This article first appeared in Forum, The Edge Malaysia Weekly on February 28, 2022 - March 6, 2022

Financial markets are right to be nervous about the Ukraine crisis and what it might mean for our part of the world. No one knows at this juncture just how the crisis will unfold but the portents are not good. So, while Europe may seem very far away, the likelihood is that there will be unpleasant consequences for Southeast Asia’s economies. Risks to economic growth will be higher but because inflationary pressures will also intensify, policymakers will face more challenges in achieving an optimum balance. Moreover, the tensions in Europe reflect a broader political deterioration — in the more insecure world we now live in, Asian nations will have to divert more resources away from productive uses to national security.

It is impossible to determine for sure what Russian President Vladimir Putin is seeking and how far he will go to achieve that. But the hard facts point in an ominous direction. The US government claims that Russia has deployed between 169,000 and 190,000 soldiers in regions bordering Ukraine — that’s roughly a fifth of its total military strength.

Russia has also formally recognised as independent states the two regions in eastern Ukraine that it helped to break away from Ukraine in 2014. Claiming that Ukrainian forces had attacked these Russian allies, Putin has also ordered his troops to enter these regions to act as “peacekeepers”.

Some fighting and shelling have already been reported along the frontlines between the breakaway regions and the rest of Ukraine.

(Editor’s note: On Thursday morning, Russian forces began a military assault on Ukraine, entering the north south and east of the country, according to news reports.)

Late last year, Putin’s government put forward a series of demands to the US and its European allies in relation to this crisis, many of which were demands that the Western allies would find difficult to accede to.

In recent days, efforts to set up a meeting between US President Joe Biden and Putin have failed, leaving little scope for a diplomatic settlement. In essence, it does not look as if Russia can achieve what it wants except through some form of military force. It is difficult to imagine that after all this military effort and political subterfuge and without its demands being met, Russia will simply stand down. The more likely outcome is that, sooner or later, Russia’s military operation against Ukraine will be an extended one. This confrontation will probably not be just a short, sharp bout of fighting. Once there is fighting, the US and its allies across the world will impose wide-ranging sanctions against Russia. So, there will be a hot war in Ukraine and a broader economic confrontation as well.

In the event of conflict, there are several channels through which Asia’s economies will be impacted.

The first and immediate impact will be ructions in global and Asian financial markets. The corrections in equity prices and currencies in recent weeks tell us that markets have been pricing in part of the higher risk but the extreme volatility in markets also indicates that probably not all of that risk is priced in.

Certainly, investors’ risk appetites will diminish and many will seek safety in safe havens such as US dollar assets like Treasury bonds while they cut holdings in riskier assets. There will be outflows from equities and bonds in emerging markets.

More than that, weaker companies attempting to refinance debt that is coming due this year will struggle to do so. In addition, in a more risk-averse setting, investors will be looking more rigorously at many companies that were funded during the heyday of easy money — those who cannot prove that their business models are viable may find it harder to sustain funding for their loss-making ventures. Many such companies may go to the wall as a result.

The second impact will be in commodity markets. Russia and Ukraine are important commodity producers. Russia’s share of world exports of several key commodities is high — close to 20% of natural gas, 12% of oil, 17% of wheat, 12% of aluminium and 8% of copper. Russia is a dominant producer of palladium, with a 40% share of mining output as well as a major producer of platinum (10% of output). It is the world’s third largest producer of gold. On its part, Ukraine has a 12% share of wheat exports. In other words, there is little doubt that prices of these commodities, which have already spiked in anticipation of the crisis, will remain elevated. If supplies of some of these commodities are disrupted by the fighting, then supply chain dislocations that have hurt, for example, the production of autos and semiconductors could worsen.

The third impact will be on global growth and inflation. The rise in oil prices is the greatest single danger. Oil prices have risen around 23% so far this year, mostly as a result of concerns over Ukraine. If this level is maintained for most of this year, it could shave 50 basis points off global growth in 2022. In addition, higher food and energy prices will raise headline inflation everywhere, hitting lower-income groups the hardest. Since inflation has already been rising in the past year, developed economy central banks will have to tighten monetary policy by raising interest rates — even though economic growth was at risk.

Asia could also be affected indirectly by Western sanctions on Russia even though the direct effect may not be substantial. These sanctions could aggravate the US’ difficulties with China and result in more American trade aggressiveness against China, which could spill over and hurt Asia. China has a complicated relationship with Russia. China is not a fan of countries blatantly invading other countries. In 2014, China made it clear that it was not entirely comfortable with Russia’s takeover of Crimea, then part of Ukraine. But in recent years, as China’s relations with the US worsened, it has moved closer to Russia. A joint statement issued earlier this month by the two governments made clear that China sympathised with Russia’s concerns over Ukraine. When it comes to the crunch, China may feel compelled to provide some help to Russia to overcome Western sanctions. Anticipating this, US National Security Advisor Jake Sullivan has already warned China that “if China is seen as having supported it (that is, a Russian invasion of Ukraine), it will come at some costs to China”. The American political establishment has already grown hostile to China and does not need much more persuasion to step up protectionism against China should the crisis in Ukraine deepen.

The US’ rivals around the world will be watching how Biden and his allies respond to a Russian attack on Ukraine: If the response is deemed to be weak or ineffectual, there is a danger that these rivals might be encouraged to use the opportunity of a US distracted by a crisis in Ukraine to pull off some provocation or other. Where are the potential flash points?

•     In an earlier column, we argued against the belief that a successful Russian invasion of Ukraine would encourage China to move against Taiwan. That remains our view. However, this does not preclude the possibility that China would step up its pressure on Taiwan by other means while the US was preoccupied with a Ukraine crisis. It might intensify the deployment of fighter jets into Taiwan’s air defence identification zone. Or it might start harassing Taiwan as it supplied its troops deployed in faraway islands such as the Pratas Island group.

•     North Korea has already increased the frequency of its missile tests. It may see a Ukraine crisis as an opportune time to conduct a nuclear test or a test of a long-range missile capable of reaching the US mainland — two areas it has been careful to avoid since 2017. Our sense is that there is a good chance of some kind of North Korean action.

But not everything need go wrong. In recent weeks, there has been progress in securing a revised agreement between the US and its allies on one side and Iran on the other. The US may well decide to cut a deal with Iran on its nuclear programme so that it can concentrate on addressing the Russian challenge.

Pulling all this together, the net effect on Asia cannot be good.

•     First, as global growth slows, Asian exporters will find that demand for their products will be lacklustre. The manufacturing sectors in the region may therefore suffer a slowdown. There will be some positive effects on growth as the Omicron wave of infections dissipates and as countries open up — tourism is set to recover, for example. But these gains may be offset by the reverberations of the Ukraine crisis.

•     Second, the rise in commodity prices may not benefit the Asian economies since most of them are not huge net exporters of oil, natural gas, metals such as palladium or wheat. The prices of commodities that matter to Asian economies — rice, crude palm oil and rubber, for example — are not likely to enjoy the same run-up as the prices of commodities they import. Indonesia may gain a bit from higher prices for copper and nickel but would lose more from the higher cost of energy imports.

•     Third, there would be higher financial risks. The World Bank reports that 74 low-income nations will have to repay about US$35 billion (RM147 billion) to official bilateral and private-sector lenders in the course of 2022. In Asia, one of the most vulnerable countries is Sri Lanka. However, the many Chinese property developers who have bonds that are maturing may find it hard to do so given the diminished risk appetites.

•     Fourth, central banks in the region will be in a quandary on calibrating monetary policy given the slower growth and higher inflation we expect. As financial markets are expecting them to tighten policy after two years of low rates and easy money, delays in doing so may result in pressures in currency markets.

•     Fifth, there will be political implications. Over the past years, big powers have violated international norms with impunity, whether it was the US invasion of Iraq or Russia’s actions in Ukraine and Georgia. A successful Russian attack on Ukraine would aggravate the weakening of these norms that have made the world safer for smaller and less powerful countries. Faced with growing big power contestation right in its heartland, Southeast Asian countries will have to think hard about how to respond. At the very least, they will have to radically increase their defence spending so as to strengthen their capacity to deter big power bullying. But higher spending on defence, security and intelligence means less to spend on building infrastructure or on educating children and so on.

In short, investors and businesses will have to be prepared for a rough ride in the next few months.

Manu Bhaskaran is CEO of Centennial Asia Advisors

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.