Food scarcity, energy insecurity: assessing sovereign ESG risks from the Russia-Ukraine conflict
The conflict in Ukraine will long be remembered for its human toll first. It will also be remembered for having caused a vicious scarcity in agricultural products and high energy market volatility, both of which have eroded geopolitical stability and threatened to derail the global effort to address climate change. Roughly eight months into Russia’s invasion, we take stock of the attendant ESG risks and provide a brief perspective on Ukraine’s reconstruction.
- Russia’s aggression in Ukraine and its impact on energy and agricultural commodities have caused significant global economic disruption, which is likely to continue to be felt for some time. Ultimately, there will need to be a massive reconstruction and recovery aid effort to assist Ukraine and opportunities for well-designed financial markets to amplify this support.
- In terms of social risk, Russia’s slowness to release agricultural commodities from Ukraine has contributed to widespread food scarcity, with higher food costs deepening wealth disparities and exacerbating social inequality, not only in Ukraine and nearby Eastern European nations, but also across the Middle East and North Africa.
- Ultimately, we believe these developments may compound social and geopolitical risks, leading to further political instability and an exacerbation of mass migration that could trigger second-order economic and sociopolitical dislocations in Europe.
- In the short run, the conflict is damaging the world’s progress toward carbon emissions reduction; longer term, we think it will have helped accelerate the low-carbon transition—particularly as Europe seeks to reduce its dependence on Russia’s energy exports.
Looking beyond the conflict to recovery
However long the conflict in Ukraine lasts, we believe its reverberations will likely be felt through global commodity markets, political regimes, and social infrastructures for years to come. Recently shattered cities have begun to tentatively return to life as they undergo emergency renovations against a fast-approaching winter. Aid from Western nations, including pledges by dozens of sovereigns to support a comprehensive reconstruction of Ukraine’s economic infrastructure, will ultimately—and hopefully swiftly—lead to a detailed road map for financing a sustainable recovery.
Of course, although Ukraine’s reconstruction costs were recently estimated at $350 billion, we can’t yet know the final figure—particularly as it’s unclear how long the war will last and how much further civilian infrastructure will be damaged. We believe that far-reaching reconstruction will take the form of long-dated loans, guarantees, and grants that will proceed from deep reservoirs of global capital backstopped by G7 nations and supranational organizations.
The imminent conference for the recovery, reconstruction, and modernization of Ukraine should offer more clarity on how this task shall be funded. The involvement of supranational organizations such as the World Bank, the European Investment Bank (EIB), and the European Bank for Reconstruction and Development (EBRD), to name a few, is also to be expected in some form. Finally, private sector involvement can provide auxiliary support in channeling necessary funding toward a better, more resilient Ukraine. This will allow fixed-income investors to direct capital allocation where it’s needed most.
Major dislocations enhance the significance and necessity of active judgment
A highly disruptive event such as the conflict in Ukraine poses challenges for credit analysis, to say the least. With its significant economic, agricultural, and energy market dislocations, the war currently escapes the systematic, data-driven facets of our sovereign environmental, social, and governance (ESG) model—until, that is, the data catches up across each indicator and until we can reassess the impact of the conflict. Nevertheless, having an appreciation for the likely direction of ESG-related data as the sociopolitical and environmental impact continues to compound, we feel confident in making two general forecasts—one for the impact of agricultural scarcity and the second for the impact of fossil fuel insecurity.
Ukraine is famously known as a breadbasket to the world; Russia, too, is a major exporter of grains. But Russia’s blockades of Ukrainian ports halted grain exports for months until Russia agreed with Ukraine this summer, under Turkey’s auspices, to slowly unblock Ukrainian agricultural exports to the rest of the world. In addition, Russia—and Belarus for that matter—hold the lion’s share of global fertilizer exports, jeopardizing future crops on top of current global disruptions.
The volatility in the supply of grains has since caused—and is likely to continue to exacerbate—food scarcity and longer-term food insecurity affecting millions, which may intensify refugee crises and other geopolitical risks. Extreme weather conditions caused by climate change will only intensify the already bleak agricultural picture.
In addition, the conflict will either accelerate or set back the adoption of low-carbon fuel alternatives that are needed to address climate change on a global scale. That’s nothing short of existentially significant, first and foremost for the tens of millions of people who may ultimately be displaced and put at extreme risk due to the war’s impact. In the face of such turmoil, it will of course also carry a quantifiable significance for sovereigns—in terms of growth outlooks amid energy insecurity, demographic trends, and the overall liquidity and investability of their debt markets.
1 Social risks from the conflict will continue to transform the geopolitical landscape
The worst migration crisis since World War II
As of early August 2022, more than 12 million people in Ukraine, nearly a third of the country’s population, had been displaced. This has prompted it to be called the worst migration crisis since World War II. More than 6 million of these refugees—predominantly women and children—swiftly fled to neighboring countries, particularly Poland, but also Latvia, Moldova, Romania, Slovakia, Hungary, Belarus, and Russia. Of course, the housing, food, and healthcare costs assumed by these nations, and by whichever countries and cities these displaced and at-risk populations eventually call home, will be substantial. By one recent estimate, these costs could exceed $30 billion in the first year alone.
Unfortunately, 12 million is likely just the beginning of the migration wave created by the crisis. The impact on export markets for grains and fertilizer from Ukraine and Russia, while felt globally, is particularly acute in the Middle East and North Africa (MENA), where the reliance on these agricultural products is high. Even with the recently brokered agreement to resume shipping of these critical commodities, tens of millions of people who were already dealing with food scarcity before Russia’s invasion of Ukraine in February are likely to experience malnourishment as a result of the war’s substantial disruptions of the agricultural supply chain.
We see food scarcity and insecurity as a potential trigger for a major increase in refugee movements within the MENA region as well as to Europe. The effects of this on the MENA region could be predominantly negative, particularly in terms of the reduction of skilled labor forces in specific countries and the human rights implications for intraregionally displaced populations. For Europe, although the short-term impact may be negative, there could be long-term positive effects of this transfer in human capital as these migrants are integrated into communities and begin contributing to labor market growth. This assumes that European immigration policy stays more focused on welcoming temporary migrants and permanent settlers than on denial of entry based on anti-immigration sentiment.
This European immigration policy assumption is at the core of our analysis, but we treat it with caution. As a case in point, the political parties of some recent European victors have neofascist roots and offer unambiguously anti-immigrant plans for border controls, which raises the risk of negative socioeconomic surprises.
History, furthermore, suggests that a continued welcoming of displaced populations, particularly following the magnitude of displacement from Ukraine, is unlikely to occur.
Instability reigns: the Arab Spring and the European refugee crisis
A useful historical example to consider is the period involving the Arab Spring, a popular uprising in North Africa against autocratic regimes that began in 2011 in Tunisia and then spread to Libya, Egypt, Syria, and Yemen. After the political crackdown that followed in most of these countries, autocracy strengthened and democracy became more constrained, while some states collapsed into outright war zones (Syria and Yemen, for example). Needless to say, investing in the region became more of a fraught enterprise; even in the case of a more solid example such as Egypt, policy and government debt management have since revealed substantial governance risks according to our research.
The political repression that greeted the Arab Spring helped prepare the foundations of the European refugee crisis of 2015, in which 1.3 million people fled to Europe. Armed conflict was a leading cause of this mass exodus. The largest share of refugees fled to Germany, which was welcoming under then Chancellor Angela Merkel, as well as to Hungary, France, Sweden, and other countries across the European Union (EU).
The Arab Spring set the stage for a surge in refugees to Europe in 2015, and numbers have remained elevated
Annual number of asylum applications received in EEA countries and the United Kingdom, 2010–2021
Source: Eurostat, September 2022. European Economic Area (EEA) includes EU-27 countries, Iceland, Liechtenstein, and Norway. Data also includes asylum applicants to the United Kingdom, 2010–2019. Asylum applicant refers to a person having submitted an application for international protection or having been included in such application as a family member during the reference period.
This prompted a political backlash within Europe that brought the region close to adopting a critical mass of protectionist leaders bent on closing borders and reshaping climate policy in a way that promised to slow the low-carbon transition already well under way in the region.
Unfortunately, we believe the risk of a similarly extreme refugee and political crisis is high in the years ahead as a direct result of the war in Ukraine. Some of the world’s most vulnerable countries amid the Russia-Ukraine wheat shortages are in North Africa. Egypt, Sudan, and the Democratic Republic of the Congo import 82%, 75%, and 69% of their wheat, respectively, from Ukraine and Russia, while Somalia and Benin each import 100% of their wheat from either or both of the warring countries. Food scarcity across the MENA region—and the type of unrest that may follow—is part of the cycle of social and governance risk that’s emerging from the Russia-Ukraine war.
And given this impact on MENA countries, home to the world’s fastest-growing populations, the world’s primary sites of global population growth could experience rapidly rising food scarcity, poverty, and social inequality. With the prevalence—and severity—of undernourishment already much worse in Africa than other regions, we believe the war may drastically compound the humanitarian crisis in this region. In our view, these conditions could make the MENA region the largest source of mass migration in the remaining years of this decade.
Prevalence of undernourishment is worst in Africa
Source: Food and Agriculture Association of the United Nations, as of December 31, 2021. Values are based on the middle of a projected range.
Vulnerabilities in Egypt, Ghana, and Kenya
To take an example from one of two groupings of emerging markets in our model, Egypt displays unique vulnerabilities. By volume, Egypt is the largest wheat importer in the world. This means that higher import prices for soft agricultural products, such as wheat and other grains, are likely to manifest as fiscal stress that the Egyptian government and general population alike will struggle to bear.
Like many other trading partners of Russia across the commodity spectrum, Egypt will seek to diversify itself away from dependence on Russia, but this won’t be achieved overnight. Egypt’s domestic harvest season, which began in mid-April, has helped with the country’s wheat reserve accumulation from local farmers, but it hasn’t been enough to forestall rising food costs. Traditionally, the cost of food in Egypt has been a taboo issue propelling public unrest—as it did in the Arab Spring and in numerous other past crises. Given sufficient turmoil, the social and governance factors we measure are likely to register deepening weakness.
Downgrades may accelerate
Ghana and Kenya are also heavy wheat consumers, as wheat accounts for a third of their respective populations’ cereal consumption, and most of it is imported. For its part, Ghana is facing certain fiscal challenges pertaining to its deficit, which propelled Moody’s to downgrade its sovereign credit rating in March from B3 to Caa1 on a stable outlook. Standard & Poor’s and Fitch then moved in August to downgrade Ghana’s debt from B–/B (S&P) and B– (Fitch) to CCC+/C and CCC, respectively, based on a downbeat assessment of the nation’s financial profile and a variety of external pressures—including the impact of the war.
From an economic and market perspective, given the prevailing uncertainty related to agricultural product availability and sociopolitical integrity, credit ratings for these and other countries in the region are at commensurately greater risk of taking or resuming a downward trajectory. This further constrains their access to debt markets and their future ability to finance everything from infrastructure, healthcare, and social programs to subsidies against elevated food prices, new agricultural programs, and climate-adaptation strategies.
2 Today’s energy dislocations may ultimately accelerate the low-carbon transition
In addition to the potential for a protracted humanitarian crisis, the Russia-Ukraine crisis has caused major energy market dislocations that have intensified today’s global inflation problem and temporarily derailed the transition away from fossil fuels to combat climate change. But while much of Europe bears the immediate brunt of Russia’s restrictions of its energy supplies and countries that oppose Russian aggression are scrambling to shore up fossil fuel re