THE SANCTIONS ON RUSSIA WILL INEVITABLY RESULT IN A FRAGMENTATION AND FRACTURING OF THE GLOBAL TRADE PAYMENTS SYSTEM, AS ALTERNATIVES ARE SOUGHT OUT, ABOVE ALL TO PAY FOR FOOD AND ENERGY RESOURCES...
But that pool of available financing and transaction facilitation will inevitably be smaller, and will typically tend to result in credit availability for smaller intermediaries becoming scarce. The latter aspect then reduces the underlying pool of transaction financing liquidity in markets, and will also tend to reduce the pool of available credit for trade finance, above and beyond any consideration of VaR (Value at risk), and in turn this tends to disproportionately ‘penalise’ food and resources producers in emerging and developing economies. It is in other words a variation on the counterparty risk phenomenon seen during the Global Financial Crisis which, as is well documented, shrunk the pool of offshore US dollars, most of which is generated by trade. As importantly, it comes at a point when central banks are looking to raise interest rates and reduce excess liquidity, in sharp contrast to both the Global Financial Crisis and the onset of the pandemic.
However, this current variation of counterparty risk has two other potentially significant components. Firstly the sanctions on Russia will inevitably result in a fragmentation and fracturing of the global trade payments system, as alternatives are sought out, above all to pay for food and energy resources, and in many cases likely settled in the local currencies of the two countries involved, thus reducing demand for USD for this specific purpose. It would be worse than simplistic to suggest that the likes of China and India, who account for 35% of the world’s population, should become largely self-sufficient in food produce, leaving aside the thornier issue of hydrocarbon energy supplies. It also implies that there will likely be greater accumulation of FX reserves not denominated in USD or EUR, which for many Asian central bank FX reserve managers will probably come as some relief, given that many have fretted for years about the high proportion of reserves held in USD. It might also encourage some countries to examine the viability of holding crypto assets, as an alternative payment methodology, even if this opens up a whole new set of other considerations related to cybersecurity, as well as volatility and price discovery.
That said, this may prove to be a case of ‘out of the frying pan and into the fire’, given that other currencies may prove to be a good deal more volatile, as well as being less liquid. Some countries may even question the need to hold as much in the way of FX reserves, both given the precedent set by the seizure of Russian central bank assets, and indeed the fact that locking away some trade surplus cash in FX reserves deprives some countries of much needed capital that could (and I stress could) be deployed to improve local economy infrastructure, amongst other things. Admittedly for some countries, FX reserves are a way of keeping their currencies competitive in trade terms, or even artificially weak. But in turn, this would leave many questions about how all the mountain of debt denominated in USD (including but far from limited to US Treasuries) would be either be repaid or refinanced, given that the vast majority of foreign currency and corporate debt is USD denominated.
Secondly in terms of counterparty risk, it also leaves some questions about secured lending and collateral, and perhaps ultimately leverage. For many wealthy individuals and families, purchasing foreign property abroad is a means to access lending in a given country, as well as diversifying in risk terms. If fear of asset seizure becomes a more significant consideration, then the risks are two-fold, firstly demand for foreign property will likely be somewhat impaired, and secondly banks and other lenders may well look at applying larger precautionary ‘haircuts’ to potential secured lending, both due to seizure risk, but above all as borrowers may consider simply ‘walking away’ from the liabilities secured on such assets.
In conclusion, it should be stressed that many of these risks have been ever present, and have been an increasing consideration for many investors and lenders over the past decade. To a certain extent they have been largely trampled all over by central banks’ financial repression, and the need to try and generate better real returns, by adopting a higher risk profile in portfolios. But with capital mobility likely to be an increasing concern for many, the need to protect capital access may become as significant a concern as both capital returns and protection.
Marc Ostwald E:
marc.ostwald@admisi.com T: +44(0) 20 7716 8534
21 | ADMISI - The Ghost In The Machine | Q1 Edition 2022
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