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Russia’s military aggression against Ukraine, which has become Europe’s largest ground war in generations, has impacted millions of people and triggered a large-scale humanitarian crisis as vulnerable Ukrainians take shelter or flee their homes. The intensification and spread of the conflict is deeply troubling and is having a devastating impact on those people caught in the crisis.

This article focuses on potential market and economic implications of the conflict.

In this Q&A, Kirstie Spence and Robert Burgess share their views on Russia, commodity prices and the impact of the conflict on emerging markets. 

How does the Russia-Ukraine conflict compare to previous periods of geopolitical instability?

Kirstie: The current situation is primarily a humanitarian tragedy, resulting from the conflict between two major emerging market (EM) countries. It is unlike any other humanitarian tragedy we have seen in the past, given the impact that it is having on the global economy and its long-lasting nature.

The other differentiating factor is the scale and speed of the sanctions. The freezing of Russia’s central bank reserves was especially unexpected and as a result, the magnitude of the price moves in Russian and Ukrainian bonds have been unlike anything that we have witnessed before.

Another unique aspect of this crisis is that some of the rule books of investing are no longer valid. Historically, when countries have gone through defaults there have been international law precedents on how to settle bonds. Given that this is a crisis about willingness to pay from Russia rather than their ability to pay, many of the rules that bond investors are familiar with, do not currently hold.

How likely is it that Russia will default on its debt and what kind of impact could that cause?

Robert:  Russia currently has both the resources and the technical capacity to service its debt, at least until 25 May 2022.  In terms of the willingness to pay, statements from Russian authorities have suggested that payments on hard currency bonds might be made in roubles, but then they have reportedly made the first coupon payment in foreign currency that was due on 16 March. While the payment does not seem to have reached bondholders yet (as of 17 March), Russia has until 15 April for the payment to go through to avoid an official default.

If it did occur, it is unlikely that a sovereign hard currency default would turn into a major systematic event. This is because foreigners only hold about US$60 billion of Russian government debt and because many of the repercussions of a default have already happened. Russian sovereign bonds are already priced at distressed levels, the rating agencies assume an imminent default in their ratings and the major index providers are already removing Russia from key benchmarks.

How have EM countries been impacted by the conflict and are you seeing outflows from the asset class?

Kirstie: Market contagion has been relatively limited when considering the magnitude of the crisis. This is partly because bond valuations have already been pricing in uncertainties around growth and inflation, and the impact of the pandemic.

While EM debt issuance may take a dip as banks, syndicates and investors remain preoccupied managing the practicalities of the crisis, as time goes on liquidity should start to pick up and issuance should start to resume. Meanwhile, we could see a tactical pause in inflows into the asset class as investors calibrate the impact of the crisis, but strategically I do not see a big withdrawal. There may be changes in the way we think about things like political risk premium, but with 70 investable countries continuing to deploy capital around the global financial system, there remains plenty of opportunity within EM debt.

Risk factors you should consider before investing:

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
• Depending on the strategy, risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.