How will the war in Ukraine, and sanctions against Russia, affect the global economy?

By Roxy Kharachko

The Russia-Ukraine war caused a turmoil in the financial markets and increased the uncertainty about the recovery of global economy. Currently the world is facing a stagflation shock, but this one is less violent that the one in 1973-1974.

Before analyzing the global economy, let us first talk about Russia. Russia is the world’s third largest producer of oil, the second largest producer of natural gas and one of the five largest producers of steel, nickel, and aluminum. It is also the largest exporter of wheat in the world (almost 20% of world trade).

Moving away from the Western world, Russia is beginning to destroy the modern, outward-looking part of its economy. Excluded from the international financial system and subject to a partial embargo on American and European imports, from technology to aircraft parts, it has entered the inflation and depression, and the ruble has lost 32% of its value since the beginning of the year (72% since the annexation of Crimea). The state is still benefiting from the continued sale of oil and gas to Europe, despite all that is happening in Ukraine.

The sanctions target Russia’s major banks, Russia’s central bank, Russia’s sovereign debt, individual Russian government officials and oligarchs, and export controls on high-tech components to Russia. These measures put significant downward pressure on the Russian ruble, which has already fallen, and caused the consumer price inflation.

In case of a prolonged occupation of Ukraine, the Russian economy will shrink forever. For Russia, the future is not completely closed. If a satisfactory agreement is reached quickly, the sanctions that are currently hitting the heart of the Russian economy could be lifted. In this case, the shock will be relatively temporary and the economy will recover (in many years). However, in the event of a prolonged occupation of Ukraine, the Russian economy will shrink forever. Based on the sanctions already in place, the IMF predicts that Russia’s GDP will fall at least by 7% in 2022. Putin’s strategy is leading Russia into a prolonged depression with a steady loss of 15% to 20% of production and a reduction in real incomes of at least that much. Back to global economy: on the day of the invasion, financial markets around the world fell sharply, and prices for oil, natural gas, metals and food rose. After recent events, Brent oil prices exceeded the mark of 100 US dollars per barrel for the first time since 2014. Due to its dependence on Russian oil and natural gas, Europe appears to be the region most prone to the consequences of this conflict. It is impossible to replace all Russian natural gas supplies to Europe in the short and medium term, and the current price level will have a significant impact on inflation. Although Germany, Italy and some Central and Eastern European countries are more dependent on Russian natural gas, the trade interdependence of the eurozone countries indicates a general slowdown. In the rest of the world, the economic consequences will be felt mainly due to rising commodity prices, which will fuel the already existing inflationary pressures. As always, as raw material prices rise, net importers of energy and food will suffer particularly, in the event of an even greater escalation of the conflict with the specter of serious supply disruptions. Declining demand from Europe will also hamper world trade. In the Asia-Pacific region, the impact will be felt almost immediately through rising import prices, especially energy prices, with many countries in the region being net energy importers, led by China, Japan, India, South Korea, Taiwan and Thailand. As North America’s trade and financial ties with Russia and Ukraine are rather limited, the impact of the conflict will largely be felt through the price channel and slowing growth in Europe. Despite the prospect of slowing economic growth and higher inflation, recent geopolitical developments at this stage are not expected to disrupt monetary policy in North America.