Instability in Ukraine is not bad news for UAE economy

Instability in Ukraine is not bad news for UAE economy

Collapse in Ukrainian economy may hit global food prices

By Francisco Quintana (Economatrix)

Published: Tue 25 Mar 2014, 10:36 AM

Last updated: Fri 3 Apr 2015, 7:08 PM

How important is Ukraine for the UAE? In a nutshell, not really.

The Ukraine-Russia crisis has been in the media spotlight in the last few weeks, and potential implications of an increase in tension in the Black Sea have been the focus of numerous analyses. However, its impact on the Gulf region is unclear.

Ukraine plays a marginal role for the countries in the GCC: trade exchanges are minimal and investment flows are almost non-existent. In 2012, Ukrainian exports to the UAE amounted to only $414 million, 29 per cent of total exports to the GCC but equivalent to only 0.24 per cent of Ukrainian GDP.

The UAE’s exports to Ukraine were insignificant, reaching only $68 million in 2012, or 0.02 per cent of Emirati exports. This pattern is not particular to the UAE. Exchanges between Ukraine and the GCC have been historically small. On average, only two per cent of Ukrainian exports went to the GCC over the last decade, while Ukraine was the destination of 0.02 per cent of the Gulf’s exports.

GCC countries run a structural deficit with Ukraine because the key export commodity of the region, oil, is largely irrelevant to Ukraine, which relies on Russia to cover its energy needs.

Even at the global level, Ukraine’s relevance is limited. The country only accounts for 0.2 per cent of global GDP. A collapse of its financial system or a default in its debt repayments would not pose a systemic threat to the world’s economy, given that the country only accounts for three per cent of emerging markets’ debt, and 0.1 per cent of international bank claims. Ukraine’s external public debt accounts for around $10 billion, and the European Union has already pledged financial support for $15 billion, reducing the likelihood of a default.

On the other hand, Ukraine matters as an agricultural exporter, being the world’s third-largest exporter of corn, with 16 per cent of the total, and the sixth global exporter of wheat. A collapse of its economy could impact food prices and that is why futures of both products have risen sharply in the last few days.

The real relevance of the country lies in its role as an energy distribution hub. About 20 per cent of Russian gas is exported as liquefied natural gas to Japan and South Korea. The rest, around 80 per cent, is exported as dry gas to Europe and half of those exports go through Ukraine. A third of European natural gas consumption comes from Russia. Europe is, therefore where the blow of a Ukrainian breakdown would be felt first. Germany in particular uses up a quarter of all Russian gas, but Turkey (19 per cent) and Italy (nine per cent) are also heavily exposed. If they need to start buying natural gas in the spot market, rising energy costs are likely to translate into rising manufacturing costs and headline inflation.

Elsewhere, the current instability will also put pressure on energy prices. Up until now the rise has been moderate, with a 10 per cent rise in natural gas prices since December, which is benefiting other natural gas exporters like Canada, Algeria or Qatar along with Russia itself.

If the conflict escalates and Russia receives trade sanctions, Gulf countries would probably benefit, at least in its first phase, given that Russia and the GCC compete in the same market as energy exporters.

Russia is one of the largest oil producers in the world (around 11 million barrels per day) and the second-largest exporter after Saudi Arabia, with more than seven million barrels per day. Any disruption in Russian energy exports due to military conflict or sanctions would translate into higher oil prices and, consequently, larger fiscal surpluses for the GCC.

Furthermore, Gulf countries, and in particular Saudi Arabia, would probably have to expand production to minimise the impact of a hypothetical Russian disruption. The increase in revenues for Saudi Arabia would come not only from rising prices but also from higher volumes. Again, Europe is the largest destination of Russian oil and would have the most trouble finding an alternative provider.

Global growth would decelerate as not even Saudi Arabia would be able to compensate a strong decline in Russian exports, but the GCC would be one of the few regions to benefit.

Our base-case scenario does not involve a fully-fledged conflict or embargo. The incentives to avoid an escalation of conflict are very high. Russia depends on oil and gas for 45 to 50 per cent of its budget. The EU represents 50 per cent of its trade, while Russia represents less than 10 per cent of the EU’s trade. Even if China takes a neutral stance, the impact in Russia would still be significant, as China represents only 10 per cent of Russian exchanges.

Similarly, the international community would prefer to avoid troubling Russia. Global corporate interests in the country are very large and it would require a long time for the sanctions to have an impact, as the country produces a large share of its own fuel and food. But the solution to the current conflict seems to be complex. Even though only the province of Crimea has a Russian majority, Russians still account for 30 per cent of the total population of Ukraine. Instability will probably last for months and the likelihood of an accident sparking a military conflict remains high. However, as long as it does not spiral out of control, that is not such bad news for this region.

The writer is a senior economist at Asiya Investments.

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