Ukraine
Risk-sharing now and beyond the Ukraine conflict
Finn McGuirk, Mosaic Insurance’s head of political risk, and Martin Blum, head of desk strategy and capital markets development for Vienna-based Raiffeissen Bank International, discuss the macroeconomic impact of Ukraine’s conflict.
The pair also debated how best to facilitate private-sector participation in the war-wracked nation’s eventual reconstruction. The following is a transcript of the July 20 edition of the Mosaic Moment podcast series.
Finn McGuirk: Martin and I have known each other for many years and we have a shared professional interest in keeping up to date and analysing macroeconomic developments, but we come at that subject with very different perspectives and levels of focus.
As a political risk underwriter, I’m required to stay abreast of macroeconomic developments, as they affect developing markets around the world, whereas Martin is a focus expert on Central and Eastern Europe and developing political and economic risk there.
Obviously one of the big issues facing political risk underwriters at the moment is the conflict in Ukraine and, on the human level, that is almost unfathomable in terms of the level of suffering. It’s a huge, tragic event that is still emerging, but the conflict also has considerable effects on economies around the world.
From my teams and my following of those effects around the world, I think we’ve been a little surprised by the focus being almost as much on countries that are geographically far away from the epicentre, rather than what you might describe as the “near abroad”. But nevertheless, we are asked to support clients who are doing business in Central Asia and Central and Eastern Europe so it requires us to stay abreast of those developments and try and analyse those risks.
Martin, from your point of view, has sufficient time now passed to get an idea about the effects of that conflict in terms of remittances and energy prices on those economies in the near abroad, or do you think that that story is still evolving too rapidly to come to a firm view?
Martin Blum: The simple answer is yes and yes. There’s been certainly enough time to appraise the initial impact on the region’s economies and markets, but by the same token, clearly, the situation is still evolving on the ground, not only in terms of the human tragedy of the conflict, but also in terms of its spillover to economies in the region.
The sanctions response is also still playing out. So in this context, we’ve by no means seen the full impact on Central European (CE) or Central Asian economies yet, but we can say a couple of things already if we if we look back over the last four months.
The first point I’d touch on is that higher energy prices have had a profound impact on the CE region’s external imbalances and also, obviously, inflation. What that means in practice is that the current account deficits in the CE region have widened in some cases to levels not seen since before the 2008/2009 global financial crisis.
By the same token, higher energy prices have been one of the key factors pushing inflation in many countries in the region above 10 percent.
From an immediate spillover impact from Russia’s invasion of Ukraine, the inflation impact is perhaps the most visible, and that in turn creates a real challenge for policymakers, not only in the US or the eurozone, but also in the CE and Central Asian regions, too. The positive, particularly from a sovereign risk perspective, is that central banks across the region have really stepped up to the challenge of significantly tightened monetary policy.
That’s something which I think is underpinning the medium-term credibility of policymakers across the region.
It’s also worth noting that the National Bank of Ukraine, Ukraine’s central bank, recently tightened monetary policy, hiking interest rates 15 to 25 percent in a bid to reduce foreign exchange pressure, and that’s important for two reasons.
One because, obviously, it reduces the scope for further international reserves loss which is good for sovereign credit worthiness, and also because it underscores that, notwithstanding the conflict, the policymakers still have to do relatively orthodox things in terms of policy choices, and that’s exactly what’s happening in Ukraine, which is ultimately positive.
The second point I’d make in terms of the immediate spillover of the conflict to the region, is that its impact on economic activity so far has been somewhat more muted than feared. And that’s also true for Central Asia and the Caucasus.
What we’ve seen in terms of inward remittances has been quite surprising insofar as the flows from March onwards have been stronger than previously—they’ve accelerated rather than decelerated. That’s been very visible, for example, in Uzbekistan. Foreign exchange depreciation pressure across Central Asia has also been limited and reversed quite fast, following the initial weakening of currencies in Central Asia. And the reason for that was also because the rouble has been surprisingly strong since sanctions were imposed.
In short, the initial impact of Russia’s invasion of Ukraine has been relatively muted in terms of economic activity outside Ukraine, but we think that headwinds to economic activity will progressively intensify as we move into the second half of this year, particularly if energy price pressure is sustained.
“Grants from the international community are preferred, as opposed to concessional loans.”
Martin Blum, Raiffeissen Bank International
McGuirk: You’ve already touched on Ukraine’s own actions in trying to manage the economic fallout of the crisis. From our point of view, we’ve seen in the UK quite a strong reaction from British people in looking to help Ukraine through the crisis, and perhaps partly because of that, the UK government has been visible in offering significant tangible help to Ukraine. More broadly and more significantly, from the international community there has been significant help offered, particularly from international financial institutions.
From a political risk underwriter’s point of view, it will be nigh on impossible for us to increase our exposure to Ukraine at the moment, but the level of international support has profound implications on our existing exposures that we ran out from previously supporting the Ukrainian economy.
From our point of view, that level of international support signifies a strong, ongoing commitment to the future of Ukraine. Is that how you’re seeing it?
Blum: That’s absolutely right and it’s difficult to overstate the importance of international support for the Ukrainian economy. The US came up recently with a $40 billion aid package, of which around $8 billion will be channelled in direct budget support for the Ukrainian government. The European Commission has proposed a €9 billion macro financial assistance package for Ukraine for this year, which would directly support Ukraine’s government and hence also the economy. That’s in addition to support from supranational organisations such as the IMF, the EIB and the World Bank, and a lot of bilateral support.
This is very important because the budgetary and fiscal impacts of the war are significant. The finance ministry estimates around $5 billion a month of deficit related to the impact of the war on the budget and the economy. That gap needs to be plugged, and if it’s not plugged by international support then it needs to be plugged by domestic bond sales, which is occurring on a weekly basis, every Tuesday.
In addition, if there are gaps, the central bank has to directly finance the government, which from a longer-term perspective, the lower that is, the better it will be for Ukrainian markets and the exchange rate when markets reopen again at some point in the future.
Two related points are very important to highlight in this context and, if you speak to people in Ukraine’s finance ministry, which I have in the last few months, these are points which strongly come across. The first one is that grants from the international community are preferred, as opposed to concessional loans because grants do not add to the country’s debt, so it’s better for long-term credit worthiness.
The second point, from a medium-term perspective, is how best to facilitate private sector participation in Ukraine’s reconstruction. This is obviously a crucial point, insofar as it will define the welfare of Ukrainian citizens in the long term. It cannot be done only by international bodies—the private sector progressively will have to become involved, and there will be an element there of risk-sharing.
“That level of international support signifies a strong, ongoing commitment to the future of Ukraine.”
Finn McGuirk, Mosaic Insurance
McGuirk: In terms of the European response, we are seeing a lot of coverage of the European energy sanctions being applied to Russia, particularly the uneven pain that represents for the member states of the EU. I wonder if you see that as a strain on the cohesion of the EU, and maybe a threat to the formation of a single coherent EU foreign policy?
Blum: I view it somewhat more optimistically than that, as a mirror image to some extent of what you just asked. Specifically, if we if we take a step back and look at the six rounds of sanctions that the EU countries have so far imposed against Russia, it proves that pretty robust and aggressive EU foreign policy has worked, and that the EU can, from a foreign policy perspective, act in concert with other large players such as the US or the UK. And that’s despite having to make compromises to placate countries such as Hungary.
Also keep in mind that, in the context of trying to offset or work against some of the countries’ specific spillovers from the energy price implications from sanctions, the EU has an initiative called REPowerEU. Part of that provides up to €225 billion of funding to facilitate energy transition and essentially to improve energy security in the region. Taken together, on balance the EU’s actions in the last four months strengthen my belief in a common EU foreign policy.
Image Credit; Shutterstock.com / GagoDesign
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