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Ukraine Crisis: The Global Economic Fallout
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Ukraine Crisis: The Global Economic Fallout

The near term outlook is worrying

Post by on Monday, March 14, 2022

First slide

Call it a crisis, conflict, war whatever. It’s happening right now in Ukraine, and across the globe. Ukraine and Russia are fighting it out in a conventional military battle on the ground in Ukraine. The United States (US) and the European Union (EU) are extending outside support to Ukraine terms of arms and funding. Theyhave also embarked on a no holds barred economic war against Russia. It is indeed a world war of sorts.


There are merits and demerits of the positions. Death and destruction are rife. There is no way of knowing how this will end. Without going into any of the above, what is sure is however that this global level conflict will have gloomy economic consequences, regardless of the outcome of the fighting.


The US led coalition has imposed severe and unprecedented financial sanctions on Russia. It has in fact launched a whole-of-society economic war on Russia. Russian foreign exchange reserves (denominated in US dollars) have been frozen. Russian banks have been cut off from making interbank settlements through SWIFT, the global standard for the purpose. For the first time, private sector enterprises based in US/EU jurisdictions have been wielded as an economic weapon. Multinational tech giants like Apple and Tesla, credit card majors like Visa and MasterCard, consumer giants like McDonalds and Coca-Cola have all stopped operating in Russia.


Which way will this go? The costs of war are always immense, and will take a long time to overcome. Both the combatants, Ukraine and Russia, are going to get very messed up. Their GDP may contract by up to a third, according to some estimates. Ukraine is obviously suffering direct damage. For Russia too, the financial sanctions will cause considerable disruption. To trade or do business with Russia with these sanctions will become very difficult. The Russian economy, and the economies of countries that have significant trade with Russia, will be hit.


But these sweeping sanctions will also strike at the heart of the international capitalist order based on open global trade and business.  Now, mere ownership (e.g. of foreign exchange reserves) of assets does not mean control, it seems. Hitherto sacrosanct international and intergovernmental commercial contracts can be easily repudiated! The private sector too has to toe the line, at its own cost.


The ease with which the time-honoured rules of the game can be changed overnight by an American diktat is going to worry others outside the Western ambit. It will shake their confidence in the existing international financial system.  Today, Russia is the target. Tomorrow, someone else may be at the receiving end.

These developments may actually spur other major countries to look for independent alternatives to the Western financial system, (like a SWIFT substitute, or settlements in digital currency). This is something that hasn’t been seriously considered so far.


Globalization will reverse, and so will its projected benefits. For example, there is now a strong possibility of an increasing segmentation of world trade, communications and even the Internet after the crisis is over.


In the near term, the trade embargoes will impact commodity markets. The biggest impact would be on the oil market. Russia is a major supplier of oil and gas to Europe. So far Russian oil and gas supply to Europe has not been sanctioned. Sooner or later, these supplies are likely to be hit, exacerbating shortages. Already oil is trading at over $ 130 a barrel. Oil importers, including India and China, will have a tough time.


The food commodity market will also be in turmoil. Russia and Ukraine put together account for about a third of global wheat and corn exports. In edible oils, 80% of global sunflower exports emanates from these two countries. Supply shortages here will affect prices, and affect importing regions, as far away as Africa.


Russia is a significant fertilizer exporter. Fertilizer production in Europe is dependent on gas. There will be problems for the countries that rely on imported fertilizer such as Brazil and India.


The microchip shortages already plaguing global industry in 2021 will be prolonged. Russia is a major supplier of base metals like palladium, neon and platinum that are essential for microchip production. The automobile industry will be a prominent sufferer, across countries.


Though it is part of the economic offensive against Russia, Europe will also face a blowback effect of the sanctions. Europe is heavily reliant on Russian gas. Energy supply shortages are likely, and what is available will cost more. Germany has (for now) stopped the commissioning of the $ 11 billion Nord Strom II gas pipeline from Russia. If started, this pipeline would have made gas cheaper and more plentiful in Europe. Oil, gas, food and fertilizer shortages will lead to price rises and increase inflation.


For the EU countries, there is a dramatic increase in threat perception from Russia. This means that European countries will be spending a lot more on arms. For example, even normally hesitant Germany has declared that it will spend an additional $ 100 billion on armaments. It goes without saying that this would be at the expense of spending on development and welfare. Other EU countries will have to follow suit.



As a result, the US may gain in the short term. In Europe it has created a huge additional demand for the output of its weapons industry, as also for export of gas. At one stroke, it has successfully scuttled the growing European-Russian trade relationship, and strengthened its own economic links with European markets.


The longer-term economic fallout for the US is less certain. The weaponising of private sector entities may threaten their multinational credibility. The present defining of Russia as the “enemy” also means a dilution of focus on China. For the US, the principal economic, technological and military challenge in the future is still going to be from China. In reviving Cold War hostilities with gusto, maybe the US has taken its eyes off the ball.  This might cost it in the years to come, in ways yet to be foreseen.


Where does this leave India? Politically, India has been maintaining balance between the two sides. Regardless of its political positioning, the Indian economy will be adversely affected. The Japanese research group Nomura predicts that India will be the worst hit among major economies in Asia.


The biggest reason is that India imports 80% of its oil needs. The Union budget estimates were based on an oil price of $ 70-75 per barrel. Prices are already much higher. This gap will widen both the budget deficit and the trade deficit. The rupee will depreciate. Fertilizers and edible oils will also become costlier.


There is no easy way out. Prices will rise. Inflation is already at the upper end of the mandated 4-6% band. Sooner or later, the RBI will have to raise interest rates to dampen inflationary expectations. GDP growth is likely to be more modest than expected. There isn’t any immediate silver lining in the cloud.


As an ancient proverb puts it, it’s an ill wind that blows no good!



(The author is a former civil servant who has also served with the World Bank. He writes by invitation for RK)

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