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RUSSIA-UKRAINE CONFLICT: GLOBAL ECONOMIC IMPACT

4th March, 2022

                                     PERSPECTIVE: RUSSIA-UKRAINE CONFLICT: GLOBAL ECONOMIC IMPACT

Context:

  • The Russia-Ukraine conflict has upended commodity markets from oil to gas and wheat leading to the prospects of increase in inflationary pressure on countries trying to revive their economic growth after the pandemic.
  • Crude oil prices continue to rise and oil companies like Shell and BP are winding up their operations in Russia.
  • Russia is the world’s third-biggest oil producer and the second-most influential member of the OPEC+ alliance behind Saudi Arabia.
  • Sanctions imposed by US and other western countries on Russia particularly banning some Russian banks from the SWIFT global financial payment system is expected to make it cumbersome for many companies to do any kind of business with Russia.
  • Finance Minister Nirmala Sitharaman has recently said that the Centre govt was seized of the matter and discussions were on for a complete assessment of the issue.

 

Impact of sanctions:

  • War has immediate consequences for global trade, capital flows, financial markets and access to technology.
  • There are five areas where impact was clearly visible: A sharp tanking of the Russian ruble, a looming fear of a run on its banks, a panic reaction by the Russian central bank to suspend the execution of all orders by foreigners to sell securities indefinitely, a looming shortage of most consumer goods that Moscow sources from the West, and a worsening of terms of trade on future imports.
  • Also, the global commodity markets are seeing an upsurge, with crude, gas and metals spiking.
  • Currency impact: The Russian ruble tanked 30 per cent versus the dollar in offshore trading.
  • Suspension of sell orders of Russian securities: Reacting to the plans announced by the US and European Union nations to sanction Moscow’s central bank and cut off some financial institutions from the SWIFT messaging system, Russia’s central bank ordered professional stock market participants “to suspend the execution of all orders by foreign legal entities and individuals” to sell Russian securities.
  • Consumer goods shortage: The impact of some of these measures would clearly end hurting middle class Russians, given that the country remains highly dependent on the West for many of its consumer goods.
  • Bank run: The US, EU, United Kingdom and Canada had announced that the assets of Russia’s central bank will be frozen, which would make it difficult for it from selling them overseas to support its own banks and companies. Also, some Russian banks are to be excluded from the SWIFT payment network.
  • Oil surge: Brent crude surged past $104 a barrel in the wake of the fresh sanctions on Russia, one of the top global producers of oil, gas, metals and agricultural products.

 

Impact on global economy:

  • A rising concern: Russia’s attack on Ukraine could cause dizzying spikes in prices for energy and food and could spook investors. The economic damage from supply disruptions and economic sanctions would be severe in some countries and industries and unnoticed in others.
  • The cost of energy: Oil prices already are the highest since 2014, and they have risen as the conflict has escalated. Russia is the third-largest producer of oil, providing roughly one of every 10 barrels the global economy consumes.
  • Gas supplies: Europe gets nearly 40 percent of its natural gas from Russia, and it is likely to be walloped with higher heating bills. Natural gas reserves are running low, and European leaders have accused Russia’s president of reducing supplies to gain a political edge.
  • Food prices: Russia is the world’s largest supplier of wheat and, together with Ukraine, accounts for nearly a quarter of total global exports. In countries like Egypt and Turkey, that flow of grain makes up more than 70 percent of wheat imports.
  • Shortages of essential metals: The price of palladium, used in automotive exhaust systems and mobile phones, has been soaring amid fears that Russia, the world’s largest exporter of the metal, could be cut off from global markets. The price of nickel, another key Russian export, has also been rising.
  • Financial turmoil: Global banks are bracing for the effects of sanctions designed to restrict Russia’s access to foreign capital and limit its ability to process payments in dollars, euros and other currencies crucial for trade. Banks are also on alert for retaliatory cyberattacks by Russia.

Impact on India:

Inflation risks

  • Rising oil prices could speed up already rising inflation.
  • India imports more than 80% of its oil requirement, but the share of oil imports in its total imports is around 25%.
  • Rising oil prices will also impact the current account deficit, which is the difference between the values of goods and services imported and exported.
  • Recent surge in global crude could intensify the pressure on the state-owned oil retailers.
  • Calibrating price hikes is now more complex, given the cascading inflation impact that could follow the increase.
  • India imports most of its requirement of sunflower oil from Ukraine, and the two countries now at war are also two of the world’s biggest producers of wheat.

Economic recovery

  • The rise in crude prices poses inflationary, fiscal, and external sector risks.
  • Oil-related products have a share of over 9% in the WPI basket — and a 10% increase in crude would lead to an increase of around 0.9% in WPI inflation.
  • A larger oil import bill will impact India’s external position; it is also likely to increase subsidies on LPG and kerosene, pushing up the overall subsidy bill.

FPI sentiment, rupee

  • Foreign portfolio investors have been selling their holdings in Indian equities over the last four months. This outflow is likely to continue over the coming days.
  • As FPIs pulled out, domestic institutions emerged as net investors.

Equity investors

  • While markets may remain volatile, retail investors should look at the DII investment pattern. If DIIs are investing amid the sharp fall in markets, retail investors too should not panic — and should increase their investments if they are underweight in equities.
  • Experts say that the current geopolitical concerns will not impact long-term fundamentals and prospects of businesses, and investors should take the fall in markets as an opportunity to invest in mutual funds and high-quality blue chip companies.

Gold outlook

  • In times of uncertainty and inflation, gold emerges as the asset class of choice for investors. It is important to note that at a time when equities have been falling, gold has risen sharply.

Trade

  • India runs trade deficit with Russia, with exports declining while imports are increasing. Oil forms a major part of our import basket from Russia.
  • 8 per cent of our total imports have been imported from Russia in FY22 so far.

Banking

  • Banking sector has remained resilient to the Russia-Ukraine conflict so far.
  • Profitability, asset quality and capital adequacy has risen to a new peak with profitability of banks in Dec’21 quarter, as well as YTD FY22 seen touching new highs.

 

Recent developments in Indian economy as a follow-up:

  • India's top lender SBI will not process any transactions involving Russian entities subject to international sanctions imposed on Russia.
  • Besides, Indian Oil Corp (IOC) said it would no longer accept cargoes of Russian crude and Kazakh CPC Blend cargoes on a free on board (FOB) basis due to insurance risk.

 

Conclusion:

International short run

  • Global trade will be immediately impacted by sanctions on both sides.
  • Exports and imports will be hit and the existing supply bottlenecks due to the pandemic will aggravate.
  • The Western powers are likely to insist on other nations stopping trade with Russia. For instance, they will ask other nations to stop their import of energy from Russia and threaten sanctions against those nations and companies that continue to trade with Russia
  • Since China is the biggest trading partner for many of the rich countries, this will disrupt trade massively and lead to further supply bottlenecks.
  • Ukraine is a major exporter of agricultural produce and their supplies will get disrupted, leading to increase in food prices.
  • Consequently, inflation will kick up globally and impact purchasing power of people and weaken demand which was already hit by the pandemic. With liquidity ruling high due to the quantitative easing during the pandemic, inflation can kick up quickly. This will slow down global growth.
  • Global capital flows will decline since many countries would want their capital to invest at home rather than abroad.
  • The stock markets will decline not only due to this factor but also due to increased uncertainty facing the world and the likely end of quantitative easing by Central Banks in the face of higher inflation and moves to increase interest rates. All this will adversely impact private investments.
  • Growth will be hit as a result of these adverse changes in consumption and investment. Budgets of nations will be impacted as military expenditures rise. The already high fiscal deficits in the budgets will rise further and most likely setback social sector expenditures which will impact the poor the most.

International long run

  • There will be greater distrust between the important nations on the two sides and cooperation on important world matters will decline.
  • The current moves to freeze the assets of Russians in Western banks and to cut off credit to their companies, would force them to devise alternative international payments system independent of the dollar.
  • Those companies like, the Chinese, which defy Western sanctions will also need such a payment system. So, two trading and financial blocs will emerge. The Chinese and the Russians have large foreign exchange reserves and the surplus in trade that they can successfully create a bloc. All this will have uncertain consequences.
  • With deglobalisation and a greater need for investment in the home countries, global capital flows are likely to decline with less going to the developing world. This may be partly compensated by the reduced flow of capital from the rich countries to China.
  • But MNCs will make the developing world compete with each other for its capital by offering more concessions. This will work against the interest of the workers.
  • The military industrial complex everywhere will be strengthened as militarisation increases.
  • With greater investment in armament there will be shortage of high technology for civilian use and that will slow down growth while raising inflation and decreasing investment in social sectors. All this will aggravate poverty in spite of more employment. Inequalities will rise further with workers getting marginalized and capital making higher profits.
  • Expenditures on R&D will increase and the technology companies will do even better than they did during the pandemic. Old style companies producing intermediate technology goods in the developing world will suffer as their exports decline with deglobalisation and production in the home countries.

 

 National considerations:

  • India will see an immediate impact on inflation (already ruling at high levels) with rise in fuel and food prices.
  • Other prices will also rise as supply bottlenecks get aggravated due to sanctions and the war situation.
  • The investment climate will deteriorate due to the uncertainty.
  • Capital flows into the country will decline leading to a further decline in the stock markets. The P/E ratio was already ruling at high levels and such a big shock was bound to hit stock prices.
  • Demand for gold is likely to increase leading to its increased import. This along with the high bill for petro goods will mean that the imports bill will rise.
  • Exports are likely to be hit due to the decline in growth in the world economy and deglobalisation.
  • With capital flows declining the Balance of Payment which was already turning adverse will deteriorate further. Consequently the rupee will weaken compared to the dollar which will aggravate inflation further.
  • All these factors, uncertainty, demand, investment, inflation and BOP, will reduce the rate of growth of the economy which was badly hit by the pandemic.
  • Budgetary arithmetic will also be impacted.
  • Expenditures will increase while real revenues will be hit due to slow down and other difficulties. The already high fiscal deficit will increase further and in such circumstances, it is the social sector and capital account expenditures that are curtailed. The support to the poor then declines.
  • It will face difficulty in procuring defence equipment already contracted since both the rich countries and the Russians will delay deliveries, given their own requirements.

 

Way forward for India:

  • India will have to strengthen its economy on its own.
  • The public sector will have to play an important role since the private sector will not be able to boost itself on its own when demand is short.
  • The country will have to strengthen its R&D.
  • Social sectors will have to receive a much higher priority so that the productivity of workers rises and their degrading living conditions improve. That will not only provide the market for growth of Indian economy but strengthen the country.

 

https://youtu.be/g3RMOcnli9Q

 

https://indianexpress.com/article/explained/explained-5-ways-the-new-sanctions-are-playing-out-in-russia-7794360/

 

https://timesofindia.indiatimes.com/business/india-business/explained-how-russia-ukraine-conflict-may-impact-indias-economy/articleshow/89909200.cms

 

https://thewire.in/economy/india-russia-ukraine-war-consequences-impact

 

https://indianexpress.com/article/explained/russia-ukraine-war-india-economy-impact-sensex-crude-oil-price-7789900/

 

https://www.business-standard.com/article/international/russia-ukraine-conflict-raises-big-risks-for-global-economy-122022401023_1.html

 

https://economictimes.indiatimes.com/news/international/business/ukraine-how-the-russian-invasion-could-derail-the-fragile-world-economy/articleshow/89846199.cms

 

https://www.nytimes.com/2022/02/21/business/economy/ukraine-russia-economy.html

 

https://economictimes.indiatimes.com/news/economy/indicators/russia-ukraine-crisis-what-it-means-for-india-and-investors/articleshow/89792293.cms?from=mdr

 

https://www.bloomberg.com/news/features/2022-02-25/war-in-ukraine-how-the-ukraine-russia-conflict-could-impact-the-global-economy

 

 

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