How war in Ukraine threatens world’s economic recovery

How the war in Ukraine threatens world’s economic recovery

by: Samuel Shay, March 2022

NEW DELHI: Russia's invasion of Ukraine poses significant risks to a global economy still reeling from the effects of the virus. The fight appears to be Europe's most serious conflict since 1945. As residents fled, Russian forces carried out extensive airstrikes, grabbed army bases, and pushed toward Kyiv. According to Western sources, the capital might fall at any time now that its air defenses have been removed.

The attack came after weeks of tensions that had already shaken the global economy by rising oil prices. On Thursday, the pace picked up. Oil momentarily surpassed $100 per barrel for the first time since 2014, while European natural gas prices soared by as much as 62%.

What’s at Stake for the Global Economy as Conflict Looms in Ukraine

The global economy is about to be sent on yet another uncertain route by an armed battle on Europe's border, after being pummeled by the epidemic, supply chain chokeholds, and price jumps. The tensions were high even before the Kremlin ordered Russian troops into Ukraine's rebel territory on Monday. President Biden's threat of punitive measures in return, as well as the possibility of Russian reprisal, had already driven down stock returns and pushed up petrol costs. An open attack by Russian forces may generate dizzying price jumps in energy and food, stoke inflation fears, and frighten investors, posing a threat to global investment and growth.

Regardless of how severe the consequences are, they will be far less severe than the coronavirus's initial economic shutdowns in 2020. With 146 million people and a massive nuclear arsenal, Russia is a transcontinental behemoth as well as a major source of the oil, gas, and raw materials that keep the world's factories operating. Russia, on the other hand, is a modest player in the global economy, compared to China, which is a manufacturing powerhouse with sophisticated supply lines. With half the population and fewer natural resources, Italy boasts a twice-as-large economy. In comparison to Russia, Poland exports more items to the European Union.

"With the exception of oil and gas, Russia is incredibly irrelevant in the world economy," stated Jason Furman a Harvard economist who was an adviser to President Barack Obama. “It’s basically a big gas station.”

Of course, for those who rely on it, a closed gas station can be devastating. As a result, any economic harm will be unevenly distributed, with some countries and industries suffering greatly while others go unnoticed. Europe, which imports about 40% of its natural gas and 25% of its oil from Russia, is likely to be hit hard by increases in heating and gas prices, which are already high. With weeks of cold weather ahead, natural gas reserves are at less than a third of capacity, and European politicians have already accused Russia's president, Vladimir V. Putin, of restricting supplies to gain a political advantage.

Then there are food costs, which, according to a recent United Nations assessment, have risen to their highest level in more than a decade, owing partly to the pandemic's supply chain tangle. Russia is the world's largest wheat exporter, accounting for about a quarter of total worldwide exports with Ukraine. Some countries are significantly more reliant than others. This grain movement accounts for more than 70% of Egypt's and Turkey's total wheat imports.

This will put even more pressure on Turkey, which is currently in the midst of an economic crisis and dealing with near-fifty percent inflation, as well as increasing food, fuel, and energy prices. And, as is customary, the most vulnerable bear the brunt of the load. "Poorer individuals spend a bigger proportion of their income on food and heating," said Ian Goldin, an Oxford University professor of globalization and development.

Ukraine, long considered as Europe's "breadbasket," actually sells more than 40% of its wheat and corn to the Middle East and Africa, where fears of future food shortages and price hikes have sparked civil unrest. Lebanon, for example, is undergoing one of the most severe economic crises in recent memory, getting more than half of its wheat from Ukraine, which is also the world’s largest exporter of seed oils like sunflower and rapeseed.

On Monday, the White House said that it will begin imposing limited sanctions on the so-called Donetsk and Luhansk People's Republics in response to Mr. Putin's decision to recognize the independence of two Russian-backed areas in Ukraine's east. Mr. Biden would release an executive order restricting investment, trade, and funding with people in certain regions, according to Jen Psaki, the White House press secretary.

Analysts monitoring the situation have devised a series of scenarios ranging from moderate to severe. The impact on working-class families and Wall Street traders will vary depending on how the invasion unfolds: whether Russian troops remain near the border or attack Kyiv, the Ukrainian capital; whether the fighting lasts days or months; what kind of Western sanctions are imposed; and how long the fighting lasts; and whether Mr. Putin responds by withholding critical gas supplies from Europe or launching insidious cyberattacks.

"Think of it going out in stages," said Julia Friedlander, director of the Atlantic Council's economic statecraft initiative. "This is most likely going to be a slow-paced drama." Minor disruptions in one location might cause major disruptions further away, as the epidemic demonstrated. Isolated shortages and price increases in commodities like as petroleum, wheat, aluminum, and nickel can snowball in a globe still recovering from the pandemic.

"You have to consider the context in which this is occurring," said Gregory Daco, chief economist at EY-Parthenon. "Inflation is high, supply chains are tight, and there is uncertainty about what central banks will do and how persistent price rises will be." As a result, an invasion might have a twofold effect: reducing economic growth and destabilizing the economy.

The Federal Reserve in the United States is already dealing with the highest inflation rate in 40 years, at 7.5 percent in January, and is poised to raise interest rates next month. Higher energy prices triggered by a European war may be temporary, but they could fuel fears of a wage-price spiral. "We could witness a new burst of inflation," said Christopher Miller, an assistant professor at Tufts University and a visiting scholar at the American Enterprise Institute.

Possible shortages of critical metals such as palladium, aluminum, and nickel are also driving inflation fears, causing more disruption to global supply networks already strained by the epidemic, trucker blockades in Canada, and semiconductor shortages. Palladium, which is used in car exhaust systems, mobile phones, and even dental fillings, has risen sharply in recent weeks amid fears that Russia, the world's largest exporter of metal, maybe shut off from global markets. Nickel, which is needed to create steel and electric car batteries, has also been rising in price.

According to Lars Stenqvist, the Swedish truck maker's chief technology officer, it's too early to assess the precise consequences of an armed conflict. "It is a very, very serious situation," he added. Mr. Stenqvist said Monday, "We have a variety of alternatives on the table and we are following the situation day by day."

If Mr. Putin chose to react, the West has taken precautions to mitigate the impact on Europe. The United States has increased liquefied natural gas deliveries and has asked other suppliers, such as Qatar, to do the same. Some of the sanctions that the Biden administration is considering against Russia include shutting off Russia's access to the SWIFT international payment system or imposing a travel ban or blocking companies from selling anything to Russia that contains American-made components, which would hurt anyone who does business with Russia. But across the board, the United States is much less vulnerable than the European Union, which is Russia’s?largest trading partner.

As Mr. Biden has already stated, Americans can expect rising gasoline costs. However, because the United States is a significant producer of natural gas, the price rises are not as severe or as widespread as they are elsewhere. And Europe has a lot more ties to Russia and does a lot more business with them, including paying for Russian gas. Shell and Total have joint ventures in Russia, while BP claims that it is "one of the largest international investors in Russia," with ties to Rosneft, the Russian oil major. Russia supplies titanium to Airbus, the European aviation behemoth. Furthermore, European banks, particularly those in Germany, France, and Italy, have granted Russian borrowers billions of dollars.

"Severe sanctions that hit Russia deeply and thoroughly have the potential to do enormous harm to European customers," said Adam Tooze, head of Columbia University's European Institute. The most major repercussions on the global economy may not present themselves for a long time, depending on what happens.

So far, the war has damaged $100 billion in Ukrainian assets: official

According to a Kyiv government official, the Russian invasion has destroyed nearly $100 billion in roads, bridges, and enterprises in Ukraine, causing a massive economic hit.

"Roughly half of our enterprises are currently closed, and those that are open are not running at full capacity," said Oleg Ustenko, the main economic counselor to Ukrainian President Volodymyr Zelensky. "Even if the war ends immediately, the scenario in terms of economic development will be incredibly negative," he warned in a virtual speech to the Peterson Institute for International Economics.

By boycotting Russian oil and natural gas, Ustenko reiterated his appeal to European and other governments to cut off Moscow's access to "blood money." "Europeans continue to pay this monster to kill our people, innocent people," he claimed.

While European countries rely on Russian energy to stay warm, "I can promise you it's much, much, much colder in Ukraine's underground where the people are concealed." The source complimented the US for blocking Russian oil supplies and expressed optimism that the US will also assist in the creation of a "recovery fund" for Ukraine.

Kyiv may potentially tap into the roughly $300 billion in frozen Russian central bank reserves as a result of Western sanctions, as well as cash confiscated from oligarchs who are Putin cronies. He stated, "We have to reconstruct the economy." The International Monetary Fund approved $1.4 billion in fast-track help for Ukraine on Wednesday, and the World Bank released about $500 million of what is projected to be $1 billion in funding this week.

In addition, the US Congress authorized $14 billion in aid for Ukraine on Wednesday. Ustenko, on the other hand, stated, "More guns and ammunition are the most pressing needs. This is a significant point."

How Ukraine's War is Reverberating Throughout the World

The conflict represents a big setback for the global economy, causing growth to slow and prices to rise.

Aside from the misery and humanitarian disaster caused by Russia's invasion of Ukraine, the world economy as a whole will suffer from weaker development and higher inflation.

There will be three major channels via which the effects will be felt. One, increasing costs for commodities such as food and energy will drive inflation higher, diminishing the value of incomes and putting downward pressure on demand. Two, surrounding economies, in particular, will be affected by trade disruptions, supply chains, and remittances as well as a historic surge in refugee flows. And three, reduced business confidence and higher investor uncertainty will weigh on asset prices, tightening financial conditions and potentially spurring capital outflows from emerging markets.

Russia and Ukraine are important commodity producers, and the interruptions have driven up worldwide prices, particularly for oil and natural gas. Food prices have risen sharply, with wheat shipments from Ukraine and Russia accounting for 30% of global exports. Countries with direct trade, tourist, and financial exposures will face extra pressures in addition to global spillovers. Oil-importing economies would have larger budget and trade deficits, as well as increased inflation pressure, however, certain exporters, such as those in the Middle East and Africa, may gain from higher prices.

Increased food and fuel prices may exacerbate the danger of unrest in several countries, ranging from Sub-Saharan Africa and Latin America to the Caucasus and Central Asia, while food insecurity in parts of Africa and the Middle East is likely to worsen. It's difficult to predict how these reverberations will play out, but we expect our growth predictions to be revised downward next month when we release our World Economic Outlook and regional assessments, which will provide a more complete picture.

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Europe

In Ukraine, the toll has already been enormous. Unprecedented sanctions against Russia will stifle financial intermediation and trade, resulting in a deep recession in the country. The fall of the ruble is boosting inflation, further lowering people's living standards.

Because Russia is a major source of natural gas imports, energy is the primary spillover channel for Europe. Wider supply-chain disruptions could have serious consequences. These repercussions will exacerbate inflation and slow the pandemic's recovery. Eastern Europe will face increased finance costs as well as an influx of refugees. According to UN estimates, it has absorbed the majority of the 3 million refugees who recently evacuated Ukraine.

Additional spending on energy security and defense budgets could put an economic strain on European countries.

While foreign exposure to Russian assets is small by global standards, pressures on developing markets could increase as investors seek safer havens. Most European banks, likewise, have small and manageable direct exposures to Russia.

Caucasus and Central Asia

Beyond Europe, the recession and sanctions in Russia will have a wider impact on these bordering countries. Closer trade and payment-system ties will stifle commerce, remittances, investment, and tourism, wreaking havoc on economic growth, inflation, and the external and fiscal accounts. While higher international prices should benefit commodity exporters, energy exports could be harmed if sanctions are extended to pipelines through Russia.

Middle East and North Africa

Higher food and energy prices, as well as tighter global financial circumstances, are likely to have major consequences. For example, Egypt imports over 80% of its wheat from Russia and Ukraine. In addition, as a popular tourist site for both, visitor spending will decrease.

Policies aimed at containing inflation, such as increasing government subsidies, could put additional strain on already strained fiscal balances. Furthermore, worsening external financing conditions may encourage capital outflows and add to growth challenges for countries with high debt levels and significant financing requirements. In some nations, such as those with weak social safety nets, few job possibilities, limited fiscal headroom, and unpopular administrations, rising prices may exacerbate social tensions.

Sub-Saharan Africa

At a time when the continent was slowly recovering from the pandemic, this catastrophe jeopardizes that progress. Many countries in the region are particularly vulnerable to the war's consequences, owing to rising oil and food costs, diminished tourism, and the possibility of problems accessing international credit markets.

The dispute arises at a time when most governments have limited policy options to mitigate the shock's effects. This is expected to exacerbate socioeconomic pressures, public debt vulnerability, and scarring from the pandemic, which was already wreaking havoc on millions of homes and businesses.

Record wheat prices are especially worrying for a region that imports around 85% of its supplies, with Russia and Ukraine accounting for one-third of that.

Western Hemisphere

The main source of spillovers will be food and energy prices, which will be significant in some circumstances. High commodity prices are expected to accelerate inflation in Latin America and the Caribbean, which currently has an annual rate of 8% in five of its main economies: Brazil, Mexico, Chile, Colombia, and Peru. Central banks may have to defend their credibility in combatting inflation in the future.

Costly goods have a variety of growth consequences. Higher oil prices damage importers in Central America and the Caribbean, but exporters of oil, copper, iron ore, corn, wheat, and metals can raise prices to offset the impact on growth.

Financial conditions are still good, but escalating conflict may result in global financial turmoil, which, combined with stricter domestic monetary policy, will put downward pressure on growth. Although the US has little linkages to Ukraine and Russia, which dilutes direct effects, inflation was already at a four-decade high before the war pushed commodities prices higher. Once a result, as the Federal Reserve begins to raise interest rates, prices may continue to rise.

?Asia and the Pacific

Because of the absence of direct economic linkages, spillovers from Russia are likely to be modest, but slower development in Europe and the global economy will have a significant impact on key exporters.

The petroleum importers of ASEAN nations, India, and frontier economies, including several Pacific Islands, would see the most significant repercussions on current accounts. This could be exacerbated by a drop in tourism in countries that rely on Russian visits.

Because fiscal stimulus will support this year's 5.5 percent growth goal and Russia only imports a small percentage of China's exports, the immediate repercussions for China should be limited. Nonetheless, rising commodity prices and falling demand in major export markets add to the difficulties. Japan and Korea may experience similar spillovers as a result of additional oil subsidies. India's inflation will rise as a result of higher energy prices, which is already above the central bank's goal range.

Local production and greater dependence on rice rather than wheat should alleviate Asia's food price difficulties. Imports of high-priced food and energy will raise consumer prices, though subsidies and price restrictions for fuel, food, and fertilizer may mitigate the immediate impact—at a cost to the government.

Global Shocks

The consequences of Russia's assault on Ukraine have already shook not just those countries, but also the region and the rest of the world, emphasizing the significance of a global safety net and regional agreements to cushion economies.

At a recent press conference in Washington, IMF Managing Director Kristalina Georgieva said, "We live in a more shock-prone society." "And we'll need collective strength to deal with future shocks." While some effects may take years to manifest, there are already clear signs that the war and the resulting increase in the cost of essential commodities will make it more difficult for policymakers in some countries to strike the delicate balance between containing inflation and supporting economic recovery.

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