Contagion risks from the Russia-Ukraine crisis

The Russia-Ukraine crisis has continued with complex developments

There are a number of ways in which contagion from the Russia-Ukraine war can develop. One source of contagion can occur when other countries face very similar risks to those that toppled the original victim. Examples of this might be the Asian crisis of 1997 or the euro zone debt crisis of 2010-2012. In the former, Thailand was the first to succumb, quickly followed by others. With the latter, Greece folded first, but was soon followed by others, such as Ireland. However, Mr. Steve Barrow, Head of Standard Bank G10 Strategy said in the case of the current war between Russia and Ukraine, it seems unlikely that this sort of contagion will develop. Of course, if Russia decides, as some fear it will, that its push west should not stop at Ukraine, the contagion risks will multiply dramatically, but that’s unlikely to happen.

A second form of contagion happens when other countries do not share the same characteristics as the original victim but are pulled down simply because the victim is so large that it impacts others in a very negative fashion. An example of this type of contagion would be the global financial crisis, where emerging markets, for instance, were pulled through the wringer even though none had the same housing/banking frailties that were evident in the US. In any event, the disturbance from the US was just so big that contagion was inevitable. In the current situation with Ukraine and Russia, Mr. Steve Barrow senses that these contagion risks are limit ed. In his view, Russia is not sufficiently large in his view to make other countries wobble just because an impending Russian recession damages trade, for instance. Things could be different if Russia refused to supply oil and gas to others (or was stopped from doing so), but that too seems unlikely.

A third form of contagion can occur simply because investors are so unnerved by the situation that they reduce asset exposure across the board, whether or not the country issuing those assets has similar economic or political problems as Russia or Ukraine, or could be adversely impacted by any economic spillover, such as to its exports. These might be seen as more like self-reinforcing panics that perhaps don’t require a significant spark to set them off and might be a function of excessive investor positioning rather than anything else.

In other words, it's more like the bursting of an asset bubble. But even here, Mr. Steve Barrow sees the risks as somewhat limit ed, at least in the emerging market space, where international investors appear to have stayed away, presumably in fear of factors such as the pandemic and, more recently, the prospect of Fed rate hikes. However, could we say the same about the behaviour of investors in developed markets, in areas such as equities and corporate credit?

Surveys tend to suggest that investors are overweight in these sorts of areas, if not in emerging market equities. But could the Russia/Ukraine war be the spark that creates a bonfire of selling in developed-country assets, particularly if the origin of the risk comes from emerging markets in Russia and Ukraine? Mr. Steve Barrow doesn’t see why not. Many emerging market crises tend to flow out of tensions in developed countries, such as the US, and he doesn’t see why weakness in developed-country assets cannot stem from tensions in emerging markets. On top of this, the fact that there’s already enough reason to be concerned about riskier assets in developed countries, arising from the surge in inflation and major central banks' falling behind the curve, makes us feel a bit more comfortable in suggesting that there could be some degree of contagion here.