The Case For EM In A Multipolar World

The Russian invasion of Ukraine is a shock to the existing world order. From an economic perspective, the initial impact of the war is rising inflation given the importance of Russia and Ukraine in the supply of commodities to the world. The economic sanctions imposed by the Western democracies have also lead to increased risks of liquidity shocks.1 Another consequence of the sanctions is the need to diversify reserve assets away from the USD. These events often lead to a market leadership transition and the long US capital markets’ leadership is over-extended and ripe to be overtaken by EM assets, in our view. Many large EM countries have so far kept a neutral stance in the conflict, allowing them to keep their options open in a ‘multi-polar’ world order where China challenges Western dominance. Several EM countries will also benefit from higher commodity prices and the monetary cycle favours EM. The central banks of EM countries experiencing high inflation reacted boldly over the past year, while China is bucking the trend with monetary and fiscal policy easing.The Russian invasion of Ukraine was the first major known-unknown event of the year and is a humanitarian crisis comparable to the wars in Korea, Vietnam, former Yugoslavia, Syria and Libya. In Russia’s foreign minister Sergey Lavrov’s own words, it represents a big challenge to the pre-existing geopolitical world order, with potential consequences beyond the conflict itself.

1 | Political context

The military conflict hits the world after five years of an economic and trade war between the two largest economies – the United States (US) and China – and the most deadly pandemic in 100 years. The pandemic may have played a role in Russian President Vladimir Putin’s decision-making, with him isolated and surrounded by people that are unable to dispute his viewpoints. In the West, covid-19 policy responses had a negative impact on public finances and the economy, focusing minds away from geopolitical threats. Furthermore, the pandemic exposed the fragile state of democracies around the world as inequality had built up over 40 years to an extreme only experienced before the First World War. It was hard to avoid the temptation of excessively easy fiscal and monetary policy after too little action made the recovery from the 2008 crisis more painful than it ought to have been. The policies designed to soften the blow to the lowest income population, namely helicopter money, led to a further exacerbation of inequality. As money was devalued, the poorer suffered the most.

2 | The Ukraine war and the big picture

At the risk of over-simplifying, there are two possible principal outcomes in Ukraine. Either Putin wins, after a combination of: (a) demilitarisation of Ukraine, (b) regime change in Ukraine, or © the partition of Ukraine; or Putin loses as the Ukrainian resistance deprives the Russian army of these objectives and a peace deal is reached with neither regime change nor the partition of Ukraine. If Putin were to win, his success in Ukraine may embolden his supporters and allies abroad. The competition between Western democracies and a China-led amalgamation of democracies, anocracies and autocracies will remain in place. The key risk to the world is this economic conflict turning into a military one, which could happen if China overtly supports Russia in Ukraine, if Russia decides to extend the fight beyond Ukraine, or if China decides to make a move on Taiwan. In our view, it is unlikely that China will take any major risks in the short term. In November 2022, the Chinese Communist Party (CCP) will agree on the leader for the next 10 years and Xi Jinping has made the case to remain in power for another mandate. The primary economic impact of the Ukraine war is a rise in global inflation. Inflation was already elevated before the war, with producer price inflation at double-digit levels across most G-20 countries and consumer price orders of magnitude above G7 central banks’ comfort zones. The excessive fiscal and monetary policy stimulus during the Covid-19 crisis, alongside efforts to reduce inequality, energy transition and developed world (DM) central banks’ stimulative stance despite evidence of rapidly increasing inflation, were the key structural elements driving inflation higher.