Russian war on Ukraine hurts all emerging markets

Besides the immense human tragedy that it has caused, Russia’s brutal attack on Ukraine has also thrown emerging markets back at least a decade in terms of attractivity for investors. It will be hard, if not impossible, for the asset class to bounce back.

Emerging markets were already vulnerable before. The Covid-19 pandemic dealt a heavy blow to developing nations, with many having recorded large numbers of deaths from Covid.

Governments had to scramble to support ill-equipped and short-staffed health systems; naturally, those with more money managed better than those with less.

Before the Covid-19 pandemic, one advantage that emerging markets had over developed ones was their generally low level of debt. But that advantage is going away fast.

The pandemic has forced governments in developing nations to reach deep into their pockets, thus widening budget deficits and increasing their debt.

In its latest Global Financial Stability Report, the International Monetary Fund (IMF) notes that holdings by banks in emerging markets of domestic sovereign debt have surged during the Covid-19 pandemic.

On average, domestic sovereign bonds account for about one-fifth of the assets of the banking sector in emerging markets, and make up 200% of their regulatory capital.

With public debt at historically high levels and the sovereign credit outlook deteriorating in many emerging markets, this could threaten the macroeconomic and financial stability of these countries, the IMF says.

Source: IMF

The chart above, from the IMF’s Global Financial Stability Report, shows how the public debt has increased in emerging markets following the Covid-19 pandemic.

Source: IMF

The chart above, from the same source, shows that banks in emerging markets are much more exposed to their own government’s debt than banks in developed markets. This increases risks in developing economies.

For countries already in such fragile situations, any external shock can be profoundly toxic. Russia’s war in Ukraine brings not one, but several such shocks.

For energy importers, the cost of oil and gas has surged, pushing governments even more into debt in an attempt to cushion their poorest citizens from the consequences of the increase in energy prices.

Food prices are also soaring, with exports of wheat from Ukraine and Russia making up around a quarter of the world’s need. Ukraine exports around 42% of the world’s sunflower oil, and Russia 21%. For corn, Ukraine is behind around 18% of global needs.

Prices for these and other foods have already increased substantially, and low-income emerging markets are likely to be the hardest hit.

Surging food prices could spart social unrest, but they also mean that millions of people will be too poor to be able to afford to send their children to school. In the future this will translate into societies with lower productivity and economic potential.

This will, in turn, drive young and ambitious people abroad in search of better opportunities, creating a vicious circle of emigration and economic weakness for developing countries.

Those emerging markets, such as India, that are sitting on the fence and trying to be “neutral” on Russia’s brutal military invasion on Ukraine ignore the wider consequences at their peril.