Impact of the Russia-Ukraine War on Global Economy

Introduction

On 24th February, 2022, Russia launched a full scale invasion of Ukraine. Russia had earlier invaded Ukraine back in 2014 post which Crimea got annexed. Although that invasion lasted for a month back then, this time around the war has dragged on, while making an already ailing world economy all the more distraught. It has severely hampered the prospect of a post-pandemic economic rebound for developing economies in the regions of Europe and Central Asia. By severely disrupting trade and spiking food and fuel prices, the war is still continuing to harm the world economy. This has led to rising inflation and a tightening of financial conditions around the world. The IMF warned that countries that depended on oil imports would see bigger fiscal and trade deficits as well as higher inflation. In 2023, worldwide economic growth would only be 1.7% if natural gas prices increase by more than 40% during the remaining part of the year. Due to damaged supply chains, heightened financial stresses, and a fall in consumer and company confidence, activity in the euro area has significantly deteriorated in the second half of 2022. However, the invasion’s most negative repercussions are the sharp increases in energy prices and the significant decreases in Russian energy supply. Energy markets were already dwindling before the start of the crisis, following unpredictable consumer demand and GDP growth in 2021. Though crude oil and natural gas were still around 50% above their level at the start of the year, they have been much more volatile of late.

As we delve into the detailed facets of how this war has been impacting the world as we knew it, let us first discuss its impact on Gas, Oil, Commodities and Other Industries followed by the toll it has taken on economies of certain continents like Russia, Europe, Asia.

Impact on Gas & Oil:

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, but they skyrocketed after Russia’s invasion of Ukraine, sending inflation to decade-high levels. Hardest hurt will be the nations with a medium to high reliance on natural gas imports for heating (30% of energy demand), industry, or electricity, as well as nations with tight ties to EU energy markets.  If gas prices stay where they are, energy costs will probably increase soon, tightening the stress on consumer incomes. After the planned 54% hike next month, the cap on residential gas prices in the UK could jump by more than 40% once more in October, with part of the October increment offset by the Treasury-backed £200 discount on bills. This extraordinary crisis has repercussions for both consumers and governments, limiting household welfare, company productivity, and budgetary viability. Hence countries predominantly dependant on EU energy markets must get ready for gas shortages and establish emergency measures to lessen the worst effects on people and businesses. These preparations should include energy conservation, improving energy efficiency, and implementing quota/rationing schemes.

Impact on Commodities:

The spike in commodity prices, which will feed already-existing inflationary pressures, will be the biggest economic impact on the rest of the world. Net importers of energy and food items will be disproportionately impacted, as is always the case when commodity prices surge, with the possibility of significant supply disruptions in the event of a further escalation of the conflict. Companies in the UK, the US, and China reported a slight reduction of supply chain restrictions prior to the invasion, despite the fact that they were still increasing in the Eurozone. Some of these advances can be undone by the most recent happenings. Global trade will be hampered by the decline in demand from Europe. The top 5 producers of steel, nickel, palladium, and aluminium are all in Russia. It exports more wheat than any other country in the world (almost 20% of all exports). Additionally, Ukraine ranks among the top ten producers of sugar, beet, barley, soya, and rapeseed and is a significant producer of corn (sixth largest), wheat (seventh largest), and sunflowers (first) as well. Thereby food costs have increased exponentially as well.

Impact on other Industries:

High-value supply chains for crucial components took the brunt of the disruptions in the trade corridor between Europe and Asia. Due to a variety of shortages and high commodity & raw material prices, such as those for metals, semiconductors, cobalt, lithium, and magnesium, the crisis is undoubtedly having a significant influence on the already stressed automotive and electronics sectors. The larger supply chain and industrial production could suffer from delays in their acquisition. According to the World Bank, the conflict has prevented automakers from supplying essential components like Ukrainian-made wiring systems. Some assembly lines have stopped as a result. While some of the Ukrainian auto firms that provide major Western European automakers declared the closure of their factories; other plants throughout the world have already begun to prepare outages
due to chip shortages. Construction, petrochemical, and transportation industries are among those that have been impacted by bottlenecks. The cost of petrochemical feedstock is anticipated to increase, and the entire agri-food sector would be affected by the rising natural gas prices and the fertiliser markets that could have an impact on food production as well as the global food supply chain.

Additionally, higher fuel prices would also hurt businesses that transport goods by sea and air, with airlines being especially vulnerable. First, it is predicted that gasoline will make up approximately a third of their overall expenses. Second, Russian airlines are not allowed to enter the US, Canada, or Europe, and Russia has responded by forbidding European and Canadian aircraft from entering its airspace. Airlines will need to take longer routes, which will result in greater expenses. Eventually, airlines’ ability to absorb cost increases will be limited as a result of their ongoing revenue declines.

Rail freight will also be disrupted because European firms are not allowed to conduct business with Russian Railways, which will probably disrupt freight traffic that transits via Russia on its journey from Asia to Europe.

Source : United Nations

Economic Impact of the war:

According to the OECD, the invasion of Ukraine by Russia will cost the world economy $2.8 trillion in lost output by the end of the next year—and considerably more if a harsh winter causes energy restrictions in Europe. The projected growth rates for the world economy were 2.2% next year and 3.0% this year.
It had anticipated growth of 4.5% in 2022 and 3.2% in 2023 before the war. The discrepancy between those two figures indicates that the war and its aftereffects will have cost the globe the same amount of money as the French economy produced in those two years in terms of economic output.

Due to the relatively weak trade and financial ties between North America and Russia and Ukraine, the conflict’s effects will primarily be felt through price increases and a slowdown in European economy.

Impact on Europe

The Organization for Economic Cooperation and Development(OECD) warned that in the event that energy costs rise once more, Europe’s economy could see an even more severe collapse as it is most exposed to the effects of this conflict because of its reliance on Russian oil and natural gas (Russia being the world’s third largest oil producer and second largest producer of natural gas). Such a price increase may occur if Europe has energy shortages throughout the upcoming winter due to unusually cold weather. If natural gas prices happen to increase by 50% or more during the remaining months of the year, in 2023, European economic growth may be 1.3% points lower. This will tighten the stress on consumer incomes. After the planned 54% hike next month, the cap on residential gas prices in the UK could jump by more than 40% once more in October, with part of the October increment offset by the Treasury-backed £200 discount on bills.
However it is impossible to replace the entire Russian natural gas supply to Europe in the short to medium term, and hence the current price levels are  considerably impacting inflation. Although gas prices in Europe have already increased after Russia stopped sending gas through the Nord Stream1 pipeline to Germany, there can be another dire situation as well. According to Goldman Sachs, a complete cut-off would cause a recession in the euro region, with significant contractions in Germany and Italy.  IMF predicted that global growth would slow to 2.6% in 2022 and 2% in 2023 under a plausible alternative scenario that includes a complete cut-off of Russian gas supplies to Europe by year’s end and a further 30% drop in Russian oil exports, with absolute stunted growth in Europe next year.

As energy price shocks continue to affect the region, consumer prices, which only increased 2.6% in 2021, will increase by 8.3% for the entirety of 2022 and by 6.8% in 2023.

Lithuania, whose exports to Russia account for 6% of its GDP, may be the nation most vulnerable to trade frictions as a result of the crisis. Due to trade restrictions with Russia, according to analysis by the Kiel Institute, Lithuania’s GDP might decrease by around 2.5% over time, while the economies of Latvia and Estonia could shrink by about 2% over time.

The OECD anticipates that the eurozone economy will only grow by 0.3% in 2023. The larger European economies of Germany, Italy, and France are much less exposed (Germany’s economy is projected to contract by 0.7%), with exports to Russia making up only 1 to 2 percent of total exports. The Kiel Institute’s analysis estimated that the long-term impact of trade restrictions on these economies would be a GDP reduction of 0.4% to 0.16%, with Poland potentially experiencing a slightly higher reduction of 0.78%.

Impact on Russia:

Coming to the impact to Russian economy, the Russian Rubel recovered from decline in March as the central bank doubled interest rates to protect the currency in the aftermath of inflation. Earnings from export was 65% higher than last year although imports went down by 20%. However, the economy survived mainly by virtue of fossil fuel sales. They exported around USD 140 billion in the first 100 days of war, with China buying more than USD 18 billion, followed by Germany who bought around USD 17 billion. These skyrocketing fuel prices resulted in a huge windfall for Russia. Despite exporting 15% less fuel than last year, they earned around USD 1.3 billion dollars as compared to USD 958 million last year. However, they need to now look at investing on infrastructure or acquire oil tankers since more than 70% of their fuel delivery used to be made on EU, UK and Norwegian tankers.

Apart from this, economic activities along other avenues haven’t exactly dialed down completely. Kremlin expects bilateral trade to reach USD 200 billion a year with Beijing by 2024. India and China have been buying oil at discount from Russia(around 29% discount form global prices). From January to June India imported 6.82 lakh barrels a day as compared to merely 22000 a year ago. India’s fertilizer import has also gone up (from 6 to 20%); In June alone India had imported 70% of all that had been imported in FY21. India has also increased import of coal, sunflower seeds, non-industrial diamonds. Russia, on the other hand, has circulated a fresh list of products it wants to import from India – medical equipment, pharmaceutical, chemicals, industrial equipment, garments, furniture, jewellery for more balanced bilateral trade and sustainable implementation of rupee denominated payment mechanism.
When it comes to the US, although overall imports from Russia went down, certain items have been more in demand – fertilizer import went up by 32%, rubber by 13%, marine products by 87% and wood & related items by 78%. The EU brought down oil imports from Russia but their overall imports increased by 79%. Saudi increased oil imports from Russia for use in power generation- they doubled their imports of crude oil to 6.47 lakh tonnes in the last 3 months, while exporting crude oil from their own fields to global market at elevated prices. Kingdom Holding, run by Saudi royalty, purchased stakes worth USD 600 million in major Russian energy firms Gazprom, Lukoil, Rosneft when their shares plummeted. There’s even speculation that items banned to be transported to Russia by EU and USA, are being routed through Middle East, Istanbul, Dubai, China.

Impact on Ukraine:

Since economic activity is marred by the destruction of producing capacity, damage to agricultural land, and a decreased labour supply as more than 14 million people are reported to have been displaced, the Ukrainian economy is expected to collapse by 35% this year. Recent World Bank projections indicate that USD 349 billion in recovery and reconstruction is required across the infrastructure, production, and social sectors, which is more than 1.5 times the size of Ukraine’s pre-war economy in 2021.

Impact on Asia :

The rising oil costs will have a greater impact on emerging Asian markets than any other part of the world because the majority of Asian economies are centred on consumption, with food and energy accounting for over half of consumption expenditures. The impact will be felt almost immediately in the form of higher import costs in the Asia-Pacific area, as numerous economies in the region are net energy importers.

The war’s immediate effect on the major Southeast Asian economies is the increase in commodity prices, particularly those of oil, nickel, wheat, and corn. As net importers of these goods, Singapore, Vietnam, and Thailand should be particularly concerned about this trend.

Due to the rise in commodity prices, both producer and consumer price inflation have been steadily rising in Thailand. Oil has been in low supply in Vietnam, and reports of hoarding gasoline are now emerging, which is driving up prices even further. The effects of increased oil prices are visible in the transportation, housing, electricity, gas, and other sectors in Vietnam, Malaysia, and Indonesia. However, other economies in Southeast Asia, such as those in Indonesia, Malaysia, and the Philippines, are not immediately impacted. These economies will be able to reduce the impact of rising oil prices on inflation thanks to their low energy usage. Singapore and Thailand, on the other hand, have local price increases because to their economies’ comparatively high energy and gasoline consumption.

Similarly, another country whose inflation will inevitably rise as a result of the ongoing rise in oil costs, is Japan. The high cost of energy is passed on to the final users, which reduces user needs. Even South Korea will have serious repercussions from this. The export sector in South Korea is predicted to suffer greatly as a result of high oil prices. Its export business is supported by the manufacturing sector, which is heavily reliant on energy imports. Consumer goods costs are rising as a result of the increasing prices, which will impede the nation’s economic expansion.

The war has had an effect on the Indian economy as well, especially in terms of liquidity. Consumer spending has reduced as a result of the pandemic and the constrained supply of liquid currency. Due to limited access to cash, consumers are hesitant to spend money, while major firms are unwilling to put money in the market due to the possibility of low returns. Panic selling and investor concern caused the stock market to lose Rs. 7.5 lakh crores; as a result, the Sensex fell by 2700 points. A progressive increase in the price of essential oils along with increased import costs for crude oil seem to have hurt the Indian exchequer too, with household nutrition being the most negatively impacted.

Additionally gold imports are projected to rise as a result of rising demand. The cost of imports will increase as a result of this and the high cost of petroleum products. Due to deglobalization and the slowing global economy, exports are likely to suffer as well. The falling capital flows will make the already-unfavourable balance of payments even worse. The rate of expansion of the economy, which was severely impacted by the epidemic, will be slowed down by factors like uncertainty of demand, investment, inflation, and BOP. As a result, the rupee may continue to be devalued against the dollar, which would make inflation even worse. The already significant fiscal imbalance will widen much more, which would result in a reduction in capital account spending and the social sector’s expenditures.

In an effort to resolve these issues, the governments of Asian and Southeast Asian countries, particularly those that are net oil importers, should look out for alternative oil suppliers, such as Saudi Arabia and Venezuela, to secure their energy needs in order to deal with the ongoing situation resulting from disruptions in the oil supply due to the Russia-Ukraine crisis. The International Energy Agency and the Organization of Petroleum Exporting Countries (OPEC) can be pressured to raise the supply of oil and lower the growing oil prices by using regional organisations in Asia like Asean and the South Asian Association for Regional Cooperation (SAARC).

Long-term, oil-dependent nations should endeavour to diversify their energy sources and look for additional renewable energy options. Energy efficiency may potentially play a significant role in controlling the rise in oil costs. However, the only option to lessen reliance on oil is to progressively switch to renewable energy sources in order to spur economic growth.

Conclusion:

The world economy is predicted to develop just little this year and much more slowly in 2023 due to high interest rates, punishing inflation, and Russia’s conflict against Ukraine.

Demand will experience downward pressure due to higher inflation as well as trade interruptions’ negative effects. Price increases and trade friction spillover effects will be felt in economies outside of Europe. If this were to continue, income would be redistributed from countries that use oil to those that produce it, which often have a lower tendency to spend. This could result in a decline in profitability, which could have a detrimental impact on investments in nations that import oil. Some nations may experience a short-term boost in exports as trade with Russia shifts away from the West and toward other regions.

However, Asia’s emerging markets will account for a substantial portion of the global economy’s growth next year. They are predicted to contribute towards three-quarters of global growth next year, while the U.S. and European economies contract.

All-in-all, in the long run, this war may profoundly change the global economic and geopolitical order, if supply lines are reconfigured, payment networks are fragmented, trade in energy is altered, and countries revaluate their reserve currency holdings. We can only hope for it come to a peaceful end as soon as possible, so that regular trade activities can resume and the global economy can begin to bounce back from this nadir.

-Aritra Acharyya
Junior Editor, TJEF

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