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Ukraine: the big event risk for markets

Ukraine: the big event risk for markets

Fears over conflict in the Ukraine and a renewed cold war have sent global markets tumbling.

Russia's strike into the Crimea sent the rouble tumbling to an all time low and wiped 10% off the Moscow Stock Exchange, causing panic across global markets yesterday. 

Russia's central bank responded with an emergency rate hike, raising rates by 150bps to 7% in a bid to stem capital outflows.

Some poise has been recovered today with the Russian market rebounding by 4% and the FTSE 100 recovering 75 basis points of yesterday's 100bps loss as Russian president Vladimir Putin ordered troops back to base.

However, the possibility of a full-blown war remains and presents a real threat to financial markets.

'The impact of rising commodity prices, as a result of events in Ukraine, could have a knock-on effect on market sentiment and economic growth,' said Schroders emerging market economist Craig Botham.

'There are echoes of the Georgia-Russia crisis of 2008 in current events in Ukraine, with the difference being that Ukraine has greater political significance.'

Back then, Russia fought a brief war with Georgia over the disputed territory of South Ossetia with the conflict ended by a EU-sponsored ceasefire.   

While Capital Economics' Julian Jessop expects the fallout to be short-lived, he admits the crisis has the potential to have a further significant and prolonged impact on financial markets.

'Europe is heavily dependent on supplies of Russian energy and oil prices have already jumped,' Jessop said. '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.'

With Ukraine around 10 times the size of Georgia, its debt and financial markets clearly pose more risk, which is exacerbated by the fact it shares borders with four current EU members.

Europe is exposed to Ukraine through three channels; exports, energy and bank assets.

Deutsche analysts Michael Lewis and Michael Huseh say the crisis has introduced a new event risk for markets, highlighting the Ukraine is set to become the world’s third largest exporter of corn and sixth largest exporter of wheat in 2013-14.

'Commodities play an important role for the Ukrainian economy since exports account for around 50% of Ukrainian GDP, of which commodities account for around 60% of all exports,' the pair said. 'The country’s commodity exports include agriculture, chemicals, metals and timber products.'

However, Lewis and Huseh regard the Ukraine's strategic position for natural gas flows as the most crucial. 'Europe is dependent on Russia for 30% of its gas supply, of which about 50% of these imports, or 15% of EU gas supply, arrive via Ukraine,' the duo highlight.  

'The completion of the Nord Stream pipeline route under the Baltic Sea in 2012 reduced this dependence from 80% (to 50%), but a complete halt would still be very disruptive.'

Schroders' Botham fears oil sanctions could cause a stagflation shock in the global economy. He points out that Russia will not want pre-empt sanctions, while the Ukraine does not want to anger its European allies or invite further Russian aggression, and the European Union clearly does not want higher energy costs.

A sharp spike in oil and food prices could see China become embroiled in the diplomatic battle, Botham added.

'China will be watching closely given its dependence on energy and food imports, and we might see Chinese diplomatic pressure if the issue isn’t speedily resolved.'

For Jessop, the financial burden of supporting Ukraine is also an issue.

'The country needs around $25 billion 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,' he said.  

'These are not particularly large sums when measured against the combined resources of the International Monetary Fund and the major advanced economies who 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 eurozone.'

    

 

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