China is no match for Russia when it comes to political shock to markets

If China’s regulatory crackdown had markets worried, it is nothing compared to the impact of Russia’s war in Ukraine
Hardest hit is Russia itself, where harsh sanctions have sent the rouble into free fall, but central banks everywhere will have to confront the risk of stagflation

Nicholas Spiro

Published: 10:00pm, 3 Mar, 2022

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As recently as October, prominent fund managers were warning that China had become “uninvestable”. The ferocity of Beijing’s assault on private enterprise, targeting sectors ranging from technology to education and video games, prompted billionaire financier George Soros to denounce Chinese president Xi Jinping as “the most dangerous enemy of open societies”.

Any investor buying into a rally in Chinese stocks, Soros argued, faced “a rude awakening”. There were even fears that the rapidly escalating liquidity crisis at China Evergrande Group, the world’s most indebted property developer, was a “Minsky moment”, akin to the collapse of Lehman Brothers which triggered the 2008 global financial crash.

Long-standing concerns about the regulatory and governance system in China have become more acute, amplified by the government’s deleveraging campaign in the property industry, which continues to pose a severe threat to China’s economy and markets.

Despite signs of a shift towards looser policy in recent months, the average yield on a gauge of junk-rated dollar-denominated Chinese bonds – which is dominated by real estate developers – stands at a prohibitive 20 per cent, leaving developers shut out of offshore funding markets.

Yet, while China’s capacity to shock increased sharply last year, Russia’s ability to startle global markets is of a different order of magnitude. The unexpected decision by Russian President Vladimir Putin to launch a full-scale invasion of Ukraine has caused a humanitarian crisis and opened up a Pandora’s box of geopolitical, financial and economic troubles that are far more consequential for the world.

Not only does Putin’s renewed aggression towards Ukraine pose the gravest threat to the post-1945 international order, it presents an acute challenge to global policymakers in their efforts to quell the post-pandemic surge in inflation without damaging the recovery.

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How international sanctions imposed since Ukraine invasion are hitting Russia

China’s much bigger share of the world economy and emerging market stock indices – the country accounts for 14 per cent of global GDP and 32 per cent of the benchmark MSCI emerging markets index versus Russia’s 1.7 per cent and 3.2 per cent respectively – make the spillover effects of a shock in the country more dangerous. Yet, Russia’s position as a commodities powerhouse and the nation that has brought war back to Europe has the potential to have a far-reaching impact on the global economy and markets.

The worldwide repercussions of a large-scale military conflict involving a major energy exporter – Russia is Europe’s main supplier of gas, one of the world’s biggest oil producers and a dominant player in the wheat, aluminium and palladium markets – are just beginning to be felt on trading floors.

The immediate, and most devastating, impact is in Russia itself. While investors were taken aback by the dramatic declines in the shares of Chinese companies listed in the US last year, the turmoil pales in comparison to the scale of the damage to Russia’s economy and markets caused by the West’s swingeing retaliatory sanctions.

In the space of just several days, Russia has been driven to the fringes of the Western-dominated financial system, crippled by harsher-than-expected sanctions that freeze most of the nation’s foreign reserves and eject several of its banks from the Swift global payments network.

The rouble has plummeted 46 per cent against the US dollar since February 16, capital controls have been introduced, Russian stocks and bonds face being kicked out of global indices and markets are signalling a 65 per cent chance of default within five years, data from Bloomberg shows.

A demonstrator holds a poster reading “Ban Russia from Swift” during a protest against Russia’s invasion of Ukraine, in Vienna, Austria, on February 26. Photo: AFP

In China, the issue of investability continues to split opinion. In Russia, there is no longer a debate. The country’s markets have not only become entirely uninvestable, the sanctions themselves pose a major threat to the global economy.

Although the penalties do not yet target Russia’s vast energy sector, demand for Russian oil has collapsed as many large consumers boycott the market. On Wednesday, Brent crude, the international benchmark, surged to an eight-year high, while the prices of other commodities, notably wheat, hit their highest levels in at least a decade.

For the world’s leading central banks, the fallout from Russia’s invasion of Ukraine is much more dangerous than the collateral damage caused by the regulatory and economic uncertainty in China. The war has sparked renewed fears about the outcome policymakers are most eager to avert: persistently high inflation and weaker growth.

Why China is the better bet, even as US Fed raises interest rates

The conflict has let the stagflation genie out of the bottle. As I argued previously, fears about growth are intensifying, causing investors to unwind their bets on interest rate increases. Despite mounting commodity-fuelled price pressures, traders are now pricing in five US rate hikes this year, compared with seven before the war began.

While the Federal Reserve faces an acute dilemma over how aggressively it should tighten policy amid increasing economic uncertainty, the European Central Bank is in an even bigger bind. Although inflation is likely to keep rising, the risk of a growth shock is much greater in Europe.

No corner of the global economy and markets has been left untouched by Russia’s attack on Ukraine. Even other geopolitical flashpoints are now seen through the prism of the war. Investors have turned more bearish on Taiwanese stocks because of concerns over increased tensions between Taipei and Beijing. When it comes to geopolitical shocks, Russia is in a league of its own.

Nicholas Spiro is a partner at Lauressa Advisory