"...emerging markets will grow faster than the
developed world for decades to come."

Gideon Rachman, The Financial Times

Russia, Ukraine and China

Russia, Ukraine and China

The economic implications of Russia’s war are potentially large and global. Our Head of the Franklin Templeton Investment Institute, Stephen Dover, opines on the ties between China, Russia and Ukraine.

It has become more apparent than ever that economics and finance are intertwined with national and global security. Sanctions confront armies. Banks take on tanks. And the collateral damage from economic and financial warfare is significant, as Russia is now discovering.

The economic implications of Russia’s war are potentially large and global. Inflation will be higher everywhere. Economically vulnerable groups will be worse off. Global growth is expected to be weaker.

War and sanctions create long-term, profound ramifications for economic systems. Supply chain vulnerabilities, already laid bare by COVID-19, have been further exposed. There will be no turning the clock back to the pre-pandemic, pre-war, globalized, and efficient world economy.

China is not spared from these shifts. China’s import and export supply chains are long and potentially exposed to risks. In a world where warfare and conflict exist as much in the towers of finance as on the plains of the battlefield, China may be forced to reckon with the consequences and adapt to new realities.

The Impact of Russia’s Invasion Will Be Global

Russia’s invasion of Ukraine has unleashed both supply and demand shocks that are now reverberating around the world economy and financial markets. Disruptions to Russian, Ukrainian, and Belorussian production and distribution of energy, food, and industrial metals are already pushing up many commodity prices. This partly reflects genuine supply shortfalls amid tight inventories—panic or speculative buying is exacerbating moves.

Surging prices for oil, natural gas, grains, fertilizers and industrial metals will feed through into higher producer and consumer price inflation worldwide—in advanced, emerging, and lesser- developed countries. China will not be spared. Even in countries with large domestic supplies of energy and food resources, such as China (coal, grains) or the United States (crude oil, natural gas, various agricultural products), prices are set in world markets, meaning that increases are felt universally.

Soaring energy and food prices redistribute income from consumers to producers, but that outcome typically leads to lower overall global spending and weaker global gross domestic product (GDP) growth. That is because higher prices for necessities reduce purchasing power of cohorts with high propensities to spend and transfers income to businesses and individuals with lower propensities to spend. Consequently, total spending sags.

Also, on the demand side, it is plausible to assume that consumers and businesses may postpone discretionary “big ticket” purchases. Those effects may be largest in Europe, for understandable reasons. If demand slumps, its effects will reverberate via trade channels. One significant reason for this is that Europe is China’s second-largest export market.1

For China, the impact of war and sanctions will be to lower demand for its exports, given weaker world growth. Domestic Chinese spending will also be hit, owing to higher petrol and food prices that dampen consumption.

Earlier this month, China has set a modest 5.5% growth target for 2022.2 As we’ve noted before, China was already likely to buck the trend of global monetary and fiscal tightening this year. That outcome looks even more likely now.

This time, however, China is less likely to ease monetary and credit policy given the challenges of a significant property development overhang. Accordingly, it is also likely that Beijing will deploy government spending, including on infrastructure, defense, and economic security measures, both to address fundamental needs as well as to stoke domestic demand.

China Will Likely Intensify Efforts to Bolster its Long-Term Economic Strategy

Beyond the cyclical impacts of weaker growth on the Chinese economy and macro-policy, events in Russia-Ukraine will have longer-run ramifications for China’s development strategy. “Dual circulation” is the buzz-phrase around China’s 2021-2025 five-year plan, a strategy that emphasizes domestic consumption, investment in technology, and greater self-reliance by reducing import dependency in areas such as silicon chips.

In recent years, one of the most highly-talked about development has been China’s “Belt and Road” initiative, which focused on establishing transportation and commercial networks into commodity producing parts of the world, including via the ancient “Silk Route” across central Asia.

Belt and Road has been integral for China to create and secure its own trade routes. After all, Ukraine and the surrounding areas of Russia and Belarus are historically one of the world’s greatest bread baskets. Russia and Ukraine account for 14% of global wheat production and 30% of global wheat exports.3 Both countries also supply nearly 20% of global corn exports, and Ukraine is one of China’s largest sources of corn feed. Russia and Ukraine also account for 19% of global barley production and nearly one third of global barley exports.4 They also make up 60% of global sunflower oil production and 75% of global sunflower oil exports.5

However, disruptions this year to planting and harvesting of wheat, barley, corn, and sunflower in Ukraine will impact China. Financial sanctions on financing and insuring Russian shipments may also pinch supplies of foodstuffs.

To the extent those disruptions become long lasting (if, for example, conflict and sanctions carry on for years), China will need to seek other, more reliable suppliers. For foodstuffs, that means turning to North and South America. Indeed, given China’s well-known water-supply challenges, it is unlikely that China can rely on domestic grain production to offset a lasting loss of Ukrainian and Russian supply.

Financial Sanctions May Impact China’s Foreign Reserve Philosophy

Finally, China should contemplate the possible impact of financial sanctions on its foreign reserve philosophy. A quarter century ago, China drew the lesson from the Asian financial crisis that large foreign exchange reserves were essential for national financial security. But the freezing of Russia’s foreign exchange reserves and the expulsion of large Russian banks from the SWIFT international payments system has exposed fault lines and gaps in that strategy.

China is far more economically and financial integrated in the world economy than Russia, which makes it more painful for the West to potentially impose on China the kinds of draconian financial sanctions that it has on Russia. But that same interdependence also implies a potentially high economic and financial cost on China, should sanctions nevertheless become a plausible scenario.

Plenty of discussion in China is apt to focus on other ways to hold foreign exchange reserves or to devise an alternative international payments system to SWIFT. But there is no quick fix. Existing institutions and networks that underpin the world’s financial system are not easily dislodged. Just as in social media or search, a single payments network and global reserve currency offer enormous network benefits. Global commerce works best on one platform rather than many.

And, as economist Robert Triffin pointed out over 60 years ago, if a country wishes to issue and oversee the world’s reserve currency, it must provide for its supply in international finance and commerce via persistent trade deficits and a relatively open capital account.6 Present-day China has little appetite for either, which will continue to hinder the renminbi’s development as a genuine global transactions or reserve currency rival to the US dollar.

As I’ve noted before, writing on topics that stem from human tragedy is an immense responsibility. My colleagues and I undertake this duty with great care and professionalism as part of our fiduciary responsibilities.

What Are the Risks?

All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks.

Important Legal Information

This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton.
The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realised. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance. All investments involve risks, including possible loss of principal.

Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data.  Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. The mention of any individual securities should neither constitute nor be construed as a recommendation to purchase, hold or sell any securities, and the information provided regarding such individual securities (if any) is not a sufficient basis upon which to make an investment decision. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.

Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.

Issued in the U.S. by Franklin Distributors, LLC, One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, franklintempleton.com – Franklin Distributors, LLC, member FINRA/SIPC, is the principal distributor of Franklin Templeton U.S. registered products, which are not FDIC insured; may lose value; and are not bank guaranteed and are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation.

CFA® and Chartered Financial Analyst® are trademarks owned by the CFA Institute.

 ____________________________________

1. Source: Statista as of December 31, 2021.

2. Source: People’s Bank of China as of March 5, 2022.

3. Source: United States Department of Agriculture (USDA) as of October 2021.

4.Ibid.

5.Ibid.

6. Source: Investopedia. How the Triffin Dilemma Affects Currencies, June 25, 2019.


Related Articles

Brazil on the Olympic Stage

When discussing Latin America generally, political transitions toward market-friendly governments and acceleration of reforms are key changes we’d like to

The Leapfrog: The Role of Technology in Accelerating Emerging Markets’ Growth

The potential for emerging and frontier markets to realize accelerated economic growth as a result of new technology transfer comes

Emerging markets geared for growth

Emerging markets are expected to produce “good, solid returns” this year, supported by reduced reliance on exports to the developed world

No comments

Write a comment
No Comments Yet! You can be first to comment this post!

Write a Comment

Your e-mail address will not be published.
Required fields are marked*