Fund Research Manager Legal & General
At the time of writing this article, Ukrainian officials have estimated that around 100,000 Russian troops are amassing on their Eastern borders. The economic interests of both sides are heavily interconnected and it would be ruinous if matters escalated. The situation is tense and nervous. The US is trying to intervene to calm the situation through diplomatic means. However, the outcome is very uncertain.
HOW WILL THIS IMPACT THE ECONOMY?
The impact on the global economy and for global investors is likely to be limited as Russia accounts for around 6.1% of the MSCI Emerging Markets Index and Ukraine only around 0.15% of the MSCI Frontier Markets Index. Russian Oligarchs have caused sizeable outflows from these markets for many years as they have been moving their assets offshore. However, higher political risk in Russia and Ukraine will cause ongoing volatility in their equity, fixed income and currency markets as investors take flight and seek safer havens for their money. The more significant risk is contagion of the political unrest across other neighbouring emerging and frontier markets that could increase negative sentiment towards investing in these regions.
The Russian stock market has shown a decline since tensions with Ukraine in 2013 and there was a sharp drop in March 2014 following the occupation of Crimea.
Russia’s international business dealings will be severely restricted by carefully targeted US and EU travel bans and asset freezes. At present this covers Prime Minister Putin’s closest advisors, top Russian policy makers, members of the Russian Parliament and the armed forces. The sanctions list also includes the owners of some of Russia’s biggest companies listed on the New York and London stock exchanges, whose shares are held by US and EU investors.
Foreign investors are wary of companies connected with any of the individuals being sanctioned and are selling off any current holdings. The Russian Deputy Economic Minister expects investors to withdraw around £42 billion of assets from Russia during Q1 2014. The Russian stock market could fall further if the sanction list is extended to Russian companies not just individuals.
Whilst Russian investments are very cheap, they have also become a lot riskier as they could be nationalized or expropriated by the state, which makes the investment case more challenging. Russia is already in economic slowdown and growth forecasts are likely to be revised down due to the conflict, which could push the country into recession. If Russia were to invade Ukraine, capital flight from the region could be exacerbated and credit conditions could become tighter.
Russia has vast natural resources, including oil and gas. The Russian state-run monopoly, Gazprom is the largest producer and exporter of gas globally. It is the main supplier to Europe, accounting for about 31% of European demand. In the short term it will be hard for Europe to reduce its reliance on Russian gas. Most of the global energy companies have significant stakes in Russian oil and gas companies. BP has a stake in Rosneft, Russia’s largest oil producer. Due to this dependence, Russian, European and global energy and mining sectors are likely to be affected by the conflict. The EU is likely to reduce its reliance on Russian energy supplies over the longer term as it has become an inherently unreliable source.
In the banking and insurance sectors, many global and regional companies have operations in Russia. US global players include Citigroup and JP Morgan Chase. Whilst Austria’s Raiffeisen Bank and the French bank Société Générale are considered to be amongst the most heavily exposed to the region. Big Russian banks such as Sberbank and VTB are also likely to be negatively affected.
There have long been concerns about corporate governance standards in Russia. Investors have tended to avoid companies with shareholders on government blacklists or companies controlled by Oligarchs. Future capital flows into the region are likely to diminish as investors start to view Russia as having long term business risks. The conflict could increase risk aversion to emerging and frontier markets at a time when they are already in outflow and in particular from Russia. It may well take some time to rebuild investor confidence and in the near term more volatility in the Russian and Ukrainian markets can be expected.
If you would like to discuss your own investment strategy with one of our advisers, you can call us on 0115 9061 222 or email firstname.lastname@example.org