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European Economics Daily: European exposure to tensions between Russia and Ukraine
27 March 2014 09:14:44
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Goldman Sachs Global
Macro Research
European Economics Daily: European exposure to tensions
between Russia and Ukraine
Published March 27, 2014
European News: UK debates EU membership
UK airs TV debate on EU membership. Yesterday, the UK's Deputy Prime Minister,
Nick Clegg, debated with Nick Farage MEP and leader of the euro-sceptic UKIP the
merits of EU membership. The initial poll reaction to the TV debate suggests Mr
Farage's anti-EU stance was considered the more persuasive by a significant margin
of 57% to 36%, with 7% undecided (see here for our discussion of UK membership
of the EU).
Focus: European exposure to tensions between Russia and Ukraine
Bottom line: The direct economic exposures of EU countries to tensions in the Crimea look
manageable. But an escalation of the tensions that threatens to create systemic risk would
obviously be a cause of greater concern. This would imply a very different macro outlook.
As yet, political responses on both sides have attempted to steer away from such an
escalation. Yet experience demonstrates that politics can sometimes take an economically
irrational course, particularly when issues of sovereignty, security and national pride are at
stake.
As tensions mount between Russia and Ukraine, attention has focused on the vulnerability
of the European economy to the ongoing stand-off, and its potential wider political, economic
and financial ramifications.
The channels of transmission to the European economy are numerous and complex.
At one end of the spectrum of possible outcomes, the impact on European activity is limited
to the direct exposure of EU economies to Russia and the Ukraine through trade, financial
and energy channels. Here we can be fairly concrete in quantifying the immediate risks,
which – as we discuss below – appear manageable from an overall macroeconomic
perspective.
At the other extreme of the spectrum of possible outcomes lies a tit-for-tat escalation of the
current tensions, leading to a global systemic crisis on financial, economic, geo-political or
even military dimensions. As we have learnt from experience during previous systemic
crises, the complexity of systemic interactions renders ex ante assessments of their impacts’
magnitude and orientation difficult. But we can be sure the impact would be profound and
negative.
Trade channel. Focusing on quantifiable trade links, Chart 1 shows the importance of
Russia as a destination for European exports. German exports to Russia constitute slightly
less than 1% of German GDP.
Chart 1: Destination of gross exports
% of row country's GDP
Source: IMF, Goldman Sachs Global Investment Research
However, we have argued in the past that these shipment data can overstate the importance
of particular countries for economic activity for two reasons, both related to the globalisation
of supply chains over recent decades. First, the direct impact on GDP of disruptions to trade
should reflect the value-added in exports, rather than simply the value of the shipments
themselves (since some of the value shipped abroad reflects the re-export of imported
inputs). Second, exports to one country may ultimately be re-exported to another country:
what matters for economic activity in the exporting country is the source of final demand that
the export eventually serves, rather than the first port at which the export is delivered.
Chart 2 illustrates the importance of trade with Russia and the central and east European
(CEE) economies on this value added / final demand basis (using data constructed by the
OECD and WTO). The direct impact of a cessation of trade with Russia appears modest: in
all of the western and northern European countries considered, trade exposures to China on
this basis are greater.
Chart 2: Importance of trade with Russia and CEE economies on
a value added / final demand basis
% of row country's GDP
Source: OECD/WTO, Goldman Sachs Global Investment Research
However, should disruptions extend to central Europe, the potential impact is more
significant. Germany and Sweden – with their links to Poland, the Czech Republic, Hungary
and the Baltics – are particularly exposed. A collapse in the central European economies
triggered by Russian / Ukraine tensions and their aftershocks would have a material impact
via trade channels on the Euro area.
Financial channel. Exposure through financial channels is also significant (see also here).
Chart 3 shows the cross-border exposures of European banks to Russia and CEE countries.
It illustrates several points: (1) these balance sheet exposures are significant; (2) again, the
magnifying effect of the impact via central and eastern Europe is more important than the
direct exposure to Russia itself; and (3) the most significant exposures are in Austria,
Sweden and Italy, whose banks play an important role in neighbouring CEE countries. The
Austrian exposure to CEE countries stands out.
At the same time, the exposure should not be overstated. The UK’s exposure to China alone
is almost as great as that of Sweden to central and Eastern Europe. And exposures to the
emerging markets in general are greater elsewhere, notably via Spanish banks’ penetration
of Latin American banking markets.
Chart 3: Cross-border bank exposures to Russia and CEE
countries
% of row country's GDP
Source: BIS, Goldman Sachs Global Investment Research
Energy (and commodity) channel. Russia is an important source of energy for many
European countries. To illustrate this, Chart 4 shows the proportion of total gas consumption
that is met by supplies from Russia. In some cases – Finland and the Baltics – this
dependence reaches 100%. Ukraine is also highly dependent (70%), which is one point of
leverage for Russia in the current disputes (as we have seen in the past – Russia halted gas
supplies to Ukraine in 2009 in the context of a previous dispute, with knock-on effects on
those European countries that received their Russian gas supplies via pipelines running
through Ukraine).
Chart 4: Share of Russian supplied gas in total consumption
Source: European Commission
Dependence is not limited to smaller, immediately neighbouring countries. Germany also
relies on Russia for around one-third of its total gas supplies.
While these exposures are significant, measures have been taken in the aftermath of the
2009 pipeline shutdown to insulate EU countries from a disruption to Russian gas supplies.
Efforts have been made to diversify gas supplies (and more generally sources of energy).
Gas reserves have been built up. And improvements have been made to the distribution
infrastructure to ensure that gas can be moved within the EU to where the need is greatest.
Moreover, the timing of the current tensions in Crimea is favourable from the energy
perspective, now that the high-demand winter period for gas is behind us.
More generally, the potential for disruption to commodity production and supply may imply
risks. With Russia an important player in energy markets beyond gas (notably oil) and
Ukraine a significant producer of soft commodities (notably wheat), disruption to trade with
these economies and/or to the countries themselves would threaten to disturb global
commodities markets. While sanctions against Russia could potentially have a large impact
on energy prices given the country’s large production and exports, our colleagues in the
Commodities Strategy team believe that the importance of Russian crude oil and natural gas
exports to the Russian government and to the European and Russian economies makes this
a less likely area where additional sanctions could be imposed (see here).
Summing up: Manageable direct exposures, but potential systemic risk. All in all, the
direct economic exposures of EU countries to tensions in the Crimea look manageable.
While both the US and EU are imposing economic and financial sanctions on Russia in the
aftermath of the recent referendum on secession, these remain very targeted and their
macroeconomic impact on Europe should be limited.
But retaliation by Russia and/or an escalation of the tensions that threatens to create
systemic risk would obviously be a cause of greater concern. This would imply a very
different macro outlook. As yet, political responses on both sides have attempted to steer
away from such an escalation. Yet experience demonstrates that politics can sometimes
take an economically irrational course, particularly when issues of sovereignty, security and
national pride are at stake.
Huw Pill - Goldman Sachs International
+44(20)7774-8736 [email protected]
Antoine Demongeot - Goldman Sachs International
+44(20)7774-1169 [email protected]
Sebastian Graves - Goldman Sachs International
+44(20)7552-5748 [email protected]
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