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HOME NRI JOURNAL Takahide Kiuchi's View - Insight into World Economic Trends :
Does the War in Ukraine Pose a Major Risk for the Global Economy?


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Takahide Kiuchi's View - Insight into World Economic Trends :
Does the War in Ukraine Pose a Major Risk for the Global Economy?

Takahide Kiuchi, Executive Economist, Financial Technology Solution Division

#Market Analysis

#Takahide Kiuchi

May 13, 2022

With the scars left on the global economy from the Covid-19 pandemic still very much evident, Russia’s invasion of Ukraine has brought one crisis on top of another. The invasion of Ukraine has made the problem of steeply rising prices worldwide even more serious, amplifying the downside risks for the global economy.

The war in Ukraine has intensified global economic risks

In the global economic outlook announced on April 19 by the IMF (International Monetary Fund), the global growth rate for 2022 was downwardly revised to +3.6%, which was 0.8% lower than in the previous outlook forecasted in January, while the rate for 2023 was also downwardly revised by 0.2% to the same +3.6% as well. The biggest factor behind these downward revisions was Russia’s invasion of Ukraine, along with the effects of the sanctions that have subsequently been imposed on Russia by industrialized nations.
According to the IMF, Ukraine’s growth rate for 2022 was put at -35.0%, while Russia’s was forecasted to be -8.5%, with each of their economies projected to show significant negative growth.
However, Russia’s GDP makes up 1.7% of global GDP overall (2021, IMF estimate), and even if its economy hypothetically were to shrink by 10%, that would only drive down global GDP by a mere 0.17%. In terms of the effects of the war in Ukraine on the global economy, the greater concern is not the direct impact of the economic downturns in Russia and Ukraine, but rather the indirect impact caused by soaring energy prices in the wake of sanctions against Russia by the developed world, and consequently the acceleration of monetary tightening by the FRB (US Federal Reserve Board).
From this perspective, whether the sanctions placed on Russia are to be strengthened further going forward will be important for predicting the outlook for the global economy. The IMF has indicated that if the sanctions against Russia are further enhanced and Russian energy exports are severely restricted, there is a chance that the cascading effects such as increased energy prices, deteriorating corporate and household sentiment, and financial market disruptions could depress the growth forecast outlook for the global economy by as much as an additional 2%.

The sanctions against Russia will deal a major blow to the Russian economy

It’s unclear whether the sanctions placed on Russia—which have been imposed in a coordinated fashion following the invasion of Ukraine—will swiftly have the effect of halting the Russian military’s actions, as the industrialized world hopes they will. Yet I think these sanctions stand a good chance of dealing a major blow to the Russian economy in the short term, and even in the medium and long terms.
Industrialized nations started by imposing the so-called SWIFT sanctions, which exclude major Russian banks from SWIFT (Society for Worldwide Interbank Financial Telecommunications), the largest international bank payment and settlement network, as well as by taking measures to freeze the foreign reserves kept by the Central Bank of Russia in the central banks of other major countries. These actions have undoubtedly dealt a major blow to Russian trade and economic activity.
At the time of the annexation of Crimea back in 2014, Russia may already have had its sights on this invasion of Ukraine, and perhaps it had already begun making preparations to that end. Since 2014, Russia has been transitioning to agreements under which its trade transactions are denominated in rubles instead of US dollars, thus seeking to bolster its resilience against financial sanctions. It has also created its own independent international bank payment and settlement network called “SPFS”.
Even still, in response to this current round of financial sanction measures in the form of the SWIFT sanctions and the freezing of foreign reserves, Russian trade activity has suffered a serious blow, and the significant drop in the value of the Russian ruble has led to severe price increases. Russia’s attempt to stand on its own monetarily has not gone well.
Furthermore, ever since it annexed Crimea in 2014, Russia has worked to transition from imported products to domestically produced goods to guard itself against future economic sanctions. This is one part of a medium-term plan aimed at defending the Russian economy, and it’s even referred to as the “fortification of the Russian economy”.
Yet this has been an ineffective policy in pushing for greater domestic production at a high cost, and it also hasn’t gone very well. According to a survey done by Russia’s National Research University Higher School of Economics (HSE), 75% of all non-food consumer goods handled in Russia in 2020 were imported items. That percentage even goes as high as 86% when smartphones and other communication devices are factored in.
Consequently, Russia has embarked on its invasion of Ukraine at a time when its attempts to build a more self-reliant economy have only come halfway. And now that it has been subjected to severe sanctions from the industrialized world, its economy has taken a substantial hit.

The ruble’s rebound after its sharp decline was a surprise

That said, in some sense Russia has partially recovered from the massive initial blow it took from the sanctions. By developing other payment channels, the country has managed to resume some of its trade, for which payments had temporarily come to a halt following the SWIFT sanctions.
Following the first round of sanction measures, particularly those freezing Russia’s foreign reserves, the ruble lost around half its value, and that significantly drove up the prices of imported goods. For a period of three weeks after the invasion of Ukraine, consumer prices in Russia continued to climb substantially by around 2% from the week prior. This surely must have been a major blow to consumer spending domestically.
However, having plummeted for a time, the ruble quickly started to rebound around the middle of March, and at present its value has returned to about where it was before the invasion of Ukraine. The various capital control measures introduced by the Central Bank of Russia likely played a major role in this process.
Yet what seems to have had an even larger effect here are the regulatory measures requiring export companies to convert 80% of the foreign currencies they receive as export proceeds into rubles.
Energy-related exports—especially those going to Europe—have been exempted from the direct scope of the sanctions, and while they still continue to decline, they have nevertheless stayed around a certain level. Meanwhile, imports took a greater hit from the sanctions and have fallen far more significantly than exports have, which has led Russia’s trade surplus to grow. What’s more, with export companies now converting 80% of their foreign currency income into rubles, there is a growing demand for buying rubles in the exchange markets, and this development has in some sense brought about a surprise recovery of the ruble.
As a result, the rise in prices has recently come to a halt, and the disruption to Russia’s domestic economy has abated somewhat from earlier.

The EU and Japan brace for hits to their economies, strengthen restrictions on imported Russian energy

Based on the above, in order to further reduce Russian exports, lower the value of the ruble, and deal additional damage to Russia’s economy, Europe and Japan will need to further cut down on or completely halt their imports of energy from Russia. The US and Canada have already chosen to stop importing Russian energy.
At the beginning of April, industrialized nations together announced another wave of sanctions against Russia. And the EU (European Union) has decided to prohibit all imports of Russian coal, while Japan has elected to gradually ban coal imports from Russia. Furthermore, on May 8, the leaders of the G7 (Group of Seven) clearly outlined a policy entailing a total ban on Russian oil imports.
For the EU, which heavily depends on the energy it procures from Russia, measures banning Russian energy imports would unavoidably mean a massive hit to their economy. At the moment, there isn’t actually a growing debate within the EU about banning natural gas imports. However, if the situation were to escalate going forward—e.g., if it comes to light that Russian soldiers have committed inhumane acts in Ukraine, or if Russia uses biological, chemical, or even nuclear weapons—then it’s fully possible that the EU will go so far as to ban the import of Russian natural gas. If that were to happen, Japan would probably also follow suit.
In late April, Russia announced that it was no longer going to supply natural gas to Poland and Bulgaria, which had both refused to pay in rubles. With the G7 now having decided to prohibit Russian oil imports, it’s likely that Russia may broaden the scope of its cutoff of natural gas to other EU nations as a retaliatory measure. In that case, one might even suppose that the EU will try to make the first move and stay ahead of Russia, by declaring a ban on Russian natural gas imports.
If Russian natural gas were to fall under EU sanctions, the EU economy would be at risk of slowing down. Germany’s growth rate could even end up being negative as well.

Russia may lose its status as a resource-rich country

Russia produced a total of 10.52 million barrels of oil in 2021, which accounted for nearly 12% of overall global production. However, according to the IEA (International Energy Agency), it’s expected that the impact of the sanctions placed on Russia thus far could drive down the supply of Russian oil to the markets to around 3 million barrels per day in May. The IEA’s estimates suggest that Russian oil production could be curtailed by 30% compared to its level prior to the invasion of Ukraine, meaning that the world’s oil supply would drop by around 3-4%. And if the EU and Japan actually go ahead with their restrictions on Russian oil imports, the global supply and demand of oil would likely tighten further, sending crude oil prices even higher than they are now.
It’s conceivable that the supply of Russian energy will even remain on a downward trend in the medium and long terms. Other oil-producing nations like Iran and Venezuela which have been hit with economic sanctions in the past suffered grave hits to their oil production, from which they still haven’t recovered. Russia could very well follow them down that same road.
Major corporations based in advanced nations have also decided to pull out from the energy business in Russia, a move that has already hamstrung large-scale development projects. This is because Russia has depended greatly on foreign companies for things like cutting-edge technologies for exploration and oil field maintenance.
It has long been expected that Russian oil production would peak sometime in the 2020s. The reason is that its oil fields currently in use are generally quite old by now. Russian companies have looked to develop new oil fields, seeking to learn new technologies like fracking from the shale oil industry in the US, but that too has become difficult to do.
In light of these points, Russia going forward could rapidly begin to lose its position as a resource-rich country. If Russian oil and natural gas production end up on a downward trajectory, this would have a long-term impact on global oil and natural gas supply and demand, and it could potentially even cause prices to remain high. That would no doubt be extremely adverse for global economic prospects.

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