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

LAST week, what many did not expect to happen happened. On the morning of Feb 24, Russian President Vladimir Putin declared war on its neighbour, Ukraine. While tensions had been simmering for some time now, many did not expect them to morph into a full-blown war.

When news of the Russian invasion broke, the resultant knee-jerk reaction in commodity markets came as no surprise.

At 8pm on Feb 24 local time, Brent crude oil had reached US$104 a barrel, crude palm oil (CPO) was at a new record high of RM6,458 a tonne while palladium hit US$2,610.18 an ounce. Wheat futures contracts on the Chicago Board of Trade were US$9.34 a bushel on the morning of Feb 25.

Russia and Ukraine account for about 30% of the world’s wheat exports. The former is the world’s third-largest producer of crude oil and the second largest in the production of dry natural gas.

The spike in commodity prices is one obvious impact of the war, but many are now concerned about what will happen to global economic recovery, which is still in a fragile state after emerging from two years of pandemic-induced movement restrictions.

According to UOB Research, Russia’s nominal GDP stood at US$1.48 trillion in 2020, about 1.7% of global GDP. This is far smaller than those of its Western European counterparts, the research house points out. The direct impact of the war on the global economy is therefore expected to be manageable.

Nevertheless, Lee Heng Guie, executive director of the Associated Chinese Chambers of Commerce and Industry of Malaysia’s Socio-Economic Research Centre (SERC), says the harsh sanctions on Russia have the potential to do huge damage to Europe.

“European countries buy 25% of their oil and nearly 40% of gas from Russia. The country is the world’s largest supplier of wheat and, together with Ukraine, accounts for nearly a quarter of total global exports,” he adds.

“Russia also exports a large quantity of industrial materials and minerals such as nickel, aluminium, platinum, steel, copper and palladium. Their prices are expected to surge on concerns of supply disruptions. Crude oil prices could rise to US$125 to US$150 a barrel.”

At this juncture, UOB Research does not think the conflict in Ukraine and the sanctions imposed on Russia will result in a global recession.

“It is worth noting that European countries have little incentive to further escalate the crisis, as record-high energy prices are already hurting consumers across Europe. Even then, any action is unlikely to cause a major dislocation to the global economy or result in a global recession, given Russia’s relative position in the ranking,” it says.

While a recession could be out of the question at this point, the question of how much it would affect growth cannot be ascertained.

OCBC Bank economist Wellian Wiranto believes that the impact on global economic growth will very much depend on the outcome of the war.

“If it stays contained, the impact should be more muted. But the risk of broader conflagration that could drag in the other major powers cannot be discounted altogether at this point. If that scenario plays out, growth momentum will undoubtedly take a hit due to confidence issues,” he says.

War is not a great recipe for global demand recovery, says an economist with a bank-backed research house.

“But our base case doesn’t see Russia or Europe/US interests heading for a drawn-out conflict, which keeps the initial growth shocks to the conflict zone, with manageable ripple effects on Malaysia via financial market and commodity price volatility.

“The recent response to Russia’s incursion and sanctions suggests that the US and its allies are careful about committing themselves to another war. The risk here is if it emboldens other nations to engage more aggressively in territorial or geopolitical disputes, for example, China-Taiwan or North Korea-South Korea.”

With central banks around the world preparing to raise interest rates this year, the conflict between Russia and Ukraine could cause them to approach things more carefully, given the uncertainties.

“The Russia-Ukraine conflict has provided central banks in advanced economies, particularly the US Federal Reserve, with a further headache as they ready to unwind the liquidity support and tighten interest rates to tame inflation risk,” says SERC’s Lee.

For Malaysia, apart from the ripple effects on financial market and commodity price volatility, the impact is expected to be muted. In terms of direct trade links between Malaysia and Russia and Ukraine, it is limited, says Wellian.

“Thus, any disruption in trade flows is unlikely to move the needle much for Malaysia’s trade and balance of payment (BOP) numbers. Still, the escalation in tensions came at a time when global market risk sentiment already feels battered by the prospect of a more hawkish US Federal Reserve; thus Malaysian assets may feel the bite too, at least in the near term.”

Russia is Europe’s largest energy exporter, while the region has to import 40% of its natural gas and 25% of its crude oil.

In the event that sanctions and military action lead to disruptions in Russia’s oil production, the consequences will be significant for the energy market. The country is the third-largest oil producer in the world after Saudi Arabia and the US, producing 11 million barrels a day.

Despite surging past the US$100 level, oil prices are still trading 25% lower than their peak a decade ago. This, coupled with the strong demand outlook, is likely to keep oil prices at elevated levels, says DBS chief economist Taimur Baig.

In view of the attractive energy prices, the market could see more production from US shale oil producers.

The Ukraine crisis is also threatening the supply of sunflower oil, which, in turn, will benefit rivals CPO and soy oil, as the Black Sea region accounts for 60% of world’s output of sunflower oil. CPO prices hit RM7,000 a tonne for the first time last week.

“While we make no changes to our CPO price assumptions for now, given the fluid scenario, we believe that as prices move up further, valuations will come down to even below ESG-dampened discounted levels,” RHB Research said in a note last Friday.

As Russia and Ukraine are big exporters of wheat, the conflict will have a considerable impact on the broader commodity complex, owing to the substitution effect, says OCBC’s Wellian.

“The extent to which it results in an uptick in food inflation will ultimately depend on the duration and scale of the war. While there remains hope for some sort of diplomatic resolution, the flipside scenario is distinctly possible too. In that case, the effect on Asia may be keenly felt.”

He stresses that price pressures are relatively far more contained in emerging markets than the developed world. However, this may change rapidly if food prices continue to run up, because of the higher weightage of food items in consumption baskets.

Commodity prices are expected to increase as a result of the war. What does this mean for Malaysia?

Bank Islam chief economist Dr Mohd Afzanizam Abdul Rashid believes that the higher Brent crude prices will be a boon for the country’s coffers but that the fuel subsidies may neutralise the benefits of higher oil prices. On the other hand, CPO, which is currently hovering above RM6,000 a tonne, will enhance the overall net benefit to the country, he says.

Nevertheless, Wellian warns that while Malaysia, a net commodities exporter, could benefit from higher commodity prices, “there is no such thing as a free lunch”. A sustained uptick in commodity prices could result in denting global demand, he explains. This would then prove to be a bane for the country, especially if coupled with rising food and energy prices domestically.

Global supply chains could see further disruption, given the escalating commodity prices. Lee says this would continue to drive up business costs and consumer inflation that could deeply hurt companies’ margins and crimp consumers’ purchasing power, especially in economies that are still recovering from the body blows inflicted by the pandemic.

As for gold, although the near-term technical analysis points to some upside, UOB Research’s fundamental view on the precious metal remains neutral as further strength in the commodity may not be sustainable, given the projected 150 basis-point hike in the US federal funds rate this year.

Gold spot prices soared to a high of US$1,974 an ounce last week before paring gains to US$1,902 last Friday.

As expected, global markets were thrown into turmoil last week when the Russian invasion started.

Given that the risk-off sentiment is not causing worldwide mayhem, DBS’ Taimur is not too worried about adjusting its portfolio. “Generally, a 2%-to-3% decline in global markets is not something we should worry too much about,” he said in a webinar last Thursday.

“If you look at the history of financial markets, conflicts by and large have not led to sustained market corrections. Conflicts tend not to last a very long time, unless you talk about low-level conflicts like in Afghanistan.”

Alexander Chia, head of research at RHB Research Institute, highlights that a limited conflict could be an opportunity for investors to accumulate holdings in value stocks and recovery plays. “We do not believe Russia intends to be an occupying force amid a hostile Ukrainian populace and risk extensive Western economic sanctions,” he said in a research note last Friday.

In the near term, he expects a shift to defensive sectors such as consumer, healthcare, utilities, basic materials and real estate investment trusts, and resilient high-dividend-yielding stocks.

HLIB Research sees trading opportunities in stocks with oil and gas upstream exposure to higher oil prices, with Dagang NeXchange Bhd being the top pick. The plantation sector is poised to benefit from supply disruptions to sunflower oil as well.

SERC’s Lee says risk-averse investors would seek shelter by moving into or buying safer assets, increasing demand for US Treasuries, the US dollar, the yen and gold. As a result of the flight to quality assets, the ringgit will take a hit against the greenback as investors lighten their portfolios of emerging-market assets in times of uncertainty, he adds.

“Nevertheless, given that foreign investors have lowered their holdings of domestic equities relative to Malaysian bonds, the impact of financial volatility on the domestic stock market will be manageable compared with the bond market,” he says.

Asian markets rebounded last Friday. The FBM KLCI rose 17.83 points, or 1.1%, to end the week at 1,591.72 points.  

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