The impact of the Russia-Ukraine War on the Economies began in late February 2022, in the days after Russia recognized two breakaway Ukrainian republics and launched an invasion of Ukraine. The subsequent economic sanctions have targeted large parts of the Russian economy, Russian oligarchs, and members of the Russian government. Russia has responded with sanctions of its own. Both the conflict and the sanctions have had a strongly negative impact on the world economic recovery during the COVID-19 recession. As a result of its war, estimates of a 30-year economic setback are projected for Russia. A wave of protests and strikes have occurred across Europe against the rise of bills and living expenses.
Major Commodity Producers
The International Monetary Fund (IMF) had pointed out earlier that both Russia and Ukraine are major commodity producers, and disruptions there have resulted in soaring global prices, especially that of oil and natural gas. With Ukraine and Russia accounting for up to 30% of the global exports for wheat, food prices, too, have jumped. The IMF added that the entire global economy would feel the effects with slower growth and faster inflation.
Economic Update
The World Bank also said in its Spring 2022 Economic Update for Europe and Central Asia that the conflict delivered a second major shock to the global economy in two years and caused a humanitarian catastrophe. “Even prior to the war, the global recovery had already been decelerating alongside intensifying geopolitical tensions, continued COVID-19 flare-ups, diminishing macroeconomic support, and lingering supply bottlenecks,” it noted.
The World Bank’s baseline projection assumes Ukraine’s poverty, based on the $5.50 per day threshold rate, will increase from 1.8% in 2021 to 19.8% in 2022. It added that models developed by from the United Nations suggested that a more severe and protracted war could lead to poverty affecting nearly 30% of the population. Quoting estimates from authors of a Centre for Global Development blog, the World Bank said the latest surge in food prices could push an additional 40 million people under the $1.90-per-day poverty line.
The IMF echoed similar concerns. It said in March that, “Steeper price increases for food and fuel may spur a greater risk of unrest in some regions, from Sub-Saharan Africa and Latin America to the Caucasus and Central Asia, while food insecurity is likely to further increase in parts of Africa and the Middle East.” The conflict disrupted Ukraine’s planting and harvest season, destroyed critical fields, stores, infrastructure and production, especially in eastern Ukraine. Moreover, the conflict has resulted in shipping being halted from the Black Sea, from where about 90% of Ukraine’s grains are exported.
With respect to the Middle East and North Africa, it had stated that rising prices may lead to social tensions, especially in countries with weaker social safety nets, fewer job opportunities, limited fiscal space and unpopular governments. This extends to Egypt which imports about 80% of its wheat from Russia and Ukraine.
Further, IMF noted that food pressures in Asia should be eased by local production and greater reliance on rice than wheat. “Costly food and energy imports will boost consumer prices, though subsidies and price caps for fuel, food and fertilizer may ease the immediate impact—but with fiscal costs,” it said.
Main Spillover Channel
Energy is the “main spillover channel” for Europe, with Russia being a prominent provider of natural gas. The World Bank noted that the price rise for European natural gas have been particularly sharp because of their limited spare capacity, including that of import and export terminals, and the constraint that natural gas must be transported as liquified natural gas.
According to the IMF, economies reliant on oil imports would see wider fiscal and trade deficits along with more inflation pressure. However, exporters in Middle East and Africa may benefit from higher prices. In the long term, the war may fundamentally alter the global economic and geopolitical order should there be a reconfiguration of supply chains, fragmentation of payment networks, shift in energy trade and countries rethink reserve currency holdings, it said.
During the ongoing tensions, reluctance to buy Russian caused the price of Urals to trade at a discount of more than $20/bbl. in comparison to brent. “By late March, the price of Brent crude oil eased somewhat, to above $100/bbl., with the price falling after the United States announced plans to release from its reserves about 1 million barrels of oil per day over a period of six months,” World Bank states. On Monday, brent crude fell 3% to below $100 for each barrel.
Oil Prices Raised
According to the International Energy Agency, “Oil prices were already rising prior to the war alongside a rebound in demand that accompanied the global economic recovery and after supply concerns remerged when OPEC+ production fell short of expectations amid limited spare capacity”
The IMF says that wider supply-chain disruptions, in additions to rising fuel prices, may also be consequential. Disruptions, sanctions and higher commodity prices also bear the potential of troubling global value chains. This may exacerbate the ongoing strains and add to prolonged delivery times and high production costs for manufacturers across the globe, World Bank’s report mentioned.
Although Russia and Ukraine combined account for less than 3% of global exports and less than 2% of global imports, the financial body adds, the conflict and subsequent sanctions have frayed trade connectivity by disrupting transit routes, particularly for maritime container shipping and air freight traffic. Further, higher fuel prices and insurance premiums have pushed up shipping costs.
Supply Chains for High-Value Goods
Supply chains for high-value goods and critical components, including those of automotive and electronics, particularly bore the brunt of interruptions in the trade corridor between Europe and Asia. World Bank said, the war has cut off European carmakers from supplying key parts such as wiring systems manufactured in Ukraine. This has halted some assembly lines. Bottlenecks have also affected industries including food, construction, petrochemical and transport.
World Bank also pointed to the global impact on services trade as outbound travel was disrupted with airspace closures, travel restrictions, sanctions and increased fuel prices. Russia and Ukraine are among the top 10 countries for total global departures and a key source of revenue for tourism-reliant countries in the Europe, East Asia and the Pacific, Middle East, North Africa and South Asia.
It is noted that the war is likely to stall the post-pandemic recovery in international tourism, which was already anaemic from ongoing COVID-19 disruptions. A further intensification of geopolitical tensions could trigger a renewed decline in international tourism, which would likely be akin to the sharp fall and subsequent weak recovery from 9/11.
Existence of High Debt
In March, World Bank pointed to the existence of high debt among emerging markets and developing economies. As per its estimates, these economies account for about 40% of the global GDP. The dilemma for policymakers was to trade between containing inflation and preserving economic recovery post pandemic.
It added the geopolitical tensions “darkened the outlook” for developing countries that are major commodity importers or dependent on tourism or remittances. Citing the situation across Africa, it elaborated, external borrowing costs are rising with bond spreads up by an average of 20 basis points.
Further, the calculus has suddenly changed for countries with high debt, limited reserves and payments due in the near-term, example being Sri Lanka which was considering an IMF funding to service its debt burden.
Financial Spill-Overs
Financial spill-overs are most likely to be felt in advanced economies with exposure to Russian financial assets, including some Italian, French and Austrian banks, according to World Bank. Their exposure to the sanctioned country’s economy is through business ties and local presence. “As a result, European bank stocks lost more than a fifth of their value since the onset of the war, but high capital adequacy and liquidity ratios have cushioned the impact,” the same report noted.
For India, there have been two direct impacts and another, but no less important, indirect impact. For starters, it pushed up our import bill for both energy and fertilisers. Both these (and the rising price of wheat globally) have also contributed to rising inflation globally, promoting Indian policymakers to raise interest rates in tandem with the rise in global rates. The net result: Higher inflation and lower growth for India.
“The conflict worsened the growth-inflation mix for India. It pushed up crude prices and caused supply side bottlenecks, thereby putting significant upward pressure on inflation. It also raised the fertiliser bill substantially and threatened to derail the budgetary math,” says Dharmakriti Joshi, chief economist, Crisil.
India’s Crude
India’s crude basket rose rapidly from $80 in 2022-23 to $110 in the six months after the war broke out in February 2022. Although Russian crude was available at a discount, India’s oil import bill rose 76 percent in the first six months of this fiscal to $90.3 billion (`720,403 crore) according to data from the ministry of petroleum and natural gas.
For fertilisers, the subsidy bill is expected to rise from `1.1 lakh crore in the Budget to `2.3-2.4 lakh crore, according to the Fertiliser Association of India. While this is likely to moderate by 25 percent in FY2024 on account of falling potash prices, the bill is still, on average, twice that of the last five fiscals. While the government hiked petrol and diesel prices, it shied away from raising fertiliser prices and instead raised the subsidy.
A rising import bill, coupled with supply side disruptions, has meant that Indian consumer price inflation, which in the last fiscal averaged between 4.5 and 5.5 percent, is likely to end FY23 at 6.7 percent, according to the Reserve Bank of India (RBI). This story has also played out the world over, with the only additional factor being that pandemic-era stimulus in Western economies also contributed to a surge in inflation. As a result, as central banks the world over have hiked rates to keep inflation in check, the RBI has had to do the same. After five hikes, the repo rate stands at 6.25 percent.
Final Thought
While the Ukraine war has put a strain on India’s economic prospects, the same war has also resulted in the West looking to India as a potential partner against China. Global multinationals are putting the building blocks in place for a China +1 strategy and this is most pronounced in pharma and specialty chemicals. Expect other industries like semi-conductors and low-end manufacturing to also benefit if India can get its act together.
“India is in the extremely fortunate position of being close to becoming the largest populated country in the world, bigger than China. Its demographics suggest that it has the potential to grow closer to 10
percent per annum for the next decade but it would require much bolder reforms,” says Jim O’Neill, chairman of Chatham House and author of the BRICS report.
As the world decouples from Russia and its partner China, expect 2023 to bring in more investment interest in India even as energy prices, inflation and rates stay elevated.
By: Kushagra Manas
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