The impact of the Russia-Ukraine war on the world economy
04-Apr-2022 •Puja Mehra
Economic interdependence between countries - through trade, and flow of people and money - was to have made war obsolete - for decades we lived with this belief. By sending forces to attack Ukraine, Russian President Vladimir Putin started what could be the biggest European conflict since World War II. He may or may not have overestimated Russia's military might. He certainly would have expected to attract western powers' economic sanctions stiffer than those slapped on Russia after he had annexed Crimea in 2014. But the confidence that he can pull off the stunt without significant costs or risk of escalation probably came from Europe's dependence on Russian energy, especially gas (nearly 40 per cent of its consumption). Did Putin miscalculate in assuming that Europe's dependence on Russia is Moscow's insurance against ratcheting up of sanctions by western powers?
Russia's economy is not that large. It's half that of California. The Russian central bank built up a war chest of more than $630 billion, helped in no small measure by gas prices that went up in the run up to the attacks, as reserves in the European Union ran low - chiefly because through 2021 deliveries from Russia flowed at only one-quarter their normal rate. The western powers are retaliating through financial and economic markets. The European Union (EU) and US are trying to corner Putin by isolating Russia from the global financial system. The EU, UK, US, Canada and other countries banned all transactions with Russia's central bank. The G7 economies' - France, Germany, Italy, Japan, the UK, the US and the European Union - central banks have stopped buying rubles. They have also disconnected select Russian banks from the SWIFT (Society for Worldwide Interbank Financial Telecommunication) cross-border banking messaging system.
These measures have rendered useless a substantial portion of the Russian central bank's war chest. The sanction against the central bank has triggered an enormous scramble for dollars in Russia. The ruble, in a highly illiquid currency market, sank to its life low of 137 to a dollar, losing spending power. Inflation in the country had already climbed to 8.7 per cent in January, more than double its central bank's 4 per cent target. It's set to get worse with the ruble depreciating because the Russian economy depends quite heavily on imports other than energy and defence equipment. The Bank of Russia is trying to limit the damage and find ways around the sanctions. Russians' savings and financial and price stability in the country are at risk from the currency's depreciation. The Russian central bank, therefore, has more than doubled its key interest rates to 20 per cent as a countermeasure against the rising inflation of its fiat currency to try and ensure deposit rates would increase to the levels necessary to compensate for the ruble's lost spending power.
Business is also standing up against Putin's aggression. From Ikea, Starbucks, McDonald's to Google Pay, Russians can no longer buy services and products of global companies. BP is divesting its 20 per cent stake in the Russian state oil company Rosneft which could mean a couple of billion dollars in losses of the ownership have to be, in the worst-case scenario, written off in the absence of buyers. Norway's $1.3 trillion sovereign wealth fund is divesting its Russian assets, estimated at $2.83 billion worth of stakes in 47 companies.
Ukrainians are facing Putin with extraordinary grit and attitude, retaining a sense of humour. Videos of farmers stealing Russian tanks and the Ukrainian tax department's announcement that Ukrainian people needn't declare in income tax returns the tanks and other war assets seized from Putin's forces have the internet in splits - and awe. By refusing to capitulate, Ukrainians, led by resolute President Volodymyr Zelenskyy, have won the world's admiration and support.
But still, the fact remains that western countries' sanctions on Russia are not as debilitating as those the US imposed against its other adversaries, such as Iran. For all the economic, business and financial warfare underway, Europe continues to buy Russian gas, funding Kremlin's war, as Putin may have calculated. Helped by higher global oil prices, which shot up on the news of the attacks, as traders feared uncertainty and supply disruptions, Russia's current account balance - record of a country's international transactions with the rest of the world - turned into surplus in February, something that had not happened in this month in the past 10 years at least.
The US has banned all Russian oil. Britain says it will phase it out in a year's time. Germany will reduce dependence on Russian gas over time; it isn't in a position to turn off the supplies immediately. Putin's unlikely to be worried, for China will buy even more Russian oil and gas (which can only be supplied through pipelines and is tougher, therefore, to transport relative to oil), making up for any lost markets. Plus, Russia and China have an agreement since 2019 under which they can settle all trade in rubles and yuan, without requiring dollars. It's possible that India, which has taken a more or less neutral position between Ukraine and Russia, will buy Russian oil to soften the blow of rising global crude-oil prices.
The conflict and rising uncertainty have already sent Brent prices from under $100 to more than $130 a barrel in less than a fortnight. Each one of us is already paying for Putin's war. Prolonged conflict can dramatically alter the global economic outlook. Putin knows this and is not shy to threaten Europe with stoppage of supplies, which will have ramifications even for those countries that don't import from Russia, for it will send prices soaring even higher. Russian Deputy Prime Minister, Alexander Novak, warned the world on state television that rejection of Russian oil would lead to catastrophic consequences for the global market, pushing prices to $300 per barrel, if not more, as Europe will take more than a year to replace the volume of oil it receives from Russia and in the meantime households and businesses would have to pay a lot more for fuel, electricity and heating. His attacks are condemnable, but Putin probably did calculate the power of economic dependence before going to war.
Puja Mehra is a Delhi-based journalist and author of 'The Lost Decade (2008-18): How India's Growth Story Devolved Into Growth Without A Story'