Flight MH17: Sanctions impacts on Russia and the wider business environment

The horrific news last week of the shooting down of Malaysia Airlines flight MH17 over Eastern Ukraine served to highlight how the world can be drawn into conflicts that often seem distant from our everyday lives.

Earlier this year we wrote about the potential impact sanctions would have on the Russian business environment following Russia’s annexation of the Crimean peninsula. The global response to Russia’s brazen incursion and takeover was tepid – a few half-hearted sanctions against a few members of the Russian government.

The shooting down of an international airliner is a shocking development that has once again turned attention back to the region; the alarming rise of ISIS in Iraq and the latest flaring of the decades long tensions in Israel and Gaza had drawn international focus away from Ukraine.

So what, if anything, will likely happen in the Russian and Ukrainian business environment and what should firms do to protect themselves from business impact?

  • The Russian economy is being severely impacted by its growing isolation. Recent economic data showed the Russian economy was at a standstill in the second quarter relative to the first quarter. And in the first quarter it contracted 0.5%. Russian companies involved in financial services, energy, chemicals and property could all be adversely impacted, potentially exacerbating the already sluggish economy. These conditions can in turn lead to reduced demand for mobile devices. It is worth noting that the Russian handset market was already forecast to be marginally down year on year in 2014. This conflict will potentially exacerbate the market’s inherent weakness. We will be tracking the impact of the crisis and may adjust down our forecast for Russia still further.
  • Russia is one of the world’s largest suppliers of oil and natural gas. It is also a supplier of chemicals for industry. Any sustained disruption to fuel supplies from Russia, or even the threat of it, will cause commodity prices to spike upward. The price of crude oil rose to the highest level in 6 months on 3rd March, fell back as tensions between Russia and the West eased, but spiked again on the news of flight MH17. The consequence of a sustained increase in commodity prices will be to increase the cost of business for players in the mobile device supply chain. It will also drive up costs for consumers. With fuel for heating and cooking accounting for as much as 30% of disposable income for the poorest segments in society, these people will be forced to curtail spending on other goods including mobile services and devices. This is an impact we saw in the aftermath of the financial crisis in 2008/9. The result will be reduced demand for ultra-low cost handsets and even some of the low cost smartphones.
  • Preventing companies from doing business in Russia. Russia imports all mobile devices sold in the country from overseas suppliers. If sanctions are applied broadly that hinder this supply line, companies with significant market positions in Russia will be adversely affected. Russia has a more diverse competitive landscape than some markets, nevertheless Samsung, Apple and Nokia (Microsoft) would bear the brunt of any sanctions that restrict their ability to supply into the Russian market.
  • Political and economic turmoil: Russia is a major player on the world stage. Throughout the Cold War the threat of destructive military activity maintained an uneasy truce between the global superpowers. In the roughly 25 years since the cold war ended, the world has changed dramatically with global trade becoming the accepted norm for nations and businesses. A return to the bad old days would have grave implications for economic activity.
  • Currency fluctuations: The Russian Ruble is down ~7% against the dollar year to date. The Russian central bank has spent billions propping up the currency, but it remains at risk of further declines. Most handsets are likely traded in dollars but the final sale to consumers is typically in Rubles. Extended periods of weak Ruble can lead to the consumer price increasing. Mobile device purchases are price elastic so demand will decline if prices go up, or consumers will switch to cheaper models. Either way the net impact is negative.

Bottom-line: given that the sanctions applied against Russia following the annexation of Crimea turned out to be more limited than we originally expected, we doubt the impacts of sanctions now will be significantly more dramatic. There may be limits placed on the sale of defence related products and services to Russia, but it is unlikely sanctions will be applied more broadly – for example to telecom-related products.
Depending on the diplomatic developments there may be an escalation in tension between Russia and the West. Any company with significant business interests in the region, if they haven’t already, should develop contingency plans for a range of eventualities.