For Institutional Investors in the US

The Domino Effect: Russia, Ukraine and the Rest of EM

Daniel J. Graña, CFA

Daniel J. Graña, CFA

Portfolio Manager, Emerging Market Equity

Hervé Biancotto

Hervé Biancotto

Portfolio Manager

Matthew Culley

Matthew Culley

Portfolio Manager | Research Analyst

Mar 25, 2022

Key takeaways:

While Russia is being distanced from the emerging market (EM) universe through exclusion from debt and equity indices, its role as a key commodity exporter will have far-reaching effects across emerging markets that investors need to consider.

Key Takeaways

  • Russia has or will be removed from debt and equity indices, eliminating some of the technical headwinds facing emerging markets (EM) and potentially limiting broader contagion over time.
  • While many Russian companies have escaped sanctions, the visibility around sanctions is low. Similarly, the fungibility of commodities make supply chains hard for investors to unravel.
  • The domino effect of rising prices from the disrupted supply of commodities and resources from Russia and Ukraine could have far-reaching effects across EMs. These represent both a boost and a roadblock to innovation in these markets.

Capital Market Intervention

The Russian invasion of Ukraine has had significant implications for Russia in the form of explicit sanctions, but also in restricting access to the capital markets. One example is the removal of Russian securities from debt and equity indices. JPMorgan caught the market by surprise in its announcement that it will remove the securities from its indices ahead of any kind of default, which is normally the trigger for index exclusion. Russia’s weighting in the Corporate Emerging Markets Bond Index (CEMBI) and Emerging Markets Bond Index (EMBI) was already small at ~3%- to 4% prior to the tensions1, falling to ~1 to 2%2 as tensions began, and will now be excluded altogether at the end of March. This will result in the re-weighting slightly higher of other countries within the indices, while also removing some price volatility stemming from Russian bonds. Similarly, MSCI and the FTSE Russell removed Russian securities from all of their indices. MSCI also said it is reclassifying MSCI Russia indices from emerging markets to standalone markets status, a badge of being uninvestable.

While Russia is uninvestable from an environmental, social and governance (ESG) standpoint, in our view, such removal from indices could limit the broader contagion to the rest of EM over time. Russia’s prominence in international financial markets waned after sanctions were introduced in 2014 following the annexation of Crimea. At the beginning of the Global Financial Crisis, Russia was the fourth-largest EM country in the MSCI EM index at 10%, but its weight has dropped due to the impact of the 2008 recession alongside economic sanctions, which drove currency depreciation.3 Consequently, it was a small part of indices and investors’ portfolios. The hurdle for inclusion again is high, and we believe it would take years and a regime shift in Russia for the country to be considered for inclusion again.

Sanctions on Companies

Nevertheless, while some Russian companies have been sanctioned directly, many have not, with some corporations coming out publicly against the conflict. However, the visibility of where sanctions could fall is low, as the fragmented, global nature of companies means that sometimes a parent company and not a subsidiary is sanctioned, or vice versa. Such visibility can take time to be unraveled by government authorities and often appears capricious. The state-owned nature of many emerging market companies exacerbates this risk.

As many of the largest companies in Russia are producers of either energy or raw materials, it is hard to envision a neat replacement of these sources of production. Coupled with the existing sanctions on the supply of Russia’s energy to other nations, sharp commodity price inflation may have implications beyond the companies that the sanctions directly touch. Just as with the lack of visibility around sanctions, the fungibility of commodities also complicates a transparent picture of the intertwined global supply chains. So, companies are likely to be careful how they trade goods and materials that do not have a tag to say where they come from.

The Domino Effect   

While Russia has been distanced from international markets, its role in supplying metals, minerals, agricultural commodities and energy cannot be as neatly siloed. For many EM economies, inflation causes a domino effect impacting consumers’ real incomes through to company margins in industrial production and the health of economies with weaker terms of trade (the value of imports exceeds exports) and even decarbonization efforts.

One example of an affected supply chain is natural gas and minerals used to make artificial fertilizer, where shortages or price increases could impede the quality of crops grown to feed a population. Both Russia and Ukraine have banned some exports of fertilizer, reportedly to protect domestic needs. Russia is within the top two of world exporters3 of all three types of fertilizer (nitrogen, potassium and sulphur). Fertilizers account for around 2% of Russian (including Belarus) export revenues, but 29% of the world’s total trade (Exhibit 1). Sharp price inflation in foodstuffs is also evident where Russia is a key exporter, such as wheat, corn, barley and sunflower seed oil (together with Ukraine equating to originating half of the world’s output).4

Exhibit 1: Russia’s Production and Relevance to Its Export Revenues (% share, 2020-21e) and World Trade (%)

Russia’s Production and Relevance to Its Export Revenues (% share, 2020-21e) and World Trade (%)

Source: BNP Paribas, 9 March 2022. Figures include Belarus exports.

This drives up the import bill for EM economies, which are particularly vulnerable to this, as wheat and fertilizer import dependency, for example, is highest in emerging market economies, with few developed market exceptions.4 Food and energy are higher in the consumer price index (CPI) basket for EM countries; this is skewed even more in that direction for the poorer classes. In high-income economies, foods represent generally less than 15% of price indices, whereas in EM economies they can exceed 30% of household spending.5

Such higher inflation is set to erode the EM consumer’s purchasing power and companies will have limited ability to pass on such large price spikes. This has already been reflected in some weakness seen in the performance of consumer staples companies. In our view, it could result in a significant hit to earnings for these companies. Beyond that, it creates food security issues for poorer emerging markets and those that are net commodity importers.

Substituting Countries or Commodities?

Commodity net exporters can benefit from sky-high prices and use their rich supplies of raw materials to fulfil the world’s needs where it is disrupted. For example, Russia makes 43% of the world’s palladium, which is primarily used in catalytic converters in cars, while the second-largest supplier of this metal is South Africa (Exhibit 2). Russia is also the third-largest producer of nickel, which is used in lithium-ion batteries that power electric vehicles. Indonesia is the leading producer of this metal.6 Top-producing countries can step up to compensate for the shortfall in supply, while shortages could encourage substitution. For example, the replacement of palladium – which was scarce even before the conflict – for platinum in cars, which some auto manufacturers have already started experimenting with.

Exhibit 2: Russia Is the Leading Producer Globally of Palladium
Global mine production of palladium from 2010 to 2020, by country (in metric tons)

Global mine production of palladium from 2010 to 2020, by country (in metric tons)

Source: Statista, 30 April 2021. *Estimated.

As costs filter through supply chains, and with squeezed consumers unable to absorb price increases, innovation is encouraged by need. Morgan Stanley analysts estimate that the doubling of the nickel price raises the cost of manufacturing an electric vehicle by more than $2,000.7 Coupled with the scarcity and expense of lithium, countries such as China, the U.S. and India are experimenting with alternative battery technology that does not use lithium, although we believe lithium-ion batteries will remain dominant. In short, supply shortages encourage emerging market companies to innovate to thrive and to capitalize on accessible resources.

Roadblocks to a Low-Carbon Future

One area of innovation that the commodity price spike has complicated is the journey to carbon neutral, where China, Korea and India, among others, have set net zero targets. Given high oil and natural gas prices – where Russia is again a dominant exporter – countries are pushed into exploring alternative avenues to fulfil their energy needs. Some emerging countries in Europe have shelved the phasing out of coal plans, as this source already has significant existing infrastructure that can be tapped into to meet needs in the short term. Many emerging economies are naturally endowed with this resource and can benefit from increased exports, such as Indonesia. While it may not change the carbon neutral destination that EMs are aiming for, it could change the journey as the focus shifts from distant goals to energy security for near-term economic growth.

The National Development and Reform Commission in China, for example, reportedly plans to increase its coal mining to reduce reliance on imports and avoid supply disruption. According to Credit Suisse, China’s plans could see Russia lose three-quarters of its export market.8 Clearly, supply chains and routes to decarbonization are being reshaped by the domino effect of the conflict. In the case of China, this is another example of its move toward economic self-sufficiency. These are the forces of de-globalization in action as economies come to rely more upon themselves to meet their needs. The far-reaching end of the chain of dominoes is clear, but there are less predictable ways that they stack up. Rural workers in coal mine towns in Indonesia, for example, can see the revived interest of a microbank that lends to them. It is by taking a top-down view of events and the influence on companies on the ground that we can find the clear – and less obvious – potential winners and losers from the falling dominoes of the Russia-Ukraine conflict.


1Source: JPMorgan. As at 31 December 2021.
2 Source: JPMorgan. As at 28 February 2022.
3 Source: MSCI, 3 March 2022.
4 Source: Food and Agriculture Organization of the United Nations (FAO), as a % of world exports, 11 March 2022.
5 Source: Barclays, 11 March 2022.
6 Source: Statista, 21 October 2021.
7 Source: Morgan Stanley, 8 March 2022.
8 Source: Credit Suisse, 15 March 2022.


Consumer price index (CPI): A measure that examines the price change of a basket of consumer goods and services over time. It is used to estimate ‘inflation’.

Emerging market: Countries that are transitioning away from being a low income, less developed economy to one that is more integrated with the global economy and is making progress in areas such as depth and access to bond and equity markets and development of modern financial and regulatory institutions.

Inflation: The rate at which the prices of goods and services are rising in an economy.

Volatility: The rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility. It is used as a measure of the riskiness of an investment.