Outside Ukraine and Russia, markets are failing to factor in the likelihood of an escalation of the conflict in Ukraine. But some economists and politicians are warning that the result could see Czech economic growth halved or even wiped out altogether this year.
There is a pretty prevalent perception in the business world that market reactions to events are a good guide and gague of what is going on. Some might, perhaps arrogantly, argue that they are the only real reaction that counts.
The perception is that if something does not figure on the seismograph of market trading, be it bonds, shares, commodities, whatever, then it is not really happening or its significance should be downplayed. The premise is that the market knows best, has all the facts at its fingertips, and the traders facing multiple terminals at the same time and pushing tens of millions of assets here and there are making the right calls.
Scottish historian Niall Ferguson made a pretty big dent in the market knows and evaluates best argument by pointing out that bond values in several European countries did not falter in the run up to World War I in spite of the series of moves which made the likelihood of a major war ever more likely. But, to borrow from the title of a recent book on the subject, the participants sleepwalked into the conflict and even those fearing the worst hoped it would be over by Christmas.
Bond prices are taken as a pretty good indicator of overall risk since they are a measure of the state’s ability to repay its debt, or perhaps in the final analysis still being around at the end of a conflict to be paying off its creditors.
So what about Ukraine? The fact that the country has already been partially dismembered and could be coming in for more of the same, accompanied by possible invasion and civil war, makes it a risky investment. This is reflected by the fact that the yield, or return, on Ukrainian bonds reverses the normal upward curve by falling over the long term. Ukrainian government bonds expiring in just over a year’s time in mid-2015 have a yield of just over 14 percent, but those due in 2023 have a return of just over 10 percent.
Part of the market message here is that the risks are higher in the short term but might get sorted out with more time with Ukraine expected to be around in some form a decade down the line.
Russia has seen a flight of capital outside the country, markets and the rouble have plummeted, economic growth is expected at under 1.0 percent this year, and the country’s credit rating is being cut by the worldwide agencies.
And the impact of a broader Ukraine conflict on the Czech Republic and rest of Europe? Well, Czech economic analysts say this is not really factored in at the moment in bond or share prices. The current sanctions against Russia are so weak as not to be worth remarking on by either side and the main risk is that Moscow will turn off Europe’s oil and gas supplies. But with summer approaching, and national energy stores usually full for at least 100 days, that should not have an immediate impact.
But an escalation in Ukraine clearly would have an impact on economies whether that it currently factored in on market prices or not. Czech Minister of Industry and Trade Jan Mládek said some time ago that a sustained conflict could knock 0.5 percentage point off Czech GDP growth this year. Some economists say it could easily be double that or more. Czech exports to Ukraine are fairly minimal but those to Russia are significant at around 116 billion crowns and are often in areas such as heavy engineering which will not be getting the hoped for boost from the contract to expand the Temelín nuclear power plant.
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