The Russia-Ukraine conflict could potentially last longer than S&P Global Ratings first expected, and this is likely to dent confidence further and cause additional rerouting of energy flows. The future development of the conflict is subject to a high degree of uncertainty, but so far has not spread beyond the two countries. Although the Russia-Ukraine conflict has substantially affected the macroeconomic outlook--including growth, inflation, and fiscal balances--across CEE and CIS, the immediate pressure on sovereign credit quality has proved limited.

Despite their geographical proximity, CEE/CIS countries often have only limited direct trade and financial linkages with Russia and Ukraine. In particular, for several CEE sovereigns, their most important direct linkages relate to energy imports from Russia, and generally these gas markets tend to be more regional; meanwhile, for Central Asian sovereigns, their most important financial ties relate to remittance flows.

Second-round effects, such as the economic slowdown in other trading partners or rising energy and food prices, are affecting the entire region, as well as other sovereigns globally.

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.

Frequently Asked Questions

How have CEE and CIS sovereign ratings fared so far?

Although the macroeconomic outlook--including growth, inflation, and fiscal balances--across the region has weakened, the immediate impact on sovereign ratings has been limited so far. Other than the sovereign ratings on Russia, Ukraine, and Belarus, we have not changed any CEE/CIS sovereign rating since the onset of the conflict, although on March 31, 2022, we revised the outlook on Estonia to stable from positive, on April 8, 2022, we revised the outlook on Armenia to stable from positive, and on May 21, 2022, we revised the outlook on Slovakia to negative from stable (see table 1 for current sovereign ratings in CEE/CIS). CEE/CIS sovereign ratings have generally remained stable because:

• Even after the pandemic, and despite raising funding costs, many CEE and CIS sovereigns have kept their public finances on a relatively strong footing. They generally have moderate debt levels and a relatively low effective interest rate.
• Some CEE sovereigns benefit from access to pan-European institutions, such as the European Central Bank, and directly gain from generous EU budget transfers, which help support local growth outlooks.
• Although a weaker macroeconomic outlook can affect a sovereign rating in principle, other rating factors, such as our institutional assessments, have remained unchanged. These carry significant weight in our sovereign rating analysis.
• Some sovereign ratings, especially on CIS sovereigns, were already at relatively low levels, partially because of some of the vulnerabilities that have now come to the fore. For example, it was already clear that Central Asian sovereigns such as Tajikistan and Kyrgyzstan were heavily dependent on remittances from Russia.

Table 1

How strong are the linkages between CEE/CIS sovereigns and Russia and Ukraine?

The heatmap below summarizes in relative terms some of the linkages and spillover effects affecting CEE/CIS sovereigns. This helps to us to rank the different transmission channels by which the conflict affects the different sovereigns. That said, the heatmap does not address all of the possible spillover or second-round effects, and it does not indicate future rating actions. These depend on the further evolution of the conflict, on other rating factors, or on buffers that mitigate the impact of the linkages and spillover effects. Charts 3-8 in the appendix contain the data used for the heatmap.

The heatmap shows that:

• Direct trade links to Russia and Ukraine are often stronger for CIS sovereigns than for CEE, which generally has very limited trade links with Russia and Ukraine.
• Montenegro stands out when it comes to foreign direct investment from Russia. In our view, this is related to its visa-free entry and economic citizenship scheme, which grants residency or citizenship rights through specific investments in the country and has been utilized by Russian citizens.
• Two Central Asian sovereigns have high exposure to remittances inflows from Russia. Weaker economic activity in Russia is likely to reduce remittance flows, weakening the economic growth outlook.
• Nearly all CEE/CIS sovereigns are net energy importers and will experience higher import bills given the high oil prices. This will increase inflationary pressures and external funding needs. Azerbaijan and Kazakhstan are net hydrocarbon exporters and both benefit from higher oil prices
• Net food importers, even if they don't receive food from Russia, will need to manage higher prices and potential food shortages.
• Perhaps unsurprisingly, CEE sovereigns bordering Ukraine have the highest pressures from refugee inflows.
• The heatmap does not include a number of indirect or second-round effects on CEE/CIS sovereigns, such as slower growth in the eurozone, a key trade partner.

Chart 1

The specter of a sudden halt in gas supplies to CEE sovereigns presents additional challenges. Chart 2 shows that some countries, such as Lithuania, depend entirely on Russia for fossil fuel imports.

Chart 2

How have our key sovereign risk indicators changed?

We continue to update our assumptions as the situation evolves. Table 2 compares our April 2022 Sovereign Risk Indicators with the December 2021 Sovereign Risk Indicators.

For CEE sovereigns, the key changes so far have been:

• Growth revised down to 3.1%, from our previous forecast of 4.7%, due to weaker growth in the eurozone, lower confidence, and higher commodity prices
• Consumer price index (CPI) to accelerate to 8.5%, from 4.4%, because of higher energy and food prices.
• Fiscal deficits to widen slightly to 4.4% of GDP on average, from 4.2%, based on weaker growth and tax cuts. In addition, we expect to see higher spending on refugees, defense, wages, and pensions, causing an upturn in overall expenditure.
• Higher imports and lower external demand to widen the current account deficit to 2.8% of GDP, from 1.4%.

Key changes for CIS, excluding Russia, Ukraine, and Belarus:

• Growth expectations down to 2.4% in 2022, from 3.9%, primarily because of potential spillovers from the recession in Russia, combined with higher inflation hitting households' purchasing power.
• Regional CPI to average 9.9%, instead of 7.2%, based on supply-chain bottlenecks, and higher food and energy prices.
• Higher spending to counter the macroeconomic effects of the conflict will slightly increase fiscal deficits to an average 2.2% of GDP from 1.9%.
• Mainly because of higher oil prices, we now expect the average regional average current account deficit to narrow to 0.1% of GDP, from 1.7%, primarily due to Azerbaijan's much stronger current account position.

Table 2

Appendix

Trade link exposures to Russia

Chart 3

Chart 4

Trade link exposures to Ukraine

Chart 5

Chart 6

Financial exposure to Russia

Chart 7

Chart 8

Writer: Heather Bayly

Digital Designer: Joe Carrick-Varty