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Implications of the Russia-Ukraine War

AS the world picks itself up from the ravages of the Covid-19 pandemic, it has been hit by the Russia-Ukraine conflict. The conflict, as the name suggests, is between Russia and Ukraine but there is a possible escalation of this conflict beyond these two countries.

As it stands, investors in global capital markets have already begun revisiting their portfolio allocations in a bid to avoid risks attached to the geo-political tension.

Some countries have been slow to respond to the news, mostly because of proximity, but if the ripple effect of the United State housing crisis of 2008 is anything to go by, this should unease even nations that are not yet extensively integrated with the global community.

The Russia-Ukraine conflict has been around for a while, albeit more nuanced compared to the past few weeks. However, since February 24, 2022, the conflict has escalated like never before and the number of casualties already exceeds 4500.

Many influential figures have also taken astand and have condemned Russia’s actions against Ukraine, as has other nations and global organisations. In order to understand the gravity of this conflict, we unpack the significance of the two countries in global trade.

Both countries are major players in the global trade of resources such as oil and natural gas, corn, wheat, iron and steel, and they have vast untapped resources.

According to the Observatory of Economic Complexity (OEC) database, Ukraine is the fourth largest exporter of corn, the fifth largest wheat exporter, and among the leading exporters of iron and steel.

The country has vast resources of titanium, iron, and non-metallic raw materials. The European nation also boasts of large reserves of lithium in the Kruta Balka, Donetsk, and Kirovohrad areas.  In addition, it had the second-biggest known gas reserves in Europe, which are largely untapped.

Russia, on the other hand, is the world’s largest wheat exporter in the world despite the recurrent wheat export bans that have been enacted in the country, following weather-related constraints.

The country is also a major iron and steel exporter and has iron ore deposits situated close to a Ukrainian border that make up a sixth of the world’s reserves.

The nation accounts for c.20% of the world’s oil and natural gas resources and is a leading nation in other resources such as timber, copper, nickel, zinc, and precious minerals.

Given that the conflict’s destruction is extensive in Ukraine, it stands to reason that global corn and wheat supply from Ukraine is more at risk, but Russia’s ability to export its resources could be severely constrained by sanctions from Nato-member states like the United States.

We note that, while the resources remain available, these sanctions could affect Russia’s ability to easily export goods, much in the same way that Venezuela was crippled by similar sanctions. Although the sanctions are less likely to deter Russia in the short-term, they might affect the supply and demand dynamics for commodities such as corn, wheat, and oil.

The conflict has already triggered a surge in the price of these commodities. The price of corn has gained 16,7% in the year to date to US$6,87 per bushel as of February 28, 2022 and briefly peaked at US$6,95 per bushel shortly after Russia’s full-scale invasion of Ukraine on February 24, 2022.

The price of wheat also registered a year-to-date growth of 16,8% to EUR320.25/lb (US$356,87) and prices of these commodities could remain elevated in light of additional climate-related risks such as droughts and floods in several other countries.

Oil has also surged in response to the geopolitical tension and uncertainty. Brent oil picked up 27,3% since the beginning of the year to US$99,52 per barrel, similar to the markets’ response to the political turmoil in Egypt, Libya, Yemen, and Bahrain back in 2011.

Much like investors’ response to uncertainty in 2011, the price of gold has also firmed just after slowing down over waning Covid-19 fears.

The precious metal lost 1,4% in January 2022 to US$1,801,15/oz but subsequently picked 5,9% in February and closed the month at par to its 12-month high of US$1,909,49/oz.

The strong gold price has been driven by the commodity’s long-standing status as a prime safe-haven asset especially during times of uncertainty and crises. In such times, investors shy away from risky asset classes and invest in gold.

As a result, assets classes such as equities experience a blood bath as a global selloff triggers a decline in stock prices. The Dow Jones Index has lost 7,4% since the year started while the NASDAQ 100, DAX, and FTSE 100lost 13,7%, 9,7%, and 0,62%, respectively.

The volatility in global markets has also underpinned the VIX’s YTD performance of 81,6%.

The VIX, or the S&P 500 Volatility Index, is a popular measure of the stock market’s expectation of volatility based on S&P 500 index options.

A protracted conflict between the two eastern European nations could perpetuate the divestment from equities and even more so in emerging and frontier markets.

According to etfdb.com, emerging markets ETFs have lost value since the beginning of the year, save for UAE, Turkey, and South Africa-focused ETFs.

It is not surprising to note that the worst performing emerging market ETFs are Russia-focused ETFs, which have lost over 30% since the year started.

Zimbabwe is likely to be affected by the ripple effects of the conflict. A surge in the price of corn and wheat amid election-driven fears of food shortages locally and climate-driven shortages in the region could result in desperate measures to secure these commodities even at high prices insub-Saharan Africa.

In the worst-case scenario, this could drive Zimbabwe’s demand for foreign currency to purchase grain from limited suppliers in the region with sour implications on local currency rates.

In addition, the pass-through effects of global inflation in the country could sustain the resurgent high inflation rates and warrant a revision of the current inflation target range of 25% – 35% by December 2022 by the central bank.

In the absence of inflation-hedging instruments such as gold and gold ETFs, the local stock markets remain the next best avenue for ZW$ investors to preserve value.

An empirical study of the macroeconomic drivers of ZSE volatility reveals that currency depreciation and inflation drove37,1% of ZSE’s market valuebetween 2020 and 2021.

  • Mtutu is a research analyst at Morgan & Co. — tafara@morganzim.com or +263 774 795 854.

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