Russia’s assault on Ukraine has upended its country risk profile

Photo: Reuters

It is only a week into Russia’s all-out invasion on a democratically elected and sovereign state, and the reaction to it has proved just as startling as the mounting destruction and death toll.

The outcome of the war remains unclear, but with a range of sanctions to be levied on Russia for an extensive period – and possibly tightened further depending on how events unfold – there will be huge problems not only for Russia but for Ukraine, and the west, as various consequences emerge.

In a recent article by Dmitry Dolgin, an ECR survey contributor, economist and senior analyst at ING, the sanctions are spelled out.

They include cutting off Russia from the Swift messaging system allowing financial institutions to authorize payments and other measures, therefore blocking the central bank and commercial banks such as VTB, Sberbank and smaller institutions.

However, the precise details of the sanctions are important.

There is restricted central-bank access to its foreign-exchange reserves, but not special drawing rights (SDRs) or gold. There are other exclusions, too, such as payments for oil and gas.

There are no restrictions yet on doing business with state-owned sectoral firms, but a ban on new equity and debt issues by these firms – in other words, preventing access to western financial markets.

There is room to tighten these sanctions further and for Russia to mitigate the effects, including possibly banning imports from Europe. ING estimates Russia’s imports from the EU, UK, Norway and Switzerland to be worth $120 billion in 2021.

Russia could also cut off its gas supplies to the EU and export more to China and other friendly countries, while gradually redirecting its oil supplies. It may also embargo rare metals.

Energy prices were rising before the crisis erupted and have only risen further. As both countries are leading cereals producers, there will be direct and indirect effects on food prices, while air- and sea-freight rates are expected to spike, contributing to already high inflation rates in Europe and undermining economic growth.

Various experts are warning of shortages of essential metals, such as aluminium, nickel, palladium and other inputs affecting supply chains that were supposed to have been returning to more normal conditions this year after the pandemic.

Economic growth forecasts will be revised downwards for Russia, Ukraine and European countries, although the impact on the EU may be moderate in the short term. Ultimately, it may be offset by investments in energy self-sufficiency and to beef-up defence spending, but at the risk of worsening debt burdens.

The effects may have some impact on central-bank policies, too, but there will be conflicting trends to manage in terms of weakened growth and higher inflation.

Russia will not be able to get and hold the second-largest territory in Europe while being cut off from almost all markets possible 

 - Olga Mrinska

Meanwhile, Ukraine’s economy is crashing and the crisis will have an impact on other countries, such as Turkey; its economy is already struggling with a huge inflation problem following a run on the lira and is likely to suffer a hit to tourism after being reliant on Russian and Ukrainian visitors.

In this light, it is understandable that Russia’s country risk score has rapidly worsened, sliding below 50 (out of 100 points) for the first time since early 2020 in Euromoney’s crowd-sourcing survey.

Crashing 15 places in the space of a week, Russia is now 89th out of 174 countries in the global risk rankings, but with potential for further falls when the Q1 survey is undertaken and the results are released next month, depending on how the war develops.

Ukraine was a markedly higher risk than Russia, with its political and foreign policy problems, and legacy of sovereign debt. With its score downgraded, it has slumped to 109th, and there is a similar expectation it can only worsen in the short term.

Both are lodged in the fourth of Euromoney’s five risk categories, indicating ‘considerable risk’. A war was not inevitable, but neither country was considered a particularly safe option before the crisis, Ukraine especially. In that respect, investors had been warned.

Naturally, some of Euromoney’s risk experts were unable to comment on the situation, not least to protect their personal security or that of their employers, or simply because they are too heavily involved and plainly too busy dealing with the fallout.

Policy and strategy expert Panayotis Gavras chimed in to say how his employer Black Sea Trade and Development Bank (BSTDB) had been confused with the Black Sea Bank for Reconstruction and Development in Simferopol, Crimea. The two have similar names, but are not linked, causing considerable problems.

He noted the crisis has also impacted directly on BSTDB, as Russia and Ukraine are two of its major shareholders – holding between them 30% of the capital – and accounting for a shade under a third of its portfolio.

Olga Mrinska, a Ukrainian – speaking independently while trying to get her family and friends to safety – could not offer any detailed comments, but appeared adamant there would be no partitioning of Ukraine.

“It will be either whole Ukraine or nothing,” she said defiantly, adding: “Russia will not be able to get and hold the second-largest territory in Europe while being cut off from almost all markets possible.”

Others, however, were more willing and able to air their views, not only in terms of condemning the Russian attack but explaining its effects.

We are in rapidly changing, unchartered territory. There is considerable ambiguity, lack of clarity and unpredictability with the course of this crisis 

 - Kelly McCann, PwC

Owais Arshad, a global economic sanctions expert at RBC, notes the fact the UK, which has long turned a blind eye to the flow of illicit Russian oligarch wealth, is set to unveil a series of dramatic changes to its laws. This will include blocking sterling clearing for Russian banks and providing the ability to seize – and not just freeze – the proceeds of corruption.

He goes on to say that president Volodymyr Zelensky’s defiance in the face of Russian aggression has inspired European capitals to arm Ukraine’s resistance, which has shown remarkable strength despite Russia’s overwhelming military superiority.

“The longer the war lasts, the greater the cumulative drag of the west’s sanctions on Russia’s economy,” he says.

Kelly McCann, a New York risk management specialist at PwC, says there will be widespread implications for businesses in Europe and worldwide.

“We are in rapidly changing, unchartered territory,” she says. “There is considerable ambiguity, lack of clarity and unpredictability with the course of this crisis.

“Predictions earlier this year published by the IMF forecasted Russian real GDP growth of 4.7% in 2021 followed by 2.9% in 2022. It is premature to provide figures. However, GDP is bound to plummet.”

Added to that, Ukraine’s 3.5% growth rate that was expected this year is ancient history. Its economy will now be in meltdown.

According to Constantin Gurdgiev, an associate professor of Finance with Monfort College of Business, University of Northern Colorado, “the only reasonably forecastable outlook in this environment implies that Russia will enter a recession in Q2 2022, with accelerating contraction in economic activity and aggregate demand dragging on well into Q4 2022”.

He adds that beyond the next 10 to 12 months, the impact of the sanctions already imposed on the Russian economy will likely be very painful.

“Aggregate investment (both private and public) will drop precipitously over the course of 2022 and will not recover for years to come,” he says.

“This relates both to the quantum (financially measured) investment and the quality of actual physical investment. Absent robust access to global markets for goods and services, Russia is unlikely to be able to secure necessary new technologies that it needs to sustain long-term economic growth.”

The secondary effect of these is that China has now suspended trade credits issuance for all transactions involving Chinese banks and Russian producers 

 - Constantin Gurdgiev

Gurdgiev notes the fact the sanctions imposed on Russia are unprecedented in terms of their scope, depth and range, adding that this has led to a “new reality when it comes to assessing the potential effects of financial and economic sanctions on both the global economy and the Russian economy”.

The financial-sector sanctions, he says, has made it impossible for the Russian financial system to support a normal course of goods and services trade across the Russian borders.

“We are already seeing the effectiveness of these sanctions in play, with Russian oil exporters unable to conclude any spot trading contracts despite heavy discounts on spot prices being offered by producers,” says Gurdgiev.

“Even though energy trading is explicitly exempt from sanctions, to date, buyers are unwilling to expose themselves to a risk that these exemptions might change over time or that new financial-sector sanctions can make these purchases undeliverable.”

He adds that the financial sanctions are also making it impossible for other Russian exporters and importers to transact in US dollars, euros, pound-sterling, Swiss francs or Japanese yen.

“The secondary effect of these is that China has now suspended trade credits issuance for all transactions involving Chinese banks and Russian producers,” says Gurdgiev.

Vladimir Kostin, a Russian citizen and country risk analyst who is similarly shocked by recent events, states that the sanctions will also have enormous consequences for various industries, including aviation.

He notes the fact the rouble has collapsed and the central bank has had to take defensive measures by raising its policy interest rate from 9.5% to a record 20% and obliging exporters to sell 80% of foreign-exchange earnings.

The stock market has closed for several days and president Vladimir Putin has stopped Russians from transferring foreign currency to their own accounts in foreign banks or making transfers to payment service providers.

“All this has already caused open discontent among a part of large Russian business,” says Kostin. “At the same time, the situation inside Russia is still calm and there is no panic yet among the main part of the population.

“This is most likely due to the fact that really serious sanctions and their consequences have not yet reached a sufficient multiplier effect.”

For Kostin, the biggest fear is that Putin raises the stakes further by intensifying the bombing of Ukrainian cities or he starts threatening actions against Nato countries, in the Baltics, for instance, where there is already the threat of ‘isolation’ of the Kaliningrad enclave situated between Lithuania and Poland.

He also warns that Putin may switch to more open threats of using nuclear weapons, after having already ordered the defence minister and the chief of the military’s general staff to put Russia’s nuclear deterrent forces on standby in a special regime of combat duty.

This follows nuclear military exercises undertaken in February that were also overseen by Belarusian president Alexander Lukashenko, a close ally who seems to be joining forces with Russia to attack Ukraine.

The US believes Putin’s nuclear threats are rhetoric. There are also peace talks under way to try to resolve the crisis.

Nothing is certain.

But what seems ultimately very clear is the fact the past week or so has altered Russia’s risk profile enormously – and possibly for good.