By Peter Apps, Political Risk Correspondent
Markets might have moved on after their initial shocked reaction to last year's Georgia war, but the legacy of the brief conflict remains that war in Europe is much less unthinkable than it once was.
Russia's stockmarket <.IRTS> lost roughly a quarter of its value in August 2008, while the cost of insuring sovereign debt in the credit default swaps market rose as far afield as Poland as investors reappraised regional risk.
The war had such market impact because it was so unexpected. Investors — and many analysts — had assumed that conflict risk in emerging Europe was close to zero.
The overnight outbreak of fighting in the disputed South Ossetia region shattered that, forcing an immediate reappraisal of the whole region.
It put in immediate focus on countries such as Ukraine — with its Russian-speaking Crimea region and base for Moscow's Black Sea Fleet — as well as other nearby "frozen conflicts" left over from the demise of the Soviet Union.
Such areas include the breakaway region of Transdniestria, a Russian speaking region demanding independence from Moldova, and Armenian-speaking Nagorno-Karabakh, a separatist area within Azerbaijan.
"The war came as a surprise to most people and focused attention on a lot of other potential conflicts," said Control Risks analyst Anna Walker. "It drew attention to countries with significant Russian populations, even Central Asian states such as Kazakhstan. It wasn't that people expected war, but it did make them more uneasy."
When a row erupted last year between Moscow and Ukraine over the Black Sea Fleet days into the war, markets reacted abruptly and Ukrainian CDS rose sharply as politics built on existing economic worries.
But a year later and in the aftermath of a global financial crisis that has hit countries in the region harder than most, markets have again moved on and are now focused on shattered economies rather than geopolitical tensions.
LOOKING ELSEWHERE FOR TROUBLE
When they worry about political risk, it is more likely to be over social unrest, labour disputes or policy risks linked to the wider crisis than conventional conflict.
When arguments broke out again around the Black Sea Fleet last month — with diplomats expelled and Ukrainian police halting Russian military vehicles — there were no discernible market movements at all.
"There was a strong initial reaction to the war," said Michael Ganske, head of emerging markets research at Commerzbank in London. "But markets are now looking at other things."
In part, that is because of the magnitude of the economic issues facing many of the countries in the region, which suffered more than most from the financial crisis.
Last month, investors in Ukraine had to contend with the announced restructuring of debts of state oil firm Naftogaz end questions over whether the International Monetary Fund (IMF) would continue funding the now-shattered economy.
Regional equity markets and most currencies remain significantly weaker than pre-Georgia levels, while CDS debt insurance premiums remain significantly higher.
Ukrainian credit default swaps are now quoted at around 1500 basis points, meaning it would cost $1.5 million a year to protect $10 million of five-year debt against restructuring or default — compared to 400 basis points last year before the war, implying heightened default risk.
Analysts say the sharp market reaction to the conflict was in part fuelled by factors well outside the war, from the beginnings of a global emerging markets sell-off sparked by a resurgent dollar to a string of perceived attacks on foreign investors in Russia.
SUMMER WAR RISK REMAINS
Some suggest there was also a knee-jerk overreaction.
"In the immediate aftermath, there were a lot of analysts saying things would escalate and Russia would take similar action in other regions such as Crimea but I think that was too quick an analysis," said Sabine Freizer, head of the Europe programme at International Crisis Group. "Russia wants to keep some of these areas unstable but that is not the same thing as intervening militarily."
A new U.S. administration trying to "press the reset button" in relations with Moscow is seen reducing further conflict risk, and the swiftness of the Russian victory is seen putting other former Soviet states off squaring off against their giant neighbour.
That means investors are, for example, likely to be less nervous that any new pro-western government in Moldova might spark a confrontation over Transdniestria.
Most analysts see a Russia weakened by low oil prices, slumping growth and rising unemployment as also reducing the risk — although some suggest it could also prompt Kremlin leadership to pick foreign fights to provide a distraction.
Certainly, few would now dare rule out any further war, most likely erupting over a summer period when better weather makes fighting ground wars more appealing.
"It is a risk that is always worth watching," said Joanna Gorska, deputy head of Eurasia desk at risk consultancy Exclusive Analysis. "But if we get through to September or October without anything, we are probably safe for another year."
