How Might war in Ukraine Affect Emerging Markets?

Ukraine Crisis

We have all heard the adage that a butterfly flapping its wings in the Amazon could affect the weather patterns on the other side of the planet. Might the war in Ukraine also have such unintended consequences, Les Nemethy asks?

While I despair at the scale of the humanitarian disaster in Ukraine, this article explores unexpected and unforeseeable effects beyond its borders, including the possibility of more people dying of starvation in other parts of the world than as a consequence of military action in Ukraine.

The three main possible transmission mechanisms for this butterfly effect include (a) disruption of supply chains, particularly in agriculture; (b) energy supply disruptions; and (c) monetary effects. These trends often reinforce each other. All were already underway before the war, which seems to aggravate and catalyze these effects.

Supply Chain Disruption

Global supply chains were already under strain, independent of the Ukrainian war, partly due to COVID-19. For example, 30% of the world’s containers are now at a standstill, waiting around ports, many of them stuck near Shanghai, locked down by COVID.

The war adds a significant additional dimension to the supply-side challenges, particularly related to agriculture. As the chart below shows, Russia, Ukraine and Belarus account for a substantial percentage of production of the leading agricultural commodities.

To make matters worse, a substantial percentage of the above-mentioned exports go to emerging markets. Countries such as Lebanon and Egypt (the world’s largest importer of grain), as well as the entire sub-Saharan region, are highly dependent on Russian and Ukrainian exports. But it also impacts the microchips sphere. Did you know that two Ukrainian factories supplying neon for the lasers that make microchips were closed due to the war?

Energy Supply Disruption

The war has further reinforced tightness in oil and gas markets, which has had a considerable effect on hydrocarbon prices globally, particularly in Europe. Given that ammonium fertilizer is made using gas and almost 40% of global potash exports come from Russia and Belarus, the world will see a sharp reduction in use in 2022. Many producers of ammonium, including the largest in Hungary, have stopped production altogether due to the volatility of energy prices.

If farmers don’t use fertilizer, they will see their yields fall; if they do use fertilizer, they will have to pass through input costs. Either way, the pressure on agriculture prices will accelerate. Although there have already been massive increases in agricultural prices, in my opinion, this process still has a long way to go.

Energy price increases also have a negative impact on GDP growth and a general inflationary effect. Most post-war recessions coincided with energy price increases.

Monetary Effects

The aforementioned supply chain issues and commodity price increases have contributed to accelerating inflation. This, in turn, has mobilized several central banks towards monetary tightening.

Much has been written about the difficulty central banks will have in reducing inflation without causing a recession while they target the fabled “soft landing.” Never have current inflation levels been cured without inducing a recession.

The ongoing problems of COVID (and associated lockdowns) and the Russo-Ukrainian war (and associated sanctions) further complicate central banks’ efforts to take the camel through the eye of a needle.

Jerome Powell, chairman of the U.S. Federal Reserve, has announced his intention to carry out what would amount to the most severe monetary tightening since the early 1980s. This would likely see 10-year Treasuries rise from under 3% to well over 5%.

Whenever the United States raises interest rates, emerging markets suffer greatly, as they are forced to raise interest rates by at least as much to avoid capital outflows. Many emerging countries have already been forced to raise interest rates substantially, and, once again, in my view, the trend will go further.

Servicing debt is becoming increasingly difficult. Sri Lanka has already defaulted. Pakistan and Peru, also highly indebted, have experienced outbreaks of violence or mass protests.

Emerging market banks are highly exposed to sovereign debt (usually through bonds issued by their own national governments):

As bond yields rise, government bond prices plummet, impairing banks’ Tier 1 capital. A vicious circle may ensue. Weaker banks will lend less, contributing to the contraction of the economy.

Unfortunately, the average person in emerging countries already spends a huge percentage of their income on foodstuffs and owns very few assets that might help withstand inflation. It is the average person who will feel the brunt of the phenomena discussed in this article. Remember that it was food shortages that triggered the Arab Spring roughly a decade ago.

The butterfly effect is hard to prove, but over time, the war may actually cause more deaths from starvation in the world’s poorest countries than conflict deaths in Ukraine itself.

Les Nemethy is CEO of Euro-Phoenix Financial Advisers Ltd. (, a Central European corporate finance firm. He is a former World Banker, author of Business Exit Planning (, and a previous president of the American Chamber of Commerce in Hungary.

This article was first published in the Budapest Business Journal print issue of May 6, 2022.

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