Caught up in the stream of constant news updates about the conflict in Ukraine, one thing seems to be certain so far: although various predictions about the potential end of the war keep emerging, the conflict itself is constantly evolving with both major factors and minor details making its outcome all but predictable, and its timeline even less so.
The same logic, i.e. “nothing is over and the existing issues and dangers are potentially deepening”, also applies to numerous other effects of the war and their impacts on the global economy and business.
Russia’s blockade of Ukraine is fueling the looming risk of a global food crisis and will reportedly have “ominous consequences”, with over 100 million more people unable to meet their food needs. Such a crisis and disruption of a basic commodity supply chain of course threaten many of the world’s food producers who depend on Ukrainian grain and oil-seed supplies.
Furthermore, both local and global energy markets, particularly in Europe, are bracing for what will most likely be one of the most challenging winters in recent history.
While European countries have, over the last couple of months, come to grips with the realization that transforming their energy supply mix is an absolute necessity in the face of their dependence on fossil fuels provided by an aggressor with imperialistic ambitions many had deemed to be a relic of the past, and one who is currently threatening to completely disrupt the European gas market, such a transition is going to take years and will present a significant challenge.
Meanwhile, both businesses and households are facing severe budget limitations as their energy costs increase significantly, presenting many of them with an existential threat. A second wave of refugees from Ukraine is looming large as the energy crisis deepens. And just to pour some oil on the fire, a recession might be awaiting European economies due to the energy crisis and their “highly integrated supply chains”.
And with energy demands staying high regardless of the weather and supplies severely limited or at risk of being disrupted completely, governments and businesses are urging their citizens to save energy while being pushed to quickly prepare and enforce contingency plans and solidarity agreements crucial for securing a basic supply of heat and energy in the coming months.
Yet these are just two examples of the immediate challenges businesses have to face, with many more commanding the same level of urgency. The corresponding political risks threaten to impact not only specific markets but our overall understanding and perception of long-established processes in a globalised economy.
Today, we delve into some of the political risks associated with the war in Ukraine, and their potential consequences for Europe.
Resources as political weaponry
Countries have often capitalised on their natural resources to achieve economic growth and finance their public budgets. Yet while the idea of utilising market dominance in various areas to pursue political goals is not entirely new, the scale on which Russia may potentially exploit its resource dominance on the CEE market certainly is. Regardless of whether the aim is to cause economic hardship to perceived enemies or create political tension within their public spheres observing their lowering living standards, governments and business alike will have to adjust.
Although global markets have been long used to experiencing shocks associated with political actions (e.g. the OPEC oil embargo in the 1970s), they have become increasingly more interconnected and globalised over the last 40 years. This vulnerability is clearly visible considering the EU’s dependence on Russian gas supplies. While the bloc is trying to impose various sanctions on Russia, its representatives, and its businesses on one hand, on the other hand many countries still have to pay vast sums of money to Russia in order to secure gas supplies, thus indirectly funding Russia’s war efforts.
Even that is not entirely new, as Russia has used its gas supplies as a political weapon before. But the evident effects such a tactic has been having on European societies, businesses and governments threaten to embolden Russia to expand this strategy to other commodities as well.
Russia is the second largest exporter of raw aluminium, which is a crucial commodity for numerous industries including car manufacturing, packaging or electronics. Similarly, Russia (together with Ukraine) makes up almost 40-50 % of the world’s neon exports, essential to the production of semiconductors. And the list goes on – other commodities where Russia is a major exporter include palladium, gold, iron, nickel or copper, and while Europe’s dependency here might not be as severe as it is in the case of natural gas, the targeted disruption of supplies by the Russian government could further increase supply chain and production difficulties for many European industries.
It is evident that Russia has a large arsenal of economic weaponry at hand to wreak havoc on the rest of Europe. By fueling the stagnation or recession of European economies, such an approach also brings about risks for the political stability of the CEE region.
Sanctions compliance, supply chain management and corruption risks
With regards to the ongoing war, Western countries essentially have two main ways of supporting Ukraine – either through direct aid by providing weapons, financial or other material resources, or by imposing sanctions on Russia in order to put pressure on its economy.
The EU has been at the forefront of the sanction efforts and already imposed six increasingly strict sanction packages (as of July 4, 2022). Numerous countries have been imposing their own sanctions with varying levels of seriousness, scope of impact and relevance.
Affected businesses are then trying to keep up with all of the relevant sanction regimes, with new sanctions being added virtually every week. This presents a major legal and supply chain challenge – as mentioned above, Russia is a crucial supplier of numerous commodities, and the race to replace Russian suppliers might result in either a bidding war for supplies from other territories or in driving companies to devising elaborate schemes to evade the sanctions, none of which help the overall goal of reinforcing our economies against Russian influence. Some companies from the energy sector even openly admit they will circumvent EU sanctions and meet Russia’s demands.
Furthermore, companies located in territories neutral to or uncritical of Russia’s actions can secure a significant competitive advantage as they will get privileged access to Russia’s key commodities. This is already happening on the government level, e.g. in the case of Russia’s crude oil; as the EU banned Russian imports, India moved to fill the export gap. To some degree, such a development represents another palpable political risk; the fragmentation of the global economy into several competing blocs. What started primarily with the tariff battle between the USA and China could turn into increased isolation of the pro-Ukrainian group of (mostly Western) countries from the rest of the more neutrally-positioned world and with it, the access to its low-wage labour production capacities.
Chaos breeds corruption
Companies’ motivation to stay in business in the face of rising costs, supply chain disruption and ever-present uncertainty also increases the risks of the emergence of corruption, whether in Russia itself or elsewhere.
While the responses of the EU and NATO to the war in Ukraine have been somewhat unified on the international level (with some exceptions), both the public and the political spheres within numerous countries are divided between pro-Ukrainian and pro-Russian attitudes.
Therefore, it is hardly surprising that various companies, politicians and other organised groups are already likely exploiting the opportunity to maintain or form new relationships in Russia, and aid Russian oligarchs and businesses or its government representatives, whether by helping to move or hide their assets, providing access to the Western financial system or fueling the disinformation war by either relativising the current situation or speaking out on behalf of Russia outright.
The viable path ahead
The political risks associated with the war will shape the CEE business environment for years. Whether directly or indirectly affected, companies should revise their risk management approach and factor in these political risks that have been mostly overlooked for the past 30 years.
At PRINCEPS, we specialise in providing expert insights concerning political risks in the CEE region. We leverage our access to trusted stakeholders to provide our clients with unparalleled insights into local developments. These systematically analysed insights protect our clients from threatening risks and help them make the right decisions in high-stakes situations.
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