EBefore VEN Russia invaded Ukraine, emerging markets were created for a test year. The conflict already threatens to lengthen a list of issues that include the public economy under pressure due to inflation, slower growth, rising interest rates and the prolonged disruption from Covid-19. In the worst case scenario, the fallout could even be at the top of all these concerns.
The main transmission channel is unlikely to be Russia itself, whose economy is collapsing in the face of sanctions. Comparable to Australia or Brazil in size, the world’s 11th largest economy is middle-weight and loosely integrated only with the global supply chain. It is not a major market for exports. The steps taken by Western banks to reduce their exposure to Russia after the occupation of Crimea in 2014 also limit the risk of direct financial transition. Instead the fall of the emerging world will come in three indirect ways.
The first channel is the global liquidity situation, which is getting tougher. While the war does not appear to pose a serious financial-stability threat at the moment, markets have become even more troubling. If anxiety leads to panic, the rush to get dollars could dry up liquidity and markets could collapse – reminiscent of the breakdown seen in the first months of the epidemic. Since then, the US Federal Reserve and other central banks have intervened massively to stem the tide of global financial turmoil. And even with that strong support, most emerging economies faced rapid and painful adjustments as their currencies collapsed. A few were pushed by default.
For the time being, such a catastrophe seems to be a possibility. Aggression, however, has persuaded investors to jump into assets that they consider to be the least risky. Emerging world stock markets have slipped since mid-February. In the week following the start of the war, yields on the German bond and the American Treasury, the traditional safe haven, fell 0.3 percentage points. Slowly but steadily, the dollar is climbing. Some indicators of market strain have also begun to rise, though not yet in crisis areas. The spread has increased between the rate at which rich-world banks charge each other for short-term unsecured loans and the risk-free rate overnight. But growth spurred by the spike noticed during wild volatility in early 2020, nothing to say about market frenzy during the global financial crisis.
A flight to safety can increase the cost of borrowing in emerging markets and increase the debt burden. The price of hard-currency bonds issued by governments and companies fell last week, while the yield between emerging-market corporate bonds and the spread between treasury bonds rose nearly half a percentage point. This, too, is a moderate increase compared to the market experience in the spring of 2020, when the spread jumped four percentage points in one month. But after two years of rising debt, higher debt costs for governments and agencies are less easily managed. Even in the absence of default, more credit reduces private investment and further limits the government’s revenue room for strategy.
Adverse market movements could exacerbate the challenges posed by the new macroeconomic headwind – the second channel of transition. In peacetime Russia and Ukraine are both large exporters of oil and gas, precious and industrial metals and agricultural products. Many of these prices have risen since mid-February. Oil prices have risen more than 25% over the last fortnight. Wheat prices have risen by more than 30 percent. Some emerging-market exporters will benefit from growing incomes. The rise in crude prices is an unexpected catastrophe for the Gulf economy.
Yet even the largest commodity exporters may face difficulties when food and energy costs are already high, household budgets are squeezed and monetary policymakers are bound. Brazil’s central bank’s year-long campaign to rein in high inflation before the war – in which it raised its benchmark interest rate by almost nine percentage points – seems to be paying off. Now the push for food and energy prices can do nothing about the threat of plundering its fragile achievements. Turkey, where inflation rose nearly 50% year-on-year in January, is in a more sticky place. On March 1, Turkey’s defense minister called on Russia to accept an immediate ceasefire. Large importers of wheat and sunflower oil across North Africa and the Middle East, particularly Egypt, could see prices of staple rockets, fueling popular discontent.
A third force will operate in the background as these developments unfold. The Russian aggression, and the Western push অবশ্য of course the financial and economic response প্রতিনি represents another blow to the global economy that has faced trade wars, epidemics, supply-chain disruptions and a growing unpredictable policy environment over the past half-decade. As firms and investors see genocide in Eastern Europe, they can re-evaluate how to assess the value of geopolitical risk in foreign markets. This can inflate country-risk premiums applicable to far-flung assets, increase funding costs for emerging markets, and reduce investment volumes.
In difficult times, the proverb says, global investors think less about returns than capital. If many of them decide to pack up and go home, the guaranteed losses of the war will include those that have been damaged by the emerging economies they have left behind. 3
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This article is published under the heading “Shocks, Stocks and Barrels” in the Finance and Economics section of the print edition.