The Ukraine conflict amplifies many strains on Asia-Pacific governments. The event has sent oil above US$100 a barrel, raised food and fertilizer prices, and rattled supply chains. S&P Global Ratings believes the conflict presents diverse pressures on Asia-Pacific sovereigns, and that the effect of these stresses will be most apparent in price rises.

Rising commodities costs come on top of U.S. policy interest rate hikes, which increase borrowing expenses and which risk triggering capital flight from Asia's emerging economies.

The crisis also strains U.S.-China relations further, threatening more disruptions to trade and investment ties. All this is playing out while China battles an omicron breakout that is hitting mobility and supply chains. China's property market--which powers about one-quarter of its economy--remains in a downturn.

It is a tangle of market and economic strains, wrapped around long-simmering geopolitical tensions. Here we address common investor queries about the effect of recent global developments on the region, including ones that came up in a recent webcast on Asia-Pacific rating trends. This article supplements our views on several of the key topics that were discussed at the webcast.

Frequently Asked Questions

What are the likely spillovers of the conflict in Ukraine on Asia-Pacific sovereigns?

For now, the effects will be mainly indirect. Apart from Mongolia, where 30% of goods imports come from Russia, Asia-Pacific economies do not have strong trade links with Russia and Ukraine. Banks in this region also do not have strong business links with the two countries. European banks are the most important lenders to both Russia and Ukraine. Korean banks, the largest lenders to Russian residents among Asia-Pacific institutions, had claims of just US$1.2 billion in September 2021. This was just a fraction of the US$89 billion that Russian residents owed to non-resident banks at that time (see chart 1).

Chart 1

The larger risk of the Ukraine conflict to Asia-Pacific sovereigns is in higher commodity and food prices, weakened external demand, reduced confidence, and potential capital outflows. Russia and Ukraine are both big food exporters, including wheat, barley, and vegetable oil. Russia is also an exporter of petroleum, coal, and minerals such as nickel and iron.

The disruptions of the conflict have already sharply increased global prices of these commodities. Import bills will rise at many Asia-Pacific economies. This will likely hit the economic growth, trade balances, and fiscal performances of related sovereigns.

Financing costs could also rise if risk aversion among international investors increased suddenly. This would hit the region's economic growth and fiscal performance. Following increases in interest rates after the conflict began, most emerging markets in Asia-Pacific have seen their government bond yields stabilize at slightly higher levels. If the conflict sends interest rates much further up, the hit on sovereign support would increase materially for some with weaker debt metrics.

How are Asia-Pacific sovereigns affected by the higher oil prices?

It is a positive for some, but a negative for most. Most economies in the Asia-Pacific are net energy importers. Higher oil prices will weigh on the credit metrics of these sovereigns.

There are a few net energy exporters. However, these economies are net petroleum importers in most years and depend on coal (Australia and Indonesia) and natural gas (Indonesia and Malaysia) to generate their energy surpluses (see chart 2). Consequently, their energy exports benefit only to the extent that coal and natural gas prices go up with petroleum prices.

The hit on higher energy prices on individual sovereigns will depend on the following:

• The energy intensity of a given economy;
• The reliance on imported sources of energy;
• The strength of an economy's external metrics; and
• The degree of energy subsidies.

Chart 2

Some of the Asian economies most dependent on imported energy also have the highest incomes. Such economies--Hong Kong, Singapore, Japan, and Korea—also have very strong external attributes supporting the ratings on their respective governments. Energy subsidies in these places are negligible. Owing to their large services sectors, their total energy bill is likely to be small relative to their annual economic output, compared with lower-income economies. The hit on the related governments' fiscal and external metrics should be modest.

The sovereigns that could be most affected by the increase in energy prices are likely to be those with already high inflation and weak external metrics that are reliant on imported energy. Sri Lanka and Pakistan fall into this group. Sri Lanka is especially vulnerable because it imports about half the energy it uses, and was under strong external financing pressures even before the recent surge in oil prices. The latest events have prompted the government to discuss financing support from the International Monetary Fund, according to news reports.

How is higher inflation, exacerbated by the conflict in Ukraine, going to affect sovereign-debt metrics in Asia-Pacific?

Higher inflation directly affects sovereign-debt metrics. Rising rates raises the interest payments on government debt, outpacing increases in revenue. It is also possible that higher inflation could raise the cost of budgetary spending to force governments to issue more debt.

How much interest costs rise for a given government depends on the degree to which borrowing rates are affected, and the volume of debt that needs to be refinanced.

Higher rated sovereigns--such as China, Japan, and Korea--have not seen significant changes in their borrowing costs. However, some emerging market sovereigns have seen increased yields on their debt since the start of the conflict in Ukraine. The five-year benchmark yields on local-currency government debt issued by India, Indonesia, the Philippines, and Vietnam have risen 25 basis points to 90 basis points since mid-February.

These four sovereigns should find the increase in interest payments manageable. They have relatively low central government debt rollover ratios (see chart 3). And, except for India, their government debt-to-GDP levels are not high by international comparison.

Chart 3

What is the likelihood that the U.S. will impose sanctions on China, and what risk does this present to the rating on China?

The U.S. has warned of "implications and consequences" if China provides "material support" to Russia in the conflict. This statement has been widely interpreted to have increased the risks of new economic sanctions targeting China.

We expect the Chinese government will calibrate foreign policy to maximize domestic stability in 2022. At the recently concluded National People's Congress, the government stressed the importance of ensuring a stable environment conducive to a successful 20th Party Congress in its work plan for the year. This objective extends to China's management of its external relations.

Recent statements by Chinese officials on the conflict in Ukraine suggest they favor a swift return to peace. Policymakers in the U.S. and EU will likely avoid actions that seriously undermine global economic sentiment. At a time of already heightened economic uncertainties, the U.S. and its allies will avoid imposing significant new sanctions on China unless they see very strong reasons to do so, in our view.

Consequently, this matter should not seriously affect Chinese economic performance this year. In the longer term, external developments are less important than China's structural reforms. Being a large economy with 1.4 billion people, China's growth prospects depend on domestic demand. While disruptions in international trade and investment flows with other economies could depress growth, meaningful progress in structural reforms that spur domestic consumption and drive productivity can offset some of this drag.

What impact will the Russia-Ukraine conflict have on India's fiscal metrics and its monetary policy?

India may face higher expenditure on items that the government subsidizes, particularly food and fertilizer, if those markets are upended for an extended period. Petroleum subsidies in India are more limited, and therefore have less effect on the bottom line. Higher commodity prices could also undermine buoyant private consumption trends in India as households spend more on those items.

This could moderate the economy's otherwise healthy recovery. Consumer inflation has been marginally above the central bank's target range of 4%-6% (year-on-year) for two consecutive months. A further acceleration could put more pressure on the central bank to normalize its monetary policy more quickly, including possible rate hikes.

How do rate rises affect the ability of ASEAN nations to manage their sovereign debt?

With U.S. interest rates on the rise, dollar-funding costs will be a key watchpoint for borrowers such as Indonesia and the Philippines, which actively issue in dollars. However, the immediate effect of rising interest costs will likely remain manageable. Both governments over the past two years have made more use of domestic debt markets to fund higher fiscal deficits. This has boosted the component of local-currency debt of outstanding borrowing.

A sustained rise in both foreign and local-currency rates could increase the interest burdens for those ASEAN sovereigns, particularly those that increased debt levels during the pandemic. These include Indonesia, the Philippines, and Malaysia.

Will higher commodity prices affect the negative ratings outlooks on Malaysia and Indonesia? What about the impact on the Philippines?

The higher energy and commodity prices are supportive of Indonesia and Malaysia's external dynamics, in our view, as both countries have benefited from stronger terms of trade over recent weeks. However, the fiscal hit is less clear.

Malaysia will bring in about Malaysian ringgit 300 million for every US$1 rise in the price of oil, per barrel. However, its higher domestic petrol subsidy bill will largely offset this gain. This estimate does not include the dividend paid to the government by state oil firm Petroliam Nasional Bhd. (Petronas). However, the dividend is largely determined by Petronas' performance in the previous financial year, we believe. This means that higher prices this year are likely to be primarily reflected in a higher dividend payment in 2023.

Higher commodity prices will lift Indonesia's fiscal revenues. The government has been working on a strengthened tax regime for coal, which could bolster its top line if implemented. However, direct oil and nonoil subsidies are also likely to rise, along with deferred compensation to state oil firm PT Pertamina (Persero), offsetting the higher revenues.

Record-high crude palm oil prices will benefit Indonesia and Malaysia. The countries are the world's largest and second-largest crude palm oil exporters, respectively.

As a net energy importer, the Philippines may experience a higher import bill and, potentially, a weaker current account performance owing to higher commodity prices. This could weigh on the Philippine peso.

As a net external creditor, the Philippines' external settings remain supportive of the ratings. On a net basis, lower real GDP growth and a modest current-account deficit may increase the government's fiscal deficit. The government has also introduced fuel subsidies to manage higher oil prices. So far the program is modest and unlikely to dent its fiscal performance.

What is the effect of a slow tourism recovery and high energy prices on the sovereign credit ratings on Thailand?

Our ratings on Thailand factors in a weak recovery in tourism. In large part, it reflects our view that Chinese tourist arrivals are unlikely to pick up significantly this year. China's strict border controls--a part of its anti-pandemic measures--should remain for much of 2022.

There is also no immediate rating hit from high energy prices. The increase in these costs have squeezed Thailand's current account balance, which turned negative last year. The larger expected external deficit, however, is unlikely to materially weaken external metrics supporting the sovereign ratings.

Thailand's external balance sheet remains strong, reflecting large external liquid assets and modest external debt. We also expect gross external financing needs, including payments for imports and maturing external debts, to remain modest compared with its current-account receipts and foreign reserves.

The additional pressure on the government's finances won't likely be significant as fiscal subsidies on fuel consumption are low.

Will China's real estate downturn reduce systemwide leverage and improve financial stability in the medium term?

The drop in real estate transactions and prices in recent months are related to the Chinese government's attempt to rein in developers' leverage (see "China Balances Policy Risk With A Need For Reform," published Oct. 13, 2021). The policy targeting these companies followed efforts to reduce leverage at local government financing vehicles and other state-owned enterprises. A meaningful reduction of such leverage would bolster financial stability.

A sharper-than-expected slowdown to the Chinese economy brings risks would make this outcome less likely. Real estate investment and related activities are a big contributor to real GDP growth in China. The policy to bring down leverage in the sector has already depressed economic activity. The deceleration of the Chinese economy in late 2021 has led to some easing of policy restrictions in the real estate sector. Significant share-price volatility in March 2022 has also been followed by policy announcements supportive of the sector.

A further deterioration of economic sentiment in the country could trigger a reversal of the measures implemented in 2021. This could result in a strong rebound of credit growth.

If Hong Kong cannot resume quarantine-free travel with the mainland or other countries this year, what are the ratings implications?

The Hong Kong government announced the easing of some border measures on March 21, 2022. From April, the special administrative region will reopen direct flights from nine countries, including the U.S. and the U.K. It also said it would cut the quarantine period for residents coming into Hong Kong to one week, from 14 days. The government defined the measures as consistent with a desire to rejuvenate the local economy.

The Hong Kong government's credit metrics will likely remain resilient even if border controls do not ease further within this year. The economy grew 6.4% in real terms in 2021, when borders were closed, largely driven by a rebound in domestic demand. This should help to close the budget deficit to just 0.6% of GDP in the fiscal year ending March 2022.

The latest COVID outbreak in Hong Kong does not seriously affect our view of the region's trend growth. We believe that Hong Kong's economic integration with the mainland will support its long-term growth potential. A delay in resuming normal cross-border travel is unlikely to derail this expectation.

Editing: Jasper Moiseiwitsch

Related Research

• Emerging Markets Monthly Highlights: Russia-Ukraine Conflict Causes A Storm Across Commodity Markets, March 17, 2022
• Asia-Pacific Banks And The Ukraine Crisis: Small Exposures But Secondary Impacts Could Bite, March 16, 2022
• Ukraine Conflict And Asian Companies: Commodity Prices, Sentiment Exceed Direct Effects, March 10, 2022
• Ukraine Conflict Divides Asia's Energy Haves And Have-Nots, March 9, 2022
• China's Refiners Feel The Heat As Oil Nears US$130, March 9, 2022