With this article and the next one, we shall use the instability and conflict in Ukraine and the related impacts on businesses to continue enhancing our understanding of the way businesses and the corporate world could usefully anticipate or foresee geopolitical and political risks and uncertainties.
Here we shall review two major impacts of the war in Ukraine. First we shall look at the surprising cost of sanctions related to Ukraine on businesses of sanctioning countries. Second, we shall move to the multiple impacts of the downing of Malaysian Airlines flight MH17. With the forthcoming second part, wondering how a firm could have avoided or to the least mitigated these impacts, we shall use what we learned to identify main lessons to improve strategic foresight and warning, anticipation and risk management of geopolitical and political risks and uncertainties for the corporate sector. These will thus be added to the points previously identified in “Lessons from and for the Brexit – Geopolitics, Uncertainties, and Business (2)”, after a general framework was defined in “Businesses and Geopolitics: Caught up in the Whirlwinds?” (1).
Our aim with this series is to offer tools, answers and solutions that should help businesses to properly address these very specific “risks” and uncertainties. These will also be integrated within the ways through which the Red (Team) Analysis Society serves the corporate sector, besides, more classically, governments, state apparatus and NGOs, be it through its open access articles (find out methodological and topical articles on the front page and through the menu), its membership only resources, its consulting or its training.
The surprising costly impact of sanctions related to Ukraine on businesses
The impact and cost of the Ukrainian conflict on businesses extraneous to the zone and the conflict have been, most often, envisioned from the perspective of those impacts stemming from the sanctions inflicted upon Russia by Western countries and partners, as well as from the Russian retaliation embargo on various products. As with so many topics, notably when addressing sensitive issues were various interests are at stake, there is debate.
Was trade lost as a result of sanctions against Russia?
On the one hand, some point out that sanctions did not negatively impact the sanctioning countries. For example, Daniel Gros and Federica Mustilli (“The Effects of Sanctions and Counter-Sanctions on EU-Russian Trade Flows“, CEPS Commentary, July 2016) suggest that hardly any negative effects could be felt, the lowering of exports to Russia stemming from the oil price related Russian recession and not from the sanctions. However, they neglect negative feedback effects within the Russian economy, between sanctions and other economic factors, as well as the likely role of the tension between the West and Russia in the geopolitical factors leading to low oil prices (JM Valantin, “Oil Flood (2) – Oil and Politics in a (Real) Multipolar World“, The Red (Team) Analysis Society, 12 January 2015). Similarly, Marcin Szczepański’s study for the European Parliamentary Research Service (access pdf, October 2015) finds that “the European economy is resilient to the adverse effects of falling trade with Russia. Importantly, the EU’s financial sector is not considered to be systemically threatened by its exposure. The most visible direct effect is the substantial fall in EU agri-food exports to Russia. The losses are, however, mitigated to a large extent by redirecting exports to alternative markets”.
On the other hand, a much more detailed study, using notably detailed customs data, including at firms level – which heightens the relevance of this work from a corporate sector’s point of view – argues otherwise. According to Matthieu Crozet and Julian Hinz (Collateral Damage: The impact of the Russia sanctions, CEPII Working Paper, No 2016-16,June 2016 – see a shorter version on Voxeu.org), the cost of the Ukrainian conflict, in terms of sanctions against and embargo from Russia was estimated to a trade loss of USD 60.2 billion from 2014 until mid-2015 for the 37 sanctioning countries (p.5). “The European Union bears 76.7% of all lost trade and 78.1% of lost trade in non-embargoed products” (p.23).
We are not talking here of quasi-virtual losses, resulting from market movements, which may convert into gain after a couple of days or weeks of buoyancy on world stock exchanges as in the much touted mammoth “losses” following the announcement of the Brexit vote (see “Lessons from and for the Brexit“). The losses here are real, materialised.
The impact of the sanctions ran based on a pattern which follows the start of new rounds of different types of sanctions. During the period of the “smart sanctions”, aimed at individuals and “select Russian financial institutions”, “Between March and July 2014, total exports of EU countries (excluding France) dropped by an average of 13.8% (France 20.6%)”. With the so-called “third wave” of sanctions, when “not only … Russian individuals and entities [were] targeted, but European entities were restricted from exporting certain goods and buying certain Russian assets”, implemented by the U.S. on 17 July 2014 and by the EU on 31 July 2014, total exports of EU countries started falling more strongly. Since August 2014, they “(excluding France) dropped by an average of 24.9% (France 26.7%). While French exports of embargoed products since the imposition of economic sanctions in August 2014 decreased by less than EU average (EU 89.2% and France 81.9%), those of non-embargoed products were hit relatively harder (EU 14.2% and France 20.7%) (Ibid. pp. 8-10; 15-16).”
The financial sanctions against Russia and their unexpected impact… on exports
Furthermore, in a very interesting way, especially for our purpose, this study uses French firms detailed data to evaluate the effects on companies. If businesses behave differently according to countries, indeed if each company is unique, this will give us nonetheless elements to better assess geopolitical impacts on businesses. Crozet and Hinz show that
“Sanctions have decreased the individual firm’s probability of exporting to Russia, the value of shipments, and their price. … trade finance is found to best explain the stark decrease in French firms’ exports” (Ibid., p.5).
They find out that neither “an abrupt change of Russian consumers’ preferences resulting from a spontaneous boycott of Western products in reaction to the diplomatic gridlock”, nor “a sudden rise of economic, political, and legal instability that hindered business to do business in Russia or with Russian firms” – which somehow also contributes to counter Gros and Mustilli thesis – led to the drop of export of non-sanctioned or embargoed products. What the authors find out is that the “financial sanctions, i.e., restriction on dealings with Russian financial institutions, generated a disruption of the financing of trade” (pp. 32-41), which also contradicts Szczepański’s conclusions.
Finding easily compensating markets for businesses exporting to Russia?… Think again
Finally the authors point out that companies could not find other markets to compensate for their losses.
“Firms that exported to Russia before the events, were not able to fully recover their lost trade by shifting to other markets. On the contrary, … those firms that exported agricultural and food products targeted by the Russian embargo saw their total exports decrease by 24.3 %…. The results for non-embargoed products also saw a significant decline of total exports of firms caught up in the Russian turmoil… The total export values for these firms (row 5) decreased by on average 12.3 % and total export quantities by 7.6 %.”(pp. 44-45).
As the authors of the study conclude, “Overall, trade diversion effects remain insignificant or very small in magnitude” (p. 48), i.e. the loss resulting from the Ukrainian conflict via tensions with Russia was not compensated by anything.
Furthermore, what these already negative findings hide, is that, notably for small and medium-size enterprises, even more so for already fragile relatively small farming businesses, such drops in exports may imply tragic consequences, from becoming cash-strapped up to bankruptcy. On the other hand, large firms with joint-ventures or branches already set-up in Russia, e.g. Safran, or Total Russia, or large companies in sectors such as aerospace and defence (e.g. Frost and Sullivan, “Russia-Ukraine Crisis and the Impact on the Aerospace and Defence Industry“, March 2014, an updated in-depth study would be necessary here) are much less susceptible to be hurt by sanctions.
As already mentioned in our previous articles, impacts, first and foremost, depend on each company’s situation.
What about companies from other countries?
Although a detailed specific study would be needed here, we can identify a few trends and elements.
The start of the Russian embargo on agricultural products was immediately followed by a flurry of global attempts to capture the Russian market finally freed from the notably European competitors (see Helene Lavoix, “An Isolated Russia? Think Again!“, RTAS, 15 September 2014). These exports most probably also had to face the burden of Western financial sanctions, but it would be worthwhile further researching in-depth how dynamics developed and the current state of affairs. Meanwhile, Russian agri-businesses, according to Deloitte, Current status and Strength in Russian Agribusiness, 2015, saw the opportunity to develop further local production. As a consequence, competition in the agribusiness would only be heightened, with the appearance or strengthening according to cases of Russian companies.
If some Chinese banks and firms also lowered business deals with Russia as a result notably of financial sanctions, cooperation through different financial constructions and entities developed, which could have a long-lasting impact in favouring business deals between Chinese and Russian firms (Alexander Gabuev, “Did Western Sanctions Affect Sino-Russian Economic Ties?“, China Policy Institute, republished by Carnegie, 26 April 2016; Xufeng Jess, “The “New” Russia-China Relations -Implications for the EU“, Eu-Asia Center, 22 June 2015). Indeed, projects and cooperation in Russia involving Chinese firms not only have not stalled by progress (JM Valantin, “The Warming Russian Arctic: Where Russian and Asian Business and Strategies Converge?“, RTAS 21 Nov 2016). For example, even though we are only at the stage of pledges, nine Chinese companies are planning to invest in twenty projects in the Russian Far East for close to USD 3 billion (Sputnik, 21 Nov 2016).
Overall, if we translate in the labels put forward by McKinsey’s 2016 survey (see Ibid., Caught up in the Whirlwinds?“) as depicting businesses geopolitical concerns, as a result of “instability” (indeed war), specific “restrictions on trade” were implemented that seriously impacted directly firms operations and cash-flow, while the framework and context within which companies evolve has changed, not only as far as Russia is concerned but also beyond, by reinforcing competitors, by allowing new business ties to be created or by starting generating new systems notably in terms of financing.
War is violent and tragic: multiple impacts of the downing of a civilian aircraft
A second range of impacts, which is most of the time ignored, is related to the loss of a civilian aircraft as it was flying over a war zone, the Donbass in Ukraine: Malaysian Airlines MH17 downing (e.g. BBC News, “MH17 Plane Crash: What we know“, 28 Sept 2016).
That a plane could fly over a war zone where missiles could be fired and where military planes operated (“Setting the stage“, Ibid., and more generally Portal to the War in Ukraine) shows, first, the absolute lack of understanding and awareness of what war means for some businesses. The loss of lives was a tragedy. It was translated in a USD 54.5 million compensation payment to families, as cost for the airline (Robyn Ironside, “MH17: Malaysia Airlines could be sued over flight path“, news.com.au, 20 Sept 2014). To that must be added costs in terms of rescue and search operations, which amount for both the MH370 and MH17 to USD 10 million (Jonathan Vankin, Inquistr, 13 Nov 2014), as well as most probably of loss of potential future passengers. Indeed, having already not made any profit since 2010, Malaysia Airlines was declared “technically bankrupt” by its CEO in June 2015 and embarked on a re-branding and restructuring journey, laying off 6000 jobs (Ravender Sembhy, “MH370 and MH17: How Malaysia Airlines is trying to bounce back from double tragedy“, IBT, 30 July 2015).
Second, other impacts may also be identified. Although aviation insurance rates were initially thought to increase (up to 300% for aviation war risks reinsurance and 100% for primary aviation war risks – see International Union of Aerospace Insurers, A Guide to Aviation Insurance, 2012; Sarah Veysey, Aviation insurance rates set to rise at renewals after slew of airplane losses“, Business Insurance, 3 Aug 2014), the particulars of this specific market meant that premium levels finally hardly changed, which does not preclude much larger impacts for concerned insurance brokers and lead reinsurance company.
Positively, most airlines started – or continued – re-routing their flights out of war zones, to avoid the fate of Malaysia airlines. For example, using one of the main providers of synthetic advice to airlines regarding the “Overflight of Conflict Zones”, the French Services de l’Information Aéronautique (SIA), (e.g. Overflight of conflict zones RUN A 2016-06 – see also links to some of these notices, as published by various countries, mainly France, the U.K. and the U.S., as available through the U.N. ICAO Conflict Zone Information Repository), we see that, for example. Ukraine, Libya, Iraq and Syria, Afghanistan or Yemen are considered in whole or in part as dangerous. The new routes that planes must take, as shown below for flight UAE9370 “Emirates” between Oslo and Dubai on 15 Nov 2016, are thus not anymore direct, with supplementary cost in terms of time and fuel.
Yet, most probably for various diplomatic reasons some zones which are known to be at war are not included in this list. For example, the Sinai region in Egypt, under attack from the Islamic State as it is considered as one of the Khilafah wilayat, wilayat Sinai, is not part of this list (e.g. Helene Lavoix, “Understanding the Islamic State’s System – Structure and Wilayat“, RTAS, 4 May 2015, updated 22 Feb 2016). This “omission” likely stems from considering Egypt needs for tourists and related income. As a result, we witnessed again, on 31 October 2015, the other tragic downing of a civilian plane, Metrojet Flight 9268 operated by the Russian airline Kogalymavia (see related Wikipedia article).
Similarly, no area located on the Malian territory, despite a complex and highly dangerous situation there, is included in this list (e.g. Reuters, “Mali Islamists say still waging war, dismiss ceasefire report“, 2 Nov 2016; Michael Tutton, The Canadian Press, “Canadian troops, helicopters needed in dangerous Mali mission: top UN official“, Star.com, 18 Nov 2016; AlJazeera English, “Mali holds long-delayed polls amid security fears“, 21 Nov 2016; Caleb Weiss, “Ansar Dine claims string of attacks across Mali“, The Long War Journal, 7 Nov 2016). In that case, the “omission” is probably also linked to the “communication policies” of the French – Operation Barkhane covering the Sahelo-Saharan region – and U.N. – the MINUSMA – missions, meant to support and help to stabilise and construct peace in the region.
If we use again the live flight tracker of FlightAware, and although it does not cover in detail all regions (the grey line on the map for individual flights – see details here and last map below related to coverage), we see on the first map below that a couple of planes are about to fly over Malian territory, or just left its airspace. For example, Turkish airlines flight THY625, flying to Lagos had to re-route west of Libya, but flies over Mali. (Note that we cannot know if three planes are indeed flying over southeast Libya, because of the absence of coverage for a large part of Africa – see coverage map below).
Thus, if airlines do not take specific measures, checking themselves which zones are safe or potentially dangerous, they are increasing the odds to know a fate similar to Malaysia Airlines. The problem should similarly concern most businesses of the tourist industry dealing with transportation of passengers, as well as logistics and transportation companies.
The impacts of the instability in Ukraine, from the Euromaidan crisis to Crimea to the war in Donbass on the corporate world are thus numerous, varied and evolving in time. Next, with the forthcoming second part of this article, we shall learn from them and identify lessons to practically improve strategic foresight and warning, anticipation and risk management of geopolitical and political risks and uncertainties for the corporate sector.
About the author: Dr Helene Lavoix, PhD Lond (International Relations), is the Director of The Red (Team) Analysis Society. She is specialised in strategic foresight and warning for national and international security issues.