Investing in Geopolitical Uncertainty: Russian Ukraine Crisis a Threat of World Economic Stability

Investing in Geopolitical Uncertainty: Russian Ukraine Crisis a Threat of World Economic Stability

 Investing during war times: Extreme Market Volatility and Economic Uncertainty an investor’s nightmare.

 Russian Ukraine conflict a big risk to overall geopolitical stability around the world, resulting in large collateral damage across the globe resulting in commodity prices rising thereby leading an inflation pressure due to the supply shock and destabilizing the world economy. However, invest when the first bullet is fired and exit when the white flag in waved is the age-old mantra in the stock markets.

 The world has witnessed very challenging times in the last 24 months, with millions of people losing their life due to pandemic and lakhs of businesses being shut down due to the lockdowns imposed across the globe. Just as the world was recovering from the COVID pandemic and the third wave settling down in most countries of the world, the Russian – Ukraine crisis now a full-fledged war has been a big setback to overall geopolitical stability in the world. When there is geopolitical tension between two countries, the loss of life and economic impact is not constricted to these two countries or that specific region but has a long and hard impact across economies and around the world.

 With the world economy connected in these modern times wherein every country has an economic relationship with each other either in terms of trade or investments, the contingent risk of such geopolitical stability is huge. Due to the uncertainty associated with war in terms of how much damage will it cost, how long will it last and what would be the possible economic damage, results in great instability in the financial markets and as a result the stock markets around the world turn very volatile. There are days when there is a panic in the market and immense selling and blood bath on the street. On 24th February 2022 when Russia invaded Ukraine, the Russian market fell 50%. Even though Russia was invading Ukraine and not been attacked, this kind of fall just amplifies the cost that every country pays in economic terms for a war. At the same time when there is a possible peace in the making, the markets will rally and there would be a frantic upward move thereby resulting in huge overall volatility.

 In the modern world, in order to curb aggression and maintain overall stability in the world economy, sanctions are imposed on countries which do violate laid down protocols. United Nations (UN) will possibly impose stringent sanctions on Russia thereby restricting its ability to trade with other countries at an appropriate economic cost. Russia is a very big commodity and agro commodity player and has large trade links with the European Union, Asia and rest of the world. Russia is the largest gas exporter in the world and second largest oil exporter. With India importing about 85% of the crude oil requirement and half of natural gas requirements, a spike in oil and gas process can have a large impact on the Indian economy. With the price of crude already touching USD 100 a barrel and possibly moving higher due to the geopolitical uncertainty. The price rise can have a lot of impact on the overall economic stability of India.

With the possibility of crude oil rising, the impact on the overall trade deficit is very large as oil is almost 20% of total imports in value terms. A USD 1 increase in oil price can increase trade deficit by approximately USD 1.2 billion. A USD 5 increase in oil prices would increase trade deficit by approximately USD 6.24 billion, which amounts to 0.23% of GDP. While a USD 10 increase in oil prices will increase the trade deficit by 0.45% of GDP. Oil price increase by USD 5 per barrel could depreciate Rupee by 1.4% against the US Dollar, whereas a spike in oil prices by USD 10 per barrel could lead the Rupee to depreciate around 3%.

 The Cascading Effect of Higher Crude Oil Prices

 ·      Higher oil imports → higher current account deficit

·      Rising oil prices → fiscal deficit

·      Higher oil price → higher input costs → higher overall inflation

·      Higher input costs → lower profitability for several industries

·      All above factors → depreciating INR

·      Depreciating INR → fall in stock markets

·      Fall in stock markets → loss of wealth

·      Loss of wealth → slow investment cycle

·      Slow investment cycle → slow productivity growth

·      Slow productivity growth → slowing GDP

  Top 10 Oil Producers and Total Share in Oil Production

Country

Million Barrels per Day

%Share of World

USA

18.61

19.8%

Saudi Arabia

10.81

11.5%

Russia

10.5

11.2%

Canada

5.23

5.6%

China

4.86

5.2%

Iraq

4.16

4.4%

UAE

3.78

4.0%

Brazil

3.77

4.0%

Iran

3.01

3.2%

Kuwait

2.75

2.9%

Top 10 nations

67.48

71.9%

Total World Production

93.86

 On the Agro commodity side Russia is a big exporter as well. It is the third largest exporter of Corn and Ukraine is one of the largest exporter of Barley around the world.

  Global Exports of the World

Russia's Share

Copper

4%

Aluminium

6%

Nickel

10%

Platinum

12%

Wheat

20%

Palladium

44%

Alongwith these commodities Russia being a very large natural gas exporter and almost 41% of European Unions’ natural gas requirement is procured from Russia, hence if large amounts of economic sanctions are imposed upon Russia, there would be a very big impact and inflation pressure on the already fragile European Union.

 Investors should not panic and sell equities in a hurry. The Russian stock markets peaked out in October 2021 and fell 30% before the present war cry and crashed 50% further when the war was declared. Investors should look at capital protection at a portfolio level and always remember a Bull Market Began in Darkest Days of World War II therefore never lose hope in case of an unforeseen escalation of tension. The history of war has taught the equity markets and their long-term investors that after the darkest hour the brightest light is witnessed and never sell in panic as well as never buy in euphoria.

  S&P 500 Performance in War Times

Date

Event

Post 1 month

Post 3 Months

Post 6 Months

Post 1 Year

7-Dec-41

Pearl Harbor

-3.40%

-12.7%

-9.10%

0.40%

31-Oct-56

Suez Canal Crisis

-2.80%

-3.8%

-0.20%

-11.50%

20-Oct-62

Cuban Missile Crises

8.70%

17.7%

25.10%

32%

17-Oct-73

Arab Oil Embargo

-7%

-13.2%

-14.40%

-36.20%

25-Dec-79

USSR in Afghanistan

5.60%

-7.9%

6.90%

25.60%

3-Aug-90

Iraq invades Kuwait

-8.30%

-13.10%

-2.15%

10%

17-Aug-91

Gulf War

15.10%

23.5%

20.50%

33.20%

11-Sep-01

9/11

-0.20%

2.5%

6.70%

-18.50%

20-Mar-03

Iraq War

2.50%

15.6%

17.40%

28.70%

Average

1.30%

2.1%

5.50%

8.60%

In a connected modern world, no country remains in isolation and economic pain and supply shocks / constrains cause devastating effects across the globe. In these modern times new India is an India that is self-dependent and Atmanirbar Bharat. Flagship and reformist schemes like Make in India, PLI schemes will insulate a large part of the overall economic shock that the world will witness in the near term.

 Investors in these very turbulent times should be cautions and conserve capital as capital protection is the key top overall prosperity at the portfolio level. At the same time investors should not panic and keep in mind that the overall growth story of India is intact and by virtue of such events, India will be the most attractive developing economy in the world and attract the most amount of investment and capital from foreign investors in the medium to long term. Thereby the pain in the Indian stock market will be for a short term and long-term prospects are very bright.

 _Farzan Ghadially.