By Andrew Cole, Investment Director of the Global Multi Asset Group at Baring Asset Management
In our view, the geopolitical tensions surrounding the situation in Crimea, the Russian response and the consequent sanctions imposed by Western nations present an increasing source of risk within the global economy.
The latest developments have seen Russia move to incorporate Crimea, which formally applied to become part of the Russian Federation after the 16 March referendum showed strong voter support for breaking away from Ukraine.
Alongside the government of Ukraine, the US and EU dispute the constitutionality of the referendum. Diplomatic efforts to defuse the situation have so far been elusive, with the West viewing Russia’s intervention as a violation of Ukraine’s national sovereignty and Russia viewing it as warranted due to concerns about the safety of ethnic Russians and the political instability in Ukraine following the overthrow of President Viktor Yanukovich.
The West, for its part, has imposed a narrow range of sanctions against high-ranking Russian and Crimean officials in the form of visa restrictions and freezes on assets and there is an indication that sanctions could be escalated.
The situation is still in flux and at such times markets tend to be driven much more by politics and news flow rather than fundamentals. And while we foresee a number of risk areas related to the situation, we do not expect that the situation heralds the return of a new Cold War era.
Whether Crimea remains part of Ukraine or not, it is widely acknowledged that the Ukrainian government will need multilateral and bilateral financial support to maintain economic stability in light of its large fiscal and current account deficits. In this respect, the IMF and bilateral lenders such as the EU are identifying the resources needed for an economic support programme.
From the perspective of Russia, the rouble has fallen sharply in recent weeks, and there is a risk that an intensification of the confrontation and the imposition of further sanctions could further undermine the Russian economy.
It could also have negative consequences for economies reliant on foreign trade and investment with Russia. In this respect, Western Europe could be vulnerable from an energy perspective, as Russia is the world’s largest energy exporter and a key supplier to the EU for meeting its energy needs.
In any case, it is worth noting that the recent developments have done little to reassure investors, already cautious about the prospects for emerging markets in the short term. From a fundamental perspective, we believe that other factors such as the slowdown in Chinese economic activity are of more investment significance in the long term.
While political developments are fast moving, we expect any resolution of the situation to be a protracted process. In the short term, the situation is likely to evolve quickly and we may see associated market volatility as a result. We continue to monitor the situation and stand prepared to take action as required in the portfolios we manage.