By Rebecca Ellis
TUE 01 MARCH, 2022-theGBJournal- It is difficult to remain calm in the face a brutal and unwarranted aggression from one country onto its neighbour at the heart of Europe. Events are unfolding at such rapid pace that financial markets have difficulty in absorbing the news and analysing their impact on the world economy. After an initial scare, markets assumed that Mr. Putin would get away with his aggression and returned to buying equities and propelling the indices up. This approach might be tested as unprecedented sanctions have been imposed on Russia, so let us try to assess their impact.
Economic actions against Russia over the Ukraine war have three direct transmission mechanisms for the global economy: commodity prices, international payments, and Russian demand for imports. The risk premium in commodity prices is an obvious though possibly short-lived effect depending on how commodity producers respond. The sanctions directly disrupt exports and imports pushing the Russian economy into recession or indeed into more catastrophic collapse if the financial system fail which cuts demand for exports to Russia.
In all of this it is important to remember that the Russian economy is not that significant globally. It is roughly 2 or 3% of global GDP, about half the size of California. More generally, risk aversion may lead to an increase in demand for liquidity. A key function of central banks is to balance liquidity supply and liquidity demand. It is too soon to be changing forecasts on quantitative policy, but it would be unwise to assume that there is a pre-determined path for quantitative policy tightening anymore.
Excluding Russia from the SWIFT international payment system does not stop Russia engaging in international transactions. It does make it a lot more difficult adding a layer of bureaucracy and more costly. When Iran was excluded from Swift in 2012, its trade dropped by roughly 30%. The increased cost of doing business will apply to international companies that import from or export to Russia. As well as Russian companies. While Russia is not necessarily a critical component of global supply chain, where there is trade volumes it will fall and imports and export prices will rise.
Losing Swift and more direct sanctions against specific banks may lead to a run on the Russian banking system. There are media reports of queues at banks already. Many Russians have experienced both bank runs and hyperinflation and once someone has lived through the trauma of such events there is a tendency to be quick to act if there are threatening again and clearly risks to the Russian financial system have increased. While some deposit withdrawals might be entirely rational holding cash for fear of credit cards will cease to work, for example. What starts as a rational withdrawal of money could quickly become a systemic bank run in these circumstances. Russian restrictions on social media may limit the speed of the bank run. A bank run would matter internationally because this would a more dramatic blow to the Russian economy, weakening demand and therefore again slowing exports to Russia.
Finally, placing sanctions on a central bank is unusual but not unprecedented. This is obviously negative for the Rouble as it reduces the ability of the Russian central bank to defend the currency in foreign exchange markets. Although Russia may attempt to sell its gold reserves and reserves held in China are theoretically unaffected. This affects the international economy to the extent that the sharp decline in the value of the rouble creates significantly higher Russian Inflation weakening the economy or limiting the ability of Russia to afford imports.
It is worth noting that this is unlikely to impact the role of the USD as a reserve currency because the lack of any viable alternatives. Europe and the UK are both engaging in sanctions against the Russian central bank and the persistence of capital controls into the Chinese renminbi cannot credibly play a role as a meaningful international currency reserve at this stage.
These broad financial shockwaves will be difficult for investors everywhere to navigate. Market gyrations offer opportunities for the brave unfortunately as event unfold, the brave may quickly look like a fool. We remain mostly on the side-lines for now only occasionally dipping a toe into these treacherous waters. The old stock market saying “buy on cannons” appears cynic in the light of the human suffering in Ukraine. Our thoughts go out to those who are fighting for their freedom…and ours.
Rebecca Ellis is a Personal investment advisor, based in Zurich rebecca.ellis@pomonawealth.com|pascal.crepin@pomonawealth.com
