Ukraine Crisis: The Global Economic Fallout

posted on March 14, 2022 | Author Dr. RAJAN KATOCH

Call it a crisis, a conflict, a war, whatever. This is happening right now in Ukraine and all over the world. Ukraine and Russia face off in a conventional military battle on the ground in Ukraine. The United States (US) and the European Union (EU) are extending their external support to Ukraine in terms of armaments and funding. They have also embarked on a merciless economic war against Russia. It is indeed a kind of world war.

There are merits and demerits of positions. Death and destruction are commonplace. There’s no way of knowing how this will end. Without going into the details above, what is certain is that this global conflict will have dire economic consequences, regardless of the outcome of the fighting.

The US-led coalition imposed severe and unprecedented financial sanctions on Russia. He actually launched a society-wide economic war against Russia. Russian foreign exchange reserves (denominated in US dollars) were frozen. Russian banks have been prevented from making interbank settlements via SWIFT, the global standard for this purpose. For the first time, private sector companies based in US/EU jurisdictions have been used 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 ceased operations in Russia.

Which direction will this go? The costs of war are always immense and will take a long time to overcome. Both fighters, Ukraine and Russia, are going to be very upset. Their GDP could contract by up to a third, according to some estimates. Ukraine is clearly suffering direct damage. For Russia, too, the financial sanctions will cause considerable disruption. Trading or doing business with Russia under these sanctions will become very difficult. The Russian economy and the economies of countries that have significant trade with Russia will be affected.

But these sweeping sanctions will also strike at the heart of the international capitalist order based on open trade and global affairs. Now, mere ownership (eg 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 must also toe the line, at its own expense.

The ease with which age-old rules of the game can be changed overnight by American diktat will worry others outside the Western framework. This will shake their confidence in the existing international financial system. Today, Russia is the target. Tomorrow someone else may be at the reception.

These developments may in fact prompt other major countries to seek independent alternatives to the Western financial system (such as a SWIFT substitute or digital currency settlements). This is something that has not been seriously considered so far.

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

In the short term, 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 supplies to Europe have not been sanctioned. Sooner or later, these supplies are likely to be affected, exacerbating shortages. Oil is already trading at over $130 a barrel. Oil importers, including India and China, will face a difficult period.

The market for food raw materials will also be in turmoil. Russia and Ukraine together account for about a third of world wheat and maize exports. In edible oils, 80% of world sunflower exports come from these two countries. Supply shortages here will affect prices and affect importing regions, all the way to Africa.

Russia is a major fertilizer exporter. Fertilizer production in Europe depends on gas. There will be problems for countries that depend on imported fertilizers like Brazil and India.

The microchip shortage that is already plaguing the global industry in 2021 will continue. Russia is a major supplier of base metals like palladium, neon and platinum which are essential for the production of microchips. The automobile industry will be one of the main victims, in all countries.

Although part of the economic offensive against Russia, Europe will also face the backlash effect of sanctions. Europe is heavily dependent on Russian gas. Power shortages are likely and what is available will cost more. Germany has (for now) halted the commissioning of the $11 billion Nord Strom II gas pipeline from Russia. If launched, this pipeline would have made gas cheaper and more abundant in Europe. Shortages of oil, gas, food and fertilizer will cause prices to rise and inflation to rise.

For EU countries, there is a dramatic increase in threat perception from Russia. This means that European countries will spend much more on armaments. For example, even the normally hesitant Germany declared that it would spend another $100 billion on armaments. Needless to say, this would come at the expense of development and welfare spending. Other EU countries will have to follow suit.

As a result, the United States could win in the short term. In Europe, it created enormous additional demand for the production of its armaments industry, as well as for the export of gas. In one fell swoop, he managed to scuttle the growing trade relationship between Europe and Russia and strengthen his own economic ties with European markets.

The longer-term economic fallout for the United States is less certain. The militarization of private sector entities can threaten their multinational credibility. The current definition of Russia as “the enemy” also means a dilution of attention on China. For the United States, the main economic, technological and military challenge in the future will always come from China. By brilliantly reigniting Cold War hostilities, the United States may have taken its eyes off the ball. This could cost him dearly in the years to come, in ways that are still unpredictable.

Where does that leave India? Politically, India has kept the balance between the two sides. Whatever its political position, the Indian economy will be affected. Japanese research group Nomura predicts that India will be the hardest hit among major economies in Asia.

The main reason is that India imports 80% of its oil needs. Union budget estimates were based on an oil price of $70 to $75 a barrel. The 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 more expensive.

There is no easy way out. Prices will go up. Inflation is already at the upper end of the mandatory 4-6% band. Sooner or later, the RBI will have to raise interest rates to dampen inflationary expectations. GDP growth is expected to be more modest than expected. There’s no immediate silver lining in the cloud.

As an old saying goes, it’s a bad wind that doesn’t blow well!

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

Comments are closed.