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For the past few years President Vladimir Putin of Russia has been at odds with the European Union (EU) and the United States over foreign policy. The issues range from not supporting the deconstruction of Iran’s nuclear program to providing Syria with weapons and energy. The last 18 months of antagonism has come to boil with Ukraine overthrowing the unpopular President Victor Yanukovych and Putin sending Russian troops into Crimea, the southeastern island state of Ukraine. In the face of Western nations decrying this violation of sovereignty, Putin stated that he will do everything to protect his people and his nation’s interests. Most recently, Crimea, which is predominantly ethnic Russian, has filed a referendum to secede from Ukraine and rejoin Russia.
Helping the Hyrnvia
Unrest of any kind plays havoc with financial markets. Global political conflict pitting Russia and the United States against each other has worried investors. In times of uncertainty there is invariably a flight-to-quality (investors moving their capital away from riskier investments to the safest possible investment vehicles)—U.S. Treasury Securities and gold.
Between March 13 and 18 of this year, 30-year bond yields went down from 3.6% to 3.587% reflecting an increased demand for the asset, with the 10-year bond experiencing a similar drop. Meanwhile on March 17, gold reached its highest price level since September 2013 when it hit $1381 per ounce. Political uncertainty has also put the Russian ruble and Ukrainian currency hryvnia on the defensive.
Ukraine has been suffering from the global economic meltdown which precipitated the revolution. Currently it faces a $35B shortfall and is being assisted by a combination of loans from the United States, European Union and the International Monetary Fund (IMF)—all of which might still not be enough to save it from default.
Russia—Reeling Under the Pressure?
Russia has been facing the affereffects of recession as well as several economic threats.
The first is the credit exposure Russia has to Ukraine. Sberbank and other Russian banks own large positions in Ukrainian bonds, whose default which will create credit shocks in Russia.
Second, Russia is suffering from the economic contagion of 2007. Whereas the United States had an annualized 3.4% growth rate in Q413, Russia is currently languishing at a paltry 1.3% economic growth anticipated for 2014.
The third issue is the threat of sanctions from the West, which is taking its toll. Buoyed by its $500B in foreign currency reserves, Russia can deal with short term currency fluctuations as investors withdraw their invested capital—it is unlikely whether Putin will allow it happen for long. A more serious consequence of sanctions is the deterioration of Russia’s image.
Russia largely depends on foreign direct investment from the United States and European Union. Further political conflict will irrevocably damage the west’s relationship with Russia, something it cannot afford.
An average American might pose the question “I don’t have any money in the stock market and no family or friends in that part of the world, it is troubling, but why should I care?”
Ukraine is a major exporter of corn and wheat on the world stage. With Putin’s troops occupying a major port on the Black Sea and a general level of unrest in Ukraine, these exports are not leaving the country.
The United States also happens to be a major producer of these crops as well. Those who used to buy these products in Ukraine will now look to other producers. The same demand on lower supply will drive prices up, which eventually will affect United States consumers.
Russia happens to be a big exporter of energy to worldwide markets, something it often uses as a tool in foreign policy. If the West’s threats of sanctions are implemented, it is not a stretch to assume that Russia will retaliate against the United States and the European Union by reducing oil exports, which will send gas prices soaring.
Why is India Silent?
There has been a lot of media coverage on the dynamics between the United States, Ukraine, Russia and the EU in this conflict. Normally active nations such as France, Australia, Canada and Japan have not yet demonstrated support for either side yet. Obama has been pushing China to take a strong position against Russian action in Crimea but so far it has also remained quiet.
What is surprising is that India, normally a strong ally of the United States in international affairs has not yet spoken out. There might be a reason for this—Russia and Ukraine are its largest trade partners. In fiscal year 2012, Indian exports with Ukraine was around $3B. With the Ukrainian hyrvnian devaluing 20% since mid-December against the dollar, prices of Indian goods imported to Ukraine are shooting up affecting consumers. India is worried that further political instability will further increase prices and speaking out against Russia will adversely affect its relationship with its largest trading partner in Russia. India is hoping for a quick resolution to the crisis so that Ukraine’s economy can recover, making India’s goods competitive again.
Calling the Bluff
In this conflict there are no winners. Financial markets are exhibiting incredible volatility purely on speculation of conflict. Things would only become worse with actual action on Russia. The United States can argue that it can afford to institute sanctions on Putin as it derives only a small percentage of trade from Russia. Russia’s biggest trading partner however happens to be Germany, one of the United States’s closest ally and one of the countries holding the European Union together post-economic crisis. Sanctions on Russia have a possibility of indirectly jeopardizing the entire existence of the European Union.
Although at some level, the United States can assume Putin has his country’s best interests at heart, he has stated that he has the strength to make tough choices for the greater good. President Putin’s aggressive posturing against the west is not a bluff—we must avoid lighting the powder keg, lest we all get burnt.
Rahul Varshneya graduated from the Leavey School of Business at Santa Clara University with a degree in finance and is working in the technology industry as a financial analyst.