What do the risks in Ukraine mean for emerging markets (EM) in Asia? A few things, it seems.
Despite the geographical buffer, the impact may potentially be profound and painful should worst-case outcomes be realized.
Oil's long & strong reach
The surge in oil prices on the back of the Russian supply disruption will have the largest adverse impact amid the tensions in Ukraine.
Beyond the sharply higher prices, which will inevitably drive inflation higher and dent current accounts in Asia’s EMs, the impact will also come in the form of potential disruption to direct oil and, or coal supply from Russia.
In 2021 alone, Russia exported about 1.4 million barrels of crude oil per day to Asia.
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In EM Asia outside of China:
- India's reliance on Russian coal is fairly small and substitutable. Nevertheless, there will be imposing risks, as well as the risks of unwelcome higher costs that accentuate inflation and energy-disruption.
- South Korea's dependence on Russian oil (which is its fourth-largest supplier) may bloat industrial costs, exacerbating chip shortages and downstream chemical products.
- Vietnam's reliance on Russian coal reliance (which is the largest, after Australia and Indonesia) increases the risks to energy costs and consequent state absorption of higher energy costs.
While Russia is not the largest oil exporter for EM Asia, the country’s sheer global heft in energy exports, as the second-largest exporter of oil globally pre-pandemic (despite slipping to third in 2020), means Russia will impose a disproportional global crude/energy price shock given the difficulty in compensating for Russian supply.
To some extent, this argument may extend to aluminum, as Russian company Rusal is the world’s second-largest aluminum producer. Rusal derives three-quarters of its revenues outside of Russia. That said, oil is the uncontested “big fish” for overall macroeconomic reach and impact.
Stagflation-type pressures
The combination of higher global energy prices and disrupted supply translate to a stagflation type of impact from simultaneously dulling activity and amplifying inflationary pressures.
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EM Asia is at risk of oil inflation seeping further and lingering longer. A resultant suppression of real returns/growth will be reflected in diminished GDP outcomes aggregated from eroded margins at the industry levels.
Rippling across as macro-stability risks
The most acute macro-stability vulnerabilities from the spike in oil prices will affect "twin deficit" economies with high consumption import reliance (in contrast to high proportion of refining imports, where costs may be passed on in downstream exports).
This is especially given that the adverse impact on oil may have a tendency to ripple as deterioration in credit metrics, inflaming credit risks. By this measure, India, Philippines are top on the list of the usual suspects. Indonesia, with similar risks, is certainly not off the hook, but has current account vulnerabilities partly mitigated by its offsetting coal exports.
Risks by association
Vietnam may also be subject to the risks of collateral damage from its association with Russian oil; albeit a little more upstream, specifically from the Vietnam-Russia Joint Venture (Vietsovpetro) for oil-field production.
While Vietsovpetro is not in the direct line of fire as things stand, it could face incremental indirect pressures if the situation in Ukraine blows up.
Risks of financial contagion
The risk of a war in Ukraine may set off an adverse financial contagion that will rock EMs in Asia.
A broad-based flight to safety juxtaposed against higher inflation and negative shocks to current accounts may spare few in its path. However, calmer minds may differentiate along the lines of "twin deficit" and inflation exposures.
That said, in worst-case scenarios, an intense global "risk off" will likely trigger, "shoot first, question later" fear instincts leading to generalized capital outflows from EMs in Asia.
During an indiscriminate sell-down in EM Asia financial assets, a relative resilience and ability to recovery quickly after – rather than being exposed to risks of "reflexivity" (a self-reinforcing downward spiral) – is dependent on;
i. deep USD liquidity (as USD’s safe-haven appeal dominates amid forced liquidation);
ii. stable inflation dynamics, and;
iii. the ability to endure seizures in external financing options.
The measured consolation is that recent history suggests that markets can digest geo-political risks fairly quickly; so long as a wider European war is avoided. But arresting oil-related risks in its entirety is nevertheless a tall order.
Strategic, geo-political ramifications
Finally, even if worst-case scenarios in Ukraine are averted, EM Asia may face consequential longer-term strategic ramifications from an emboldened and largely unchecked Russia, with whom China appears to have deepening ties (and implied military alliances).
This may cast doubts on the US’s commitment to its key allies (Japan, Korea and Taiwan). And a US that is judged as being reluctant to step in and step up may unwittingly motivate China to up the ante with Taiwan. Accentuated China-Taiwan risks also bring about North Korea flash points, given that China may encourage North Korea’s agitations to disperse US/North Asia's attention in the event it looks to make a move.
Imminent economic risk
With that, the situation in Ukraine is not considered an unmitigated disaster for EM Asia. However, it is an imminent economic risk (the order of which will be determined by Russia-Ukraine outcomes) and, crucially, a longer-term barometer of Asia's geopolitical stability.
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Meanwhile, high-oil import reliance (tilted to consumption), "twin deficits", exposure to high inflation, high external debt exposures and pressures on USD liquidity remain as defining features of near-term vulnerabilities that stem from Ukraine’s potential geopolitical shocks.
Vishnu Varathan is the executive director, head, economics & strategy for Mizuho Bank's Asia & Oceania Treasury
Photo: Bloomberg
