchange.

Meanwhile, Berlin appears to have raised the prospects of withdrawing its support for the Nord Stream 2 gas pipeline, which is awaiting regulatory approvals from authorities. The US has advocated for the EU to substitute Russian energy by importing US LNG.

“Should tensions persist we may see further volatility in gas prices,” says Arshad, "which could be further compounded by other stresses in EU energy markets such as the decision by France to shut down nuclear reactors to review safety conditions. The French actions will reduce energy supplies to other EU countries."

As for the direct impact on Russia, Arshad says, “an invasion [of Ukraine] may result in the designation of most of Russia's major banks, including VTB, VEB and Sberbank as well as the Russian Direct Investment Fund. Russian sovereign debt would also be blacklisted, although Russia has long incorporated provisions in its debts allowing it to pay out in roubles if required.”

Long term, a Swift cut-off may prompt innovation, and correspondingly further strengthen ties between Beijing and Moscow 

 - Owais Arshad, RBC

If it were cut off from payment messaging service Swift, Russia would effectively be severed from the global financial system, at least temporarily.

“Heeding the lessons from 2014, Russia has developed an alternative domestic payments infrastructure which should allow domestic transactions to continue,” notes Arshad. "Long term, a Swift cut-off may prompt innovation, and correspondingly further strengthen ties between Beijing and Moscow."

Another expert mentioned confidentially that there is conflicting information about Swift. If Russia is shut out, it would be a serious blow to the Russian banking system, he said, but it is unlikely to be fatal because Russia and its satellite countries have been operating and developing their own 'Mir' payment system for several years now.

Sanctions against the assets of all Russian businessmen connected in one way or another with Russia’s president, Vladimir Putin, could be a more effective lever for the West to pull.

In addition, export control measures recently announced by the US White House in high-tech areas such as defence, space, artificial intelligence and quantum computers could be an effective tactic.