As the COVID-19 pandemic and the war in Ukraine drag on, their associated humanitarian, economic, market, and trade implications have roiled the international order. The associated rising political uncertainty and geopolitical risks are radically transforming the world. Such disruptive events and new unknowns can affect funding costs and capital flows, given the deep financial and market interconnectedness of the globalized economy.
The Russia-Ukraine war has resulted in devastating humanitarian costs and consequences, amplified existing inflationary pressures just as many major central banks started to tighten monetary policy, and solidified energy security at the top of the international agenda as sanctions reshape global commodities flows. Credit conditions could significantly worsen if Western economies' sanctions on Russian energy spur additional supply and price shocks, economic growth slows further, or central banks commit policy missteps on the path to rein in inflation and normalize monetary conditions. A repricing of risk that drives up borrowing costs or limits access to funding for global market participants are additional credit risks.
Nations face competing priorities involving security (physical, energy and food), economic efficiencies, and energy transitions. Advanced economies' efforts to diversify their energy imports and reduce their reliance on Russia's fossil fuels, while also maintaining their net-zero ambitions, have the potential to create additional geopolitical tensions. At the same time, nations' widening systemic inequalities and ideological polarization will likely power more nationalistic and populist policies. This could threaten economic efficiency, credit quality, and social stability.
Whether or not the continuing coronavirus crisis is a "black swan" event, the two years of the pandemic thus far have highlighted how, under prolonged pressure, the individual components of the global system can, in a domino effect, expose their foundational cracks and fragilities. The lockdowns implemented to control the spread of the virus—once widespread around the world and most recently in place in Shanghai, China—led to credit rating deterioration for corporates mostly at the lower end of our rated universe. But while governments and central banks' substantial and sweeping fiscal and monetary policy support helped mitigate corporate credit stress and defaults, investors are now facing new rapidly evolving credit risks.
It is unlikely that global policymakers and market authorities will again supply this same type of support under different future circumstances. Their focus, in the immediate term, has shifted to addressing existing pressing conditions with national policies aimed at curbing inflationary pressures and addressing inequalities that are intensified by the surge in food and energy prices.
Because European financial markets have remained fragmented since the Great Financial Crisis of 2007-2008 and endured additional stress during the COVID-caused downturn, the European Union's Capital Markets Union (CMU) aims to increase the bloc's financial stability. Disentangling siloed markets into a single rulebook under the CMU's framework could help generate stronger integration, unify development of debt and equity financing, support small and midsize enterprises, yield greater economic growth, and limit the risks of an additional liquidity and debt crisis in Europe. While the European financial system is largely insulated from the effects of the war in Ukraine due to European financial institutions' limited exposure to Russian markets, the CMU faces challenges from nationalistic economic policies and lagging investment and financial innovation.
For now, the convergence of COVID-19 controls and social-oriented policies have been most evident in China. Stringent lockdowns have further disrupted critical supply chains and slowed economic growth. But China's continued ability to maintain and expand its central role in global production amid surging COVID-19 cases, the war in Ukraine, and its trade tensions with the U.S. underscores the resilience of its export capabilities and the power the country continues to exert on manufacturing supply chains. This comes as the government seeks to accelerate its focus on slowing the aging of its population and achieving a more equitable society, with surprising policy directives and regulations that could remain in place for the next decade—transitioning the world's second-largest economy into a new stage of development after years of expansion largely driven by debt-fueled investment.
Emerging markets and low-income economies—particularly those with less predictable institutions—find themselves more exposed to risks of social unrest and political instability, as capital flows react to the U.S. Federal Reserve's monetary policy tightening and the cost of living suffers from the inflationary implications from the Russia-Ukraine war.
According to our latest analysis, Egypt, Jordan, Lebanon, Morocco, and Tunisia face the greatest risks of income inequality and worsening sociopolitical and fiscal dynamics in the Middle East and North Africa from the conflict's effects on rising food and energy prices and supply insecurities—given that these five countries spend 4%-17% of their GDPs on energy and food imports and have high levels of youth unemployment. To soften the setbacks to consumers and producers and prevent social discontent, we expect governments in these countries will try to cover some of the costs of higher prices with fiscal measures. This will ultimately put pressure on their post-pandemic fiscal consolidation.
In the longer term, banks in emerging market economies overall may be particularly susceptible to the spillover effects of changing investor perceptions or risk-reward recalibrations. Financial institutions that are engaged in confidence-sensitive foreign short-term borrowing and that hold a material proportion of these countries' external liabilities will be most at risk.
If the first half of this year has been defined by disruption, the next six months will likely be shaped by increased fragmentation and ongoing reorientation. As geopolitical shifts develop, the resulting global system may emerge as more fluid and flexible—but ultimately more divided and unstable.
This report is part of S&P Global Ratings' "A World Redefined" 2022 research focus.
Related Research
On RatingsDirect
- Economic Research: Food Price Shock Reverberates Through MENA Economies, May 26, 2022
- What Last Year's China Policy Surprises Mean For The Future, May 19, 2022
- Economic Research: How The Capital Markets Union Can Help Europe Avoid A Liquidity Trap, April 15, 2021
On S&P Global websites
- A World Redefined
- Special Report: Russia-Ukraine Macro, Market, & Credit Risks
- G20 members' views on Russia diverge, making expulsion unlikely, May 23, 2022
- The EU Capital Markets Union: Turning The Tide, Feb. 25, 2020
This report does not constitute a rating action.
| Primary Contact: | Molly Mintz, New York; Molly.Mintz@spglobal.com |
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