UBS Lays Out Three Scenarios On Russia/Ukraine Crisis

Tom Burroughes

3 March 2014

The global economic and markets impact of the current crisis affecting Ukraine should be relatively limited, although the exact impact and severity of any fallout depends on a number of possible outcomes, UBS Wealth Management says.

With events moving so fast as to make specific forecasts difficult, the Swiss banking firm has set out three scenarios, with varying levels of probability. It set out ideas in a research note requested by this publication.

In the first scenario, which UBS says carries a 50 per cent probability, Russian troops stay in the Crimea, the International Monetary Fund provides emergency financing and elections take place in May. In this case, Russian actions have two primary objectives: first, to ensure the Crimea region, where Russia has naval bases and strong popular support, does not fall under control of the interim government in Kiev, and second, to send a message to the Ukrainian coalition being formed ahead of the upcoming elections in May, to take Russian interests seriously.

UBS reckons that in this situation, “we do not foresee further escalation of hostilities and no interruption of the flow of gas from Russia to Europe through the Ukrainian pipelines. A disorderly default of Ukrainian debt is avoided, but the IMF will likely require moderate private sector burden sharing”.

In the second scenario, to which the bank attaches a 40 per cent probability, Russian troops stay in the Crimea but an interim Ukrainian government is unable to successfully hold elections. The situation in the run-up to May 25 deteriorates as the legitimacy of the interim government is challenged, secessionist movements grow. Meanwhile, elections are postponed or cancelled. Russia's military remains alert and threatens Crimea military bases, but doesn't enter further into the Ukraine or clash with opposition forces. IMF negotiations fail and the country has to restructure its debt. Gas supply from Russia to Western Europe gets temporarily interrupted.

In the second scenario, Ukraine’s economy goes through a sharp recession and its currency falls, while the central banks runs out of dollars; there is a limited effect on the European Union. In this case, Ukraine defaults on Eurobonds; other payments are missed too. Debt restructuring with significant private sector burden sharing and oversight from the IMF takes place.

Third scenario
Under the third scenario, to which UBS gives a 10 per cent chance of happening, Russian troops advance to the interior of the Ukraine and a broad-based conflict unravels. Russian military is brought in to regain Kremlin control. Violence escalates as do tensions between Russia and the West. Secessionist movements in the Crimea grow, adding to theses tensions and increasing the risk of a country break-up. IMF negotiations fail and the country defaults on payments in June. Gas supply from Russia to Western Europe gets interrupted.

UBS said its base case is that Russian troops stay in the Crimea, the IMF provides emergency financing to Ukraine and elections take place in May. As a result, it expects Russian equities to recover from the sell-off of last week. In terms of sovereign bonds, it sees Russia remaining a solid sovereign with strong credit fundamentals.

As a result of its analysis, UBS said it is “comfortable” with Russian sovereign credit and see corrections as a buying opportunity.

“We would expect volatility in Russian corporate bonds to be elevated on the back of negative headline noise. We remain comfortable with holding bonds of the Russian majority state-owned banks and Gazprom to maturity, given the high probability of state support to be provided in case of need. We expect the Russian rouble to remain under pressure and trade largely in a range of 35.5 to 37.0 against the US dollar,” it said.

The bank points out that from an emerging markets viewpoint, the impact on emerging market investments as a whole is small. Ukraine's equities are not part of the benchmark EM equity index nor is its currency part of the EM foreign exchange index . The country’s government bonds represent 2.3 per cent of the EMBIG index and its corporate bonds account for just 0.45 per cent of that reference index.