Russo-Ukrainian War: Economic Implications

On 24 February 2022, Russia launched a full-scale invasion of Ukraine. What started as Putin’s attempt to restore a geopolitical and strategic equilibrium between the East and the West has evolved into a severe war in, and for, Ukraine. Though Putin’s actions will be felt most acutely by Ukraine, the long-term impacts could end up being more global in their nature.

One need not have followed geopolitics too closely to be aware of tensions between Russia and Ukraine. The Russian military has been intervening in Ukraine since 2014, following mass protests that erupted across the country and resulted in the pro-Russian president being ousted. Soon afterwards, the newly-installed Ukrainian government made joining NATO, a Western military alliance, a priority. However, Putin has long viewed NATO as a threat to Russian security as Ukraine shares territorial borders with Russia. ?

As Putin’s grip on Ukrainian politics weakened, he made the impulsive decision to annex Crimea, a peninsula in the southern part of Ukraine. Shortly after, he backed separatist groups in the mainly Russian-speaking regions of Donetsk and Luhansk in the east of Ukraine.

Over the last few years Russia has continued to escalate tension by building up its military forces in and around Ukraine, using false narratives to justify its military presence. On 24 February Putin took the final step and launched the largest military assault seen in Europe since World War II.

In response to the invasion, almost all Western countries announced powerful sanctions against Russia. Even Switzerland, traditionally neutral in geopolitics, aligned with the European Union’s response. So far, sanctions have included the freezing of assets owned by Russian businesses and financial institutions (including their central bank), the removal of some Russian banks from the SWIFT payment system as well as restrictions on accessing foreign financial markets.

Even before Western governments announced sanctions, many global companies started withdrawing staff, business relationships, and credit from Russia-affiliated companies and individuals. Trade with Russia has also stopped on several fronts following an embargo on goods such as semiconductors, telecommunications equipment, oil extraction machinery, and aircraft maintenance parts.

The UK and US have gone so far as to reduce imports of Russian oil, although the UK’s ban will not come into force until the end of this year. The EU’s significant reliance on Russian oil imports, around 30% of their supply, makes any decision to stop Russian imports harder to achieve.

The impact of these sweeping sanctions has created significant turmoil in the Russian economy. At the time of writing, the Russian Ruble has fallen over 22% against Sterling, Moscow’s Stock Exchange initially fell 35% before trading was suspended (trading on most stocks is still suspended). Yields on 10-year Russian government bonds have spiked from 8.4% at the end of 2021 to over 13%.

Due to the sanctions, the Russian central bank is unable to use all its $630 billion in foreign currency reserves and it has had to raise interest rates to 20% to defend their currency. Inflation in Russia, which is already at 12.5%, is expected to increase significantly due to a lack of basic goods. As the situation deteriorates there is further uncertainty as to whether the Russian government will be able to meet upcoming payments on its foreign-issued bonds.

Despite the geopolitical situation, Russia is still very integrated into the global economy and the economic costs of sanctions have already begun to trickle down into the broader financial markets. Many of these impacts are being felt in commodities markets.

Russia is a major producer of oil and gas and over the years European countries have become increasingly reliant on it. In response to the recent conflict, many countries will try to pivot away from this dependency and move towards more renewable sources of energy. However, this will take time and nations that have their own resources will have an easier transition.

Not only is Russia one of the biggest producers of oil and gas, but the Russo-Ukrainian market is one of the biggest exporters of ferrous metals, fertilizers, and crops - particularly wheat and barley. In a world that is already having to deal with higher inflation due to supply shortages, rising prices of commodities will only increase inflationary pressures.

Ultimately, this will create more pressure on central banks to raise interest rates more quickly than originally expected, and we have already seen the US Federal Reserve change its stance and talk more aggressively about combating inflation with tightening monetary policy going forwards.

However, central banks must move carefully. They have the difficult task of slowing growth to combat higher inflation by raising interest rates, while also accounting for the fact that higher commodity prices themselves will simultaneously act as a drag on demand. These two factors combined could end up being enough to tip the global economy into a recession.

So far, sanctions introduced by the West have not been enough to persuade Putin to cease his offensive. It seems that for someone like Putin, the economic costs do not factor into his calculus by any meaningful degree. However, the cost to the Russian economy and his ability to fund the military will only worsen over time and potentially become unbearable to the Russian people and Putin’s supporters. ?

Regardless, the economic cost pales in comparison when we consider the humanitarian impact of the conflict. So far, 3.5 million Ukrainians have fled their country.

There are now some glimmers of hope that negotiations will bring the conflict to a halt soon. However, in the meantime, those opposed to his actions are using all means necessary to stop him, while avoiding direct military confrontation and the potential use of nuclear weapons.

Written by Artem Dubas