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You're reading: Ukraine – contagion risk

Ukrainian asset prices are currently under pressure as
markets fret over its weak fundamentals of having twin deficits, limited cash/currency
exchange buffers, uncertainty on the political front around its relationship
with the European Union and Russia, and ability (or otherwise) to finance
itself in a new world of tapering. After Moody’s decision to cut Ukraine’s
sovereign LT FC rating to Caa1 last week, the assumption is that further rating
downgrades by Fitch and S&P will follow, creating something of a vicious
cycle.

The above raises an interesting question as to whether a
deteriorating situation in Ukraine will create contagion pressures elsewhere in
emerging markets. Note that we expressed a relatively upbeat emerging markets big
picture view in our piece “Time
to dip your feet backing EM” published on Sept. 5, and therein we
highlighted that one encouraging factor throughout the EM sell-off since May is
that while asset prices (currency exchange, rates, credit and equity) have sold
off, and the media has been full of stories over the problems in EM, no
individual emerging market has “fallen off the cliff” yet into a full blown
currency crisis, or credit event. This has suggested a stronger underlying
story still in emerging markets than the media headlines suggest.

But if Ukraine is the first emerging market domino to fall,
how far reaching would the consequences be, and which dominoes could perhaps
fall next, if any?

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