The sustainable investor for a changing world

Geopolitical shocks compound long-term systemic risks for sovereign issuers

The war in Ukraine has acted to exacerbate or complicate more fundamental and pervasive climate change and energy risks for sovereigns, argues Malika Takhtayeva.

As we are all well aware, the war is having significant effects on financial and commodity markets – and economies – worldwide.

In a recent blog article, we explored how the crisis is affecting food supplies and how it could impact longer-term food sustainability.

However, as can be seen from the UN Food and Agriculture Organization’s food price index (see Exhibit 1), rising food prices were already an issue before the conflict.

Exhibit 1: Food prices were rising before Russia invaded Ukraine (index; 2014-2016 = 100)

Annual FAO food price indices; source: FAO, June 2022.

Recent price shocks sit on top of an inflationary trend that we believe would have persisted over 2022 anyway due to unfavourable climate change-related weather conditions and the increasing cost of fertilisers and energy needed for food production.

These inflationary pressures highlight the need for governments to better respond to physical climate risk and to look to alternative methods of food production.

Recent physical climate hazards have included a major drought in the US wheat-producing state of Kansas and significant water scarcity in the Middle East, Africa, South America and Asia.

Population growth and dependency on imports have left authorities in these regions particularly vulnerable to food insecurity and they are under pressure to act. India, for example, has banned wheat exports after a record-breaking heatwave.

These strains are expected to grow. The UN recently highlighted the extent to which climate change may increase the length, frequency and severity of droughts, with water scarcity expected to affect twice the number of people in 2050 as it does today.

This is not just about crops. In California, where snowpack is significantly smaller this year than normal, water shortages will likely limit hydropower and other power generation capacity. Furthermore, a higher incidence of wildfires has threatened communities and livelihoods and could cause billions of dollars in damage.

Energy crunch

Even before the war in Ukraine, governments faced rising energy prices and a global energy supply crunch as economies bounced back amid a surge in post-lockdown demand.

Demand for energy was met mostly by fossil fuels, leading to steeply higher CO2 emissions. The greater use of coal was the main factor driving up global energy-related emissions by over two billion tonnes in 2021 – the largest ever year-on-year increase in such emissions in absolute terms.

Sanctions on Russia have highlighted the dependence of many EU countries on Russian energy, natural gas in particular. While the EU has agreed on phasing out Russian oil, gas will be harder to replace. In the absence of adequate renewable energy or electrification technologies, energy security concerns are pushing against decarbonisation and net zero goals.

Renewables may be increasing rapidly in the electricity sector, but, as REN21 highlights in its Renewables 2022 Global Status Report, renewables still account for only 12.6% of total final energy consumption (i.e. incorporating transport, heating and cooling), and only 4% in the transport sector, which represents a third of overall energy use.

This has left EU sovereigns looking to hydrocarbon exporters other than Russia; however, some alternative suppliers have questionable human rights records, including many in the Middle East.[1] In fairness, we should note while that physical climate risks are pervasive across the globe, it is also clear that for oil & gas producers these risks are more severe.

While the need for accelerated investment in green infrastructure and renewables as solutions to energy dependency are obvious to us, there is also the reality of governments having to accept trade-offs and compromises to safeguard energy security and diversify supplies away from Russia.

These have included the greater (and longer) use of coal-fired[2] or nuclear power plants, or efforts to get closer to oil-rich countries or gas exporters that are known to have disregarded democratic principles or crushed dissent. For example, the recent rapprochement between the US administration and Saudi Arabia or EU efforts to source liquefied natural gas from Qatar[3].

Arguably, such ‘leniency’ could be seen as undermining governments’ ESG credentials.

Social and political risks

Higher prices for energy and food look set to affect government finances – for example, through a deterioration in the balance of payments.

This saps the ability of governments to deal with macroeconomic challenges and existing fiscal imbalances. It could also lead to social and political upheaval, including possibly violence and rioting reminiscent of the food riots in 2007-08 and 2011-12.

Such events underscore the close relationship between food insecurity and conflict, and have led to growing interest in how food and energy price shocks – as well as competition for natural resources including water – can contribute to political instability and social unrest.

We note that social unrest can have real, adverse effects on the economy. IMF research has found that 18 months after significant unrest, GDP is still around one percentage point lower than it would otherwise have been.

The IMF’s Reported Social Unrest index is now close to its highest level since the start of the pandemic. According to the Global Conflict Tracker, there are 27 conflicts and wars currently taking place in the world.

In summary, we believe issuers of sovereign bonds face large environmental, social and governance (ESG) risks – in particular, countries with high food import costs (see Exhibit 2), weak governance frameworks, and an already negative exposure to social risks.

Source: WITS

While the war in Ukraine has resulted in price shocks, more fundamental drivers – including climate change and energy costs – need to be addressed to limit inflation-related risks for sovereigns and, by extension, fixed income investors.


[1] The UN tracks progress on human rights including tracking the number of international human rights treaties that countries have ratified; also see – OHCHR Dashboard  

[2] See for example ‘Bitter but necessary’: Germany turns to coal to replace Russian gas | Climate News | Sky News, Germany restarts coal power stations as Johnson rival attacks ‘incoherent’ energy taxes (, Poland, Ukraine increase 2022 coal production to weather cold months | Reuters  

[3] See for example Qatar’s human rights record examined by UN Member States in Universal Periodic Review | MENA Rights Group 


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