Implications of Geopolitical Risks – Russia-Ukraine War
As the world continues to grapple with the catastrophic impact of the coronavirus, geopolitical risks have unexpectedly heightened due to the invasion of Ukraine by Russian forces. The crisis comes at a time when the whole world is struggling to find ways to revive the economy and normalize the growth trajectory. Stupidly stricken by these hostile developments, the response from world leaders, including members of the North Atlantic Treaty Organization (NATO), initially begins with tough sanctions on Russia that could not only spoil the prospects for trade international, but also tend to isolate the Russian economy. In a highly interconnected world, the ramifications of sanctions could extend to many connected Russian economies.
The humanitarian crisis in Ukraine, the devastation of lives, livelihoods and property could cause colossal irretrievable losses that will take years of pain to heal. As Samaritan diplomatic channels around the world work, the onslaught of emerging geopolitical risks is causing intense uncertainty and risk. Extreme volatility in global equity markets, currencies, commodity and energy prices tends to increase inflationary headwinds, posing challenges for central banks. The road to policy normalization is about to hit the wall with a softer stance to continue to ride out the impact of the ongoing war.
1. Financial penalties:
In retaliation for the Russian attack on Ukraine, several economies imposed sanctions restricting deals with Russia. The biggest will be sanctions coming from the US, EU, UK, Japan, Canada, Taiwan and New Zealand and many more. Sanctions against Russia that target banks, military exports and oil refineries will impact not only Russian companies but also their trading partners who will find it difficult to do business with them. The US Treasury Department has targeted the basic infrastructure of the Russian financial system by imposing sanctions on their biggest banks that will impede global financial and trade flows.
They will not be able to issue letters of credit (LC) and bank guarantees (BG) impacting international banking operations. This will sever their ties with correspondent banks, allowing banks to make/receive payments from each other and move money around the world. This set of sanctions expels Russian banks from the US financial system, prohibits their trade with Americans and freezes their US assets. This will be a stumbling block for Russia with its economic ramifications of enormous magnitude and size.
2. SWIFT Connectivity:
The next financial embargo could take the form of a denial of Belgium-based SWIFT (Society for Worldwide Interbank Financial Telecommunications) connectivity services with the rest of the world, which could be more devastating for the Russian economy. It is a gateway to international money transfer and keeps the flow of the global financial system connecting nearly 200 countries. Denying access to SWIFT would hamper the ability of Russia and its financial institutions to conduct international business and could cause significant damage to the financial system.
Russia will have to find other ways to coordinate its international financial arrangements – a slow and costly process. Since this will also harm the international financial operations of many other interconnected economies, the deprivation of SWIFT connectivity will be a severe drag with its negative ramifications. But because of geopolitical risks, economies as a whole will have to factor in and take well-advanced positions to withstand the vagaries of such sanctions in the future. Since SWIFT is positioned in one of the NATO countries with the western world at its command, stakeholders will need to be prepared for such an eventuality.
3. Non-financial sanctions:
Amid mounting financial sanctions on Russia, the United States is also allowing additional troops to be stationed in Germany as NATO allies to improve defense readiness to deal with any eventuality. All the efforts of the G-7 countries are also aimed at ending the invasion of Ukraine by Russian forces which is causing immense suffering to civilians. The United Kingdom banned the Russian flight – Aeroflot from operating on its territory. In retaliation, the Russian Aviation Authority banned British flights to and over Russia and even transit flights. This will have an impact on the mobility of Russians. Japan, while announcing new punitive measures, including the freezing of visas and assets of Russian groups, reiterated that it will not favor any military intervention.
The World Health Organization (WHO) insists on creating a safe way to deliver humanitarian aid and medical assistance to war-torn Ukraine with the coordinated efforts of security forces. Transport, hospitals and the protection of healthcare workers are important at a time when human suffering needs empathy and care.
4. Geopolitical risk management:
The financial industry must be prepared to handle the sudden onslaught of such a crisis with appropriate business continuity policies (BCPs) to minimize its impact. The usual risk management system based on country risks provided by international rating agencies does not work in catastrophic situations of the type currently experienced by the financial system. The chaos in the global stock and currency markets due to the sudden war eroded the wealth of millions of investors.
Soaring crude prices above the US$105 mark may push up inflation and the Center may need to take a hit of Rs. 1 trillion due to rising import bills. Edible oil prices could rise, further impacting inflation headwinds. Rising gold prices may affect derivatives in commodity markets. The RBI, which is preparing to normalize its monetary policy in the post-pandemic era, will have to wait for the reduction in geopolitical risks and will have to continue its accommodative policy. The Rupee weakened sharply to Rs. 75.65 on Feb 24 which recovered to Rs 75.30 per dollar with lingering downside risks.
Stock market fluctuations can also impact the public issuance of LIC and its price trajectory. Yields could strengthen and the corporate sector could experience some corporate turbulence, especially related to exports. In the event of prolonged Russian military action, the risks are likely to increase. India is still using diplomatic channels to resolve the crisis and has chosen to remain neutral in the process. The economic repercussions of the impasse in Ukraine may lead to a further loss of momentum in the recovery not only in India but worldwide. RBI will closely monitor the developments to inject liquidity.
The opinions expressed above are those of the author.
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