Global Debt Crisis and the Russia-Ukraine War
The war in Ukraine has raised concerns about the outlook for global financial conditions. The tightening has been most apparent in the Middle East and eastern Europe, where countries with close ties to Russia have seen their equity valuations fall. This outbreak occurred just as the global economy was starting to recover from the COVID-19 pandemic and as most countries were bringing the pandemic under control. Despite the lack of a global systemic event, financial stability risks have risen. And the sudden intensification of the war in Ukraine and the subsequent escalation of sanctions have raised concerns about the outlook for global financial conditions. This could cause asset prices to fall.
Near term growth forecast densities:
The sudden rise in commodity prices is expected to add to the already elevated inflation pressures, which are likely to remain elevated for some time. Central banks are faced with a difficult trade-off between maintaining the recovery from the pandemic and fighting inflation. To bring inflation back to target and prevent an unmooring of expectations, central banks need to remove accommodation. However, they need to avoid a disorderly increase in financial conditions that could threaten the growth of their economies. Incoming inflation data suggests that more decisive monetary policy is needed in many countries. The escalation of the war in Ukraine has raised concerns about the outlook for inflation. The rise in commodity prices has also raised the risk that inflation will stay elevated. The break-even rate, which is a market-based measure of future inflation, has additionally risen significantly. The war in Ukraine and the subsequent sanctions have raised concerns about the outlook for global financial conditions. They have also raised the risk that the financial system will be affected by various factors. Some of these include the disruption of the commodity markets and the lack of liquidity in the financial markets.
Foreign Banks’ Gross Claims on Russia and Ukraine
The direct exposure of banks to Russia is relatively small, except for some European banks. Their indirect exposures are also less well known due to the lack of consistent disclosures and the lack of a comprehensive picture of the country's financial activities. Non-bank financial intermediaries, such as investment funds and foreign banks, have substantial exposure to Russia. These are likely to raise their counterparty risk and risk premia. Most of these investments are made by US and European funds. Since the occupation of Crimea in 2014, the share of emerging market funds' exposure to Russian debt has gradually decreased. In 2022, the average emerging market fund's exposure to Russia is around 4 percent. On the other hand, funds that are benchmarked to global indices have a small exposure to Russia.
Commodity Price Changes, 1962–2022
The sudden and severe disruptions in the global supply chains and commodity markets have caused volatility in the prices of various commodities. These factors have also raised the risk that the financial system will be affected by their effects. One of the most important factors that banks have been able to contribute to the recovery of the commodity markets is their exposure to the energy trading industry. The poor liquidity conditions in the commodity markets have led to a reduction in the risk appetite of investors and a rise in the counterparty risk concerns. This has also raised the risk that the financial system will be affected by their effects. As a result, frontier and emerging markets are experiencing tighter financial conditions. Since the war in Ukraine started, the hard currency yields of emerging market countries have increased significantly.
The number of companies trading at distressed levels has increased significantly, surpassing the pandemic-peak levels. The deterioration in spreads and the increase in US yields have caused financing costs for many borrowers to exceed their pre-crisis levels. Despite the negative effects of the war in Ukraine, the markets are still open for new issuance. and the decline in the value of the local currency bonds and equities markets has caused investors to withdraw their money from these assets for the first time since March 2020. The tighter financial conditions are expected to increase the risk that portfolio flows will be affected by geopolitical uncertainty. while the recent stock market sell-off in China has raised concerns about the country's growth potential. The rising number of COVID-19 cases and the deteriorating real estate sector have additionally raised the risk that the country's financial stability will be affected. Although it is possible that extraordinary measures will be necessary to ease the pressure on the balance sheets of companies due to the pandemic, they would also increase the vulnerability of the financial system to future shocks. The inter-bank funding requirements between banks and emerging market governments have increased significantly over the past two years.
Bank-Sovereign Debt Exposure, 2005–21
The increase in bank holdings of sovereign debt has raised the risk that the financial system will be affected by their effects. If the situation in emerging markets worsens, it could cause a feedback loop between banks and sovereigns, which could reduce the lending and capital levels of the financial system.
The war in Ukraine has additionally raised the risk that the financial system will be affected by its effects. It has additionally raised the possibility that the conflict could put climate change at risk. It has additionally raised the risk that the fragmentation of the capital markets could affect the operations of central banks. It has additionally raised the possibility that the use of crypto assets could be affected by the sanctions. To avoid the imposition of sanctions, the authorities have additionally started to implement more complex asset allocations. war has also highlighted the urgency to reduce the energy dependence on carbon-intensive sources. It has also raised the possibility that the transition to renewable energy could be delayed. Despite the various advantages of the energy transition strategy, it is still expected to face some setbacks in the coming years. As well as the sudden and severe decline in the prices of oil has raised the possibility that the phasing out of fossil fuel subsidies could be delayed in developing and emerging markets. Rising inflation could also lead to the government resorting to other forms of fiscal support.
DeFi Assets and Stablecoins
The sudden and significant increase in the trading volumes of cryptocurrencies against emerging market currencies has raised the risk that the sanctions could affect the operations of the financial system. This is because the cross-border transactions that are carried out through these assets are often difficult to manage. The sanctions have additionally raised the possibility that the capital restrictions in Ukraine and Russia could affect the operations of the financial system. Despite the technological advancements that have occurred in the financial industry, the rapid emergence and growth of new business segments can pose a threat to the financial stability of the country. This is because the lack of stringent regulation for financial firms can lead to their rapid emergence and growth.
Conclusion
Central banks should take immediate action to prevent inflation from becoming entrenched and to avoid an unmooring of expectations. They should also provide clear guidance on the normalization process while keeping data dependent. Although the global financial conditions have become more accommodative, emerging markets are still vulnerable to a disorderly increase in the interest rates. To avoid this, central banks should maintain their policy normalization efforts as needed to maintain their credibility and anchor inflation expectations.
As for now, to avoid a disorderly increase in the interest rates, policymakers should additionally step up their efforts to address the various vulnerabilities in the financial system. This can be done through the implementation of more effective macroprudential tools. However, it is also important to avoid procyclicality and maintain a balanced approach. As part of their efforts to address the energy security challenges, policymakers should also step up their efforts to implement the UN's 2021 climate change conference's road map. They should also take various measures to increase the availability of fossil fuel alternatives and lower the cost of renewable energy.And to ensure that the growth of the cryptocurrency industry is not affected by the multiple risks and activities of its operators, policymakers should develop a comprehensive global standard for the asset. They should also step up their efforts to ensure that the multiple risks associated with the industry are adequately managed. Following the sudden volatility in commodity prices, regulators have taken various steps to address the issue. These include the establishment of effective trading and clearing systems, the establishment of resilient trading systems, and the establishment of more effective margin and liquidity management.
Pic Courtsey-Dominik Lukma at unsplash.com
(The views expressed are those of the author and do not represent views of CESCUBE.)
