Chart 1

The fast-moving events of the Russia-Ukraine conflict are splitting Asia by energy haves and have-nots, havens and non-havens. The most obvious effect lies in surging oil prices. This divides those nations that export oil and coal, and those that rely heavily on energy imports. S&P Global Ratings also believes that heightened market risk could pull capital out of Asia's emerging markets, hitting currencies, and raising funding costs. The bigger economies are drawing investors seeking safety, as reflected in the stability of the yen and renminbi compared with the euro.

Economic pains and gains.   For the many economies in Asia-Pacific that are net energy importers, higher energy prices can trigger a terms-of-trade shock. This would hit current account balances and real domestic consumption and investment. This dynamic would be most keenly felt by the largest net energy importers (relative to GDP): India, the Philippines, Korea, Taiwan, and Thailand. On this front, higher energy prices would be a plus for Asia-Pacific's net energy exporters: Indonesia, Malaysia and, especially, Australia.

Meanwhile, Indonesia could see contagion effects stemming from building global risk aversion--leading to capital outflows--diluting the positive trade effect from higher energy prices.

Corporates are more concerned about rising commodity prices.  For rated companies in Asia-Pacific, rising commodity and energy prices and investor sentiment matter more than direct exposure to the countries in conflict. The hit of rising prices depends on the cost pass-through ability of an industry or issuer. It is marginally negative to negative for entities with a high share of feedstock expense in their cost base and those having difficulty incorporating rising input costs in their selling prices.

The hit is largely neutral for entities that can pass through higher input costs given steady demand. The knock-on effect of the conflict on investor sentiment and access to funding are likely to have a more pronounced effect on credit quality for weaker issuers especially those rated 'B' or below with refinancing maturities coming due in 2022 or 2023.

Spillover for other issuers is manageable.  Asia-Pacific banks and financial institutions' direct exposure to Russian counterparties appears small and manageable. Meanwhile, insurers' earnings could fluctuate because of market volatility. For sovereigns, while the conflict brings risks to inflation and growth, the recovery from the pandemic should continue despite these headwinds.

Macroeconomic Outlook

Economic impact largely via global markets

The Russia-Ukraine armed conflict--and the sanctions and geopolitical friction it brings--poses headwinds to our current baseline forecasts for Asia-Pacific. This is underscored by recent cuts to most countries' GDP forecasts, reflecting the conflict (see "Global Macro Update: Preliminary Forecasts Reflecting The Russia-Ukraine Conflict," published March 8, 2022, on RatingsDirect). Most regional economies send less than 1% of exports to Russia. The share is the highest for China, at almost 2%. The hit from the conflict would mostly come from global market turbulence and higher commodities prices.

The rising cost of energy and food will drive up prices generally in Asia-Pacific. The hit on producer prices should come faster and harder than for consumer prices, especially compared with "core" consumer prices (excluding energy and food). This will likely squeeze the margins of downstream firms.

Higher consumer price index (CPI) inflation would strain monetary policy in India, Korea, the Philippines, Singapore, and New Zealand, where CPI inflation is preoccupying central banks (see chart 2).

Chart 2

Higher energy prices could trigger a terms-of-trade shock for net energy importers in the region. This would hit current account balances and real domestic consumption and investment. On this front, higher energy prices would be a plus for Asia-Pacific's net energy exporters and hit the biggest importers (see chart 3).

Chart 3

Substantially higher energy prices and volatility will likely strain the currencies and asset markets of many Asia-Pacific countries. This pressure will be strongest where higher energy prices pressure inflation targets--such as India, the Philippines, Korea, and Thailand. Or it could cause sizable current account deficits--in India, the Philippines, and Thailand.

These risks emerge as the U.S. Federal Reserve leads several major central banks to raise policy interest rates. Traders would likely react unfavorably to large current account deficits in emerging markets. Obvious examples are India and the Philippines. Contagion effects could also strain the asset markets of countries such as Indonesia and Korea, which have historically also been vulnerable to capital outflow during bouts of global risk aversion.

Such price and financial market squeezes would reduce growth across the region, with further hits coming from dampened consumer and business confidence. External demand would also weaken. We expect this will be most apparent in demand from Eastern Europe, the Middle East, and Africa, where the economic effects of the Russia-Ukraine conflict are likely to be the largest.

Slower growth would lead to lower demand-driven inflation, especially core inflation. Many regional central banks do not have much leeway to ease monetary policy to support growth, due to their concerns about inflation or capital flight. However, in economies where neither is a major issue (Australia, China, Japan, Malaysia, and Taiwan), the Russia-Ukraine turmoil could lead to a more accommodative monetary policy path.

The Russia-Ukraine conflict is likely to lead to higher energy prices and headline inflation, lower growth and, possibly, lower core inflation. The effect on currencies, bond markets, and monetary policy could differ across Asia-Pacific, depending on trade structures, existing macroeconomic conditions, and market reaction.

Financing Conditions

Adding a strain to a squeeze

Asia-Pacific financing conditions were trending tighter prior to the conflict between Russia and Ukraine. Benchmark yields had been moving up across much of the region even as most central banks remained on hold. Rising yields are raising funding costs for Asia-Pacific borrowers. Widening credit spreads, particularly among speculative-grade borrowers, exacerbates this trend.

The conflict in Ukraine has so far not accelerated the tightening of financing conditions in Asia-Pacific. Spreads rose on both investment-grade and speculative-grade issuers in the days following the start of the conflict, but by a somewhat routine magnitude given the volatility of the past couple of months (see chart 4a).

Lower-rated entities have limited access to bond markets, but that is just a continuation of a trend seen in the year to date. Regional stock markets have dropped, but capital outflows have not been severe, as suggested by the fairly controlled depreciation in regional currencies (see chart 4b).

Chart 4a

Chart 4b

However, if the situation escalates--either in terms of the severity of the conflict or of economic sanctions--funding conditions could tighten sharply. Spreads could jump, and currencies could depreciate as capital flowed out of the region, especially from economies dependent on foreign funding. Even accounting for the possibility that economic softening would offset the inflationary effects of energy prices, rising risk aversion among investors would significantly raise funding costs and reduce liquidity.

In such a scenario, issuers at the lower end of the credit quality spectrum might lose access to funding. Entities in Japan, Australia, New Zealand, China and--to some extent--Malaysia could turn to their relatively robust domestic markets. Nevertheless, funding costs would rise for all issuers in all markets. This could create a serious problem for regional corporates that face a significant maturity wall (see "China Decelerates, Fed Deliberates," published Dec. 6, 2021).

Nonfinancial Corporate And Infrastructure

Knock-on effects for the region

Rising commodity and energy prices and increasingly volatile investor sentiment pose the most relevant immediate credit consequences for rated companies in Asia-Pacific. These are much more important factors than entities' direct exposure to the two countries.

A protracted conflict affecting investor sentiment well into 2022 could complicate refinancing for weaker credits that rely on capital markets. However, most rated companies in Asia-Pacific have little direct exposure to Russia or Ukraine in terms of revenues, asset location, or sourcing. Russian airlines and cargo are an immaterial contributor to traffic at Asian ports and airports.

The direct hit on revenues or assets is limited. Less than 3% of about 520 publicly rated issuers in Asia-Pacific have direct exposure to Russia through operations, assets, or sourcing, by our estimate.

Rising commodity and energy prices have different implications across sectors.

On March 1, 2022, we raised by about 15% our base-case crude pricing assumption used for the credit analysis of oil and gas producers globally. Brent prices will likely average US$85 per barrel in 2022, up from our prior assumption of US$75 per barrel.

The credit hit depends on the cost pass-through ability in each sector and for each issuer. It is marginally negative to negative for entities with a high share of feedstock expense in their cost base, and which face difficulty in reflecting rising input costs in their selling prices. This may either be because of government-imposed price caps, or sluggish demand. The hit is largely neutral for entities that can pass through higher input costs given steady demand. Such sectors include electronics and semiconductors.

The knock-on effect of the conflict on investor sentiment and access to funding are likely to have a more pronounced effect on credit quality for weaker issuers.

This is likely a more relevant credit issue for the roughly two dozen issuers in the region rated 'B' or below that depend on capital markets to refinance maturities in 2022 or 2023. A few such weaker-rated issuers have already postponed a proposed bond issue due to market volatility over the past week.

In China, investor sentiment remains very weak in the real estate sector. Government policies and issuers' own characteristics largely determine an entity's ability to access markets. Geopolitical settings are less of a consideration.

Shifting investor sentiment will likely raise the funding costs of weaker South and Southeast Asian (SSEA) entities. The mostly investment-grade entities of Japan, Korea, and the Pacific should be more resilient. These typically large companies often have conservative balance sheets, significant discretionary cash flows, and substantial cash balances.

Financial Institutions

Small exposure will soften the spillover effects

Direct exposures to Russian counterparties of large, internationally visible Asia-Pacific banks appear small and manageable in the context of current ratings and outlooks.

The Russian-Ukraine conflict has triggered a batch of negative rating actions on banks in Russia and Eastern Europe in the past week. Our base case is that Asia-Pacific bank ratings should remain relatively unaffected because of low exposures to Russia and Ukraine. Direct spillover from the conflict is unlikely, by itself, to hit bank ratings. However, the secondary effects on corporates will raise banks' nonperforming loans.

Asia-Pacific institutions have little direct exposure to Russia

Asia-Pacific financial institutions have very low direct exposure to Russia (see chart 5). Total Japanese banking exposure to Russia was a paltry US$9 billion as at Sept. 30, 2021--less than 0.2% of banking assets.

Chart 5

Chinese banks have insignificant exposure to Russia, even if the absolute size of some infrastructure and other investments by certain Chinese policy banks is large. Banks in South and Southeast Asia likewise do not have meaningful direct exposure to Russia.

Most banks should contend with the negative knock-on effects on their borrowers at current rating levels, but they will feel the effects of the conflict unevenly. Many Asian economies are net importers of oil and other commodities. Rising prices for such items may dampen economic growth and stress some bank borrowers in India and Thailand, for example.

Mongolian banks may experience more acute secondary effect given the strong economic ties of the region with Russia. Conversely, higher oil prices will benefit bank borrowers in Brunei. The trend may also be a positive for banks in commodity exporting countries, such as Malaysia and Indonesia.

The known unknowns…  Beyond the typical economic downside scenarios, we also consider the possibility for escalating geopolitical risk, event risk, and cyber attacks. These effects could be profound. They are difficult to predict during a time of simultaneous stress affecting sovereign, corporate, and banking sector entities in Russia and Eastern Europe.

This is a dynamic situation with many fast-moving variables. If secondary effects intensify, Asia-Pacific banks will find it difficult to manage hits on economic or financing conditions that are markedly outside our base case.

Banks' starting points varied prior to the onset of the Russian-Ukraine crisis. Economic trends were negative in Malaysia, Indonesia, and Thailand, indicating less flexibility to contend with fresh stress associated with the Russia-Ukraine conflict. While our view of the effects of long-term economic trends on the Chinese banking sector are more positive, China must now deal with the economic uncertainties of this conflict alongside significant immediate stress emanating from a weak property sector.

Insurance

Earnings to fluctuate as volatility hits

The Russia-Ukraine conflict will likely have a modest direct hit on Asia-Pacific insurers' financial performance. Regional insurers' bond and equity investments in Russia, Ukraine, and Belarus are a small part of their total assets. That said, should the event trigger significant market volatility in the region, institutions may feel the effects more directly. This could also test insurers with a high allocation to foreign-currency investments.

Spillover effects on asset valuations could heighten volatility.  Japan and Taiwan insurers have large holdings of overseas investments compared with regional peers. Taiwan's life insurance sector is most exposed to the turbulence from this event. We believe this exposure is manageable, given the sector has sufficient capital buffer to absorb any hits from the conflict. Russia-based investments account for about 4% of the total-adjusted capital (TAC) of Taiwan insurers, by our estimate. Individual life insurers' investment exposure in Russia to TAC ranges between 2% and 12%.

Prolonged market fluctuation would strain insurers' investment incomes. A likely gradual rise in interest rate differential in the coming year could hike hedging costs. It should also prompt insurers with large holding of overseas investments to revisit their hedging strategies. Greater inflation could also reveal pricing inadequacy for some long-tail business.

Liability risks are insignificant.  The effects on insurance liability are insignificant, by our estimates, given most market participants remain domestically focused. While reinsurers and some large insurance groups have gradually expanded their international footprints in recent years, the direct exposure to risk underwritten in Russia and Ukraine likely remains small. Any property exposure in affected areas may be subject to war-exclusion language in policies, and therefore not subject to major claim payouts. The termination of coverage of Russian-owned exposures in other countries could entail a small premium loss but no liability hit.

Sovereign

Conflict, inflation, and lingering pandemic effects

The armed conflict between Russia and Ukraine brings risks to inflation and growth that could slow the credit improvement among Asia-Pacific sovereigns.

The Russia-Ukraine military conflict has rocked commodity markets. The surge in prices, especially energy prices, risks spurring inflation further. Asia-Pacific is particularly vulnerable as most major economies in the region are net energy importers.

Geopolitical uncertainties have clouded global growth prospects. Increased risk aversion and rising input costs will drag on economic growth.

We expect regional GDP recoveries to continue, but that higher inflation and uncertainties associated with the Russia-Ukraine conflict will slow the pace of this rebound. Governments should still be able to meaningfully rein in fiscal deficits, although a full return to pre-COVID fiscal performances will take longer.

Key risks: Sudden capital swings and interrupted fiscal recoveries.  An unexpected deterioration of geopolitical risk could see investors withdraw from emerging markets in Asia-Pacific, making financing conditions significantly weaker for some.

High inflation, weaker demand and increased uncertainty arising from the Russia-Ukraine military conflict and continued supply chain disruptions may slow the economic and fiscal recoveries much more than currently expected.

If the Ukraine conflict escalates, so might the effects on Asia-Pacific.   If the armed conflict in Europe expands or involves more parties, it could seriously damage investor sentiment. The impact of the event on economies and financial markets in Asia-Pacific may worsen significantly.

S&P Global Ratings acknowledges a high degree of uncertainty about the extent, outcome, and consequences of the military conflict between Russia and Ukraine. Irrespective of the duration of military hostilities, sanctions and related political risks are likely to remain in place for some time. Potential effects could include dislocated commodities markets--notably for oil and gas--supply chain disruptions, inflationary pressures, weaker growth, and capital market volatility. As the situation evolves, we will update our assumptions and estimates accordingly. See our macroeconomic and credit updates here: Russia-Ukraine Macro, Market, & Credit Risks. Note that the timing of publication for rating decisions on European issuers is subject to European regulatory requirements.

Editing: Jasper Moiseiwitsch

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