The Impact Of Russia’s Invasion On Global Economic Recovery
Russia’s invasion of Ukraine poses significant threats to a global economy already reeling from the effects of the virus. The fight appears to be Europe’s most severe conflict since 1945. As residents fled, Russian forces launched extensive airstrikes, grabbed army posts, and pushed Kyiv. According to Western sources, the capital might fall at any time now that its air defenses have been removed. The attack came after weeks of tensions that had already shaken the global economy by rising oil prices. On Thursday, the pace picked up. Oil momentarily surpassed $100 per barrel for the first time since 2014, while European natural gas prices soared by as much as 62%.
Western nations are making moves to penalize Russia as Ukraine struggles for survival. They understand that they risk exacerbating the conflict’s economic consequences by doing so. President Joe Biden, who imposed further restrictions on Russia’s institutions and ability to trade in dollars on Thursday, has cautioned that there would be a cost at home, where high fuel prices are already undermining his popularity among voters. High inflation and nervous financial markets have left the global economy vulnerable due to the epidemic. The invasion’s aftershocks might exacerbate both. There is also a hazard to growth. Households that spend a growing proportion of their income on fuel and heating will have less money to spend on other products and services. Market declines would add to the drag, reducing wealth and confidence and making it more difficult for businesses to access capital for investment. The double problem of regulating prices and keeping economies thriving will become more difficult for central bankers. The Federal Reserve and the European Central Bank have been preparing to tighten monetary policy in recent months. The situation in Russia may compel a change of heart.
The size of the hit to the global economy will be determined by the length and extent of the conflict, the harshness of Western sanctions, and the probability of Russian retaliation. In addition, other twists are possible, ranging from a mass outflow of Ukrainian migrants to a wave of Russian cyberattacks. Some of these implications have been reflected by Bloomberg Economics in three scenarios that look at how the conflict would affect growth, inflation, and monetary policy.
As Russia assaults, there are three situational economic scenarios to consider.
In the first case, a quick conclusion to the conflict avoids further commodity prices, keeping the U.S. and European economies on track. Instead of scrapping their plans, central bankers would have to adjust them. In the second scenario, a protracted conflict, a more brutal Western response, and delays to Russia’s oil and gas exports would result in a more significant energy shock and a massive hit to global markets. And this would effectively rule out ECB rate rises this year, while Fed tightening would halt. Europe’s gas supply would be cut off with the worst scenario, resulting in a recession. At the same time, the United States would see much tighter financial conditions, a more significant impact on growth, and a noticeably more dovish Fed. Of course, wars are inherently unpredictable, and the real-life conclusion will almost certainly be messier than any of these fictitious versions. The financial markets’ wild swings on Thursday reflected the uncertainty. Nonetheless, the scenarios should be a starting point for considering future options.
Scenario 01 – In a best-case design, oil and gas supply are not disrupted, and prices remain stable at current levels. Financial circumstances tighten, yet global markets do not continue to fall. Oil prices reflected that confidence after the United States and its partners announced further penalties against Russia. “The sanctions we imposed are unprecedented in history,” Biden remarked on Thursday. Fines have been imposed on five banks, including Russia’s most prominent institution, Sberbank, which has $1 trillion in assets. Personal penalties were aimed at Russia’s elite, while export limits will limit the country’s access to high-tech items.
On the other hand, Russian energy sources were not targeted for sanctions. Oil prices fell as a result, with futures in New York ending below $93 a barrel. The principal route through which the Ukraine war has an immediate impact distant from the frontlines is energy costs. Because Russia is Europe’s primary oil and gas supplier, the danger is grave. Rising energy prices accounted for more than half of the euro area’s record inflation rate in January. On Thursday, European natural-gas futures topped 140 euros per megawatt-hour after surging as much as 62 percent during the day.
When combined with the oil effect, euro-area inflation might reach 3% by the end of the year. A sanctions-induced recession in Russia might have additional consequences. However, the E.U. would most likely avoid recession, and an ECB rate rise in December would remain a possibility. More costly fuel and modest financial tightening would stifle growth in the United States. The country may export more natural gas to Europe, rising domestic rates. As a result, inflationary pressures on the headline CPI may approach 8% in February and conclude the year at 5%, opposed to the consensus of 3.3 percent.
Despite this, the Fed is likely to look past the short-term price shock and proceed with its plans to raise interest rates in March — but not by 50 basis points. “I believe it will be fair to move the fund’s rate up in March and follow with further increases in the following months, barring an unanticipated shift in the economy,” Cleveland Fed President Loretta Mester stated.
Scenario 2 – Some oil ship owners are deferring taking on Russian petroleum until penalties are clarified. Major gas pipelines pass across Ukraine and might be damaged due to the conflict. Even a minor disruption in supplies might exacerbate the price shock. If gas prices stay at 180 euros per megawatt-hour, as they did in December, and oil stays at $120, euro-area inflation will be close to 4% by year’s end, worsening the real income pressure. The European Union would most likely keep the lights turned on. However, there would be a significant drop in GDP, pushing any ECB rate rise until 2023. Central bankers in Europe are already signaling a dovish stance. “It’s evident that we’re going toward normalizing monetary policy,” Austrian economist Robert Holzmann, one of the ECB’s most hawkish members, told Bloomberg in Paris. “However, it’s probable that the pace will now be somewhat delayed.”
Within the United States, this scenario may bring headline inflation to 9% in March and keep it close to 6% by the end of the year. But, at the same time, the Fed would be torn between additional financial turbulence and a weaker economy, owing in part to the European slump. As a result, it may look past the short-term price shock and concentrate on growth threats. And this wouldn’t impact the start of the rate rises in March, but it may sway the balance toward slower hikes in the second half of the year.
Scenario 3 – Russia may react by cutting off the gas flow to Europe if it faces maximum sanctions from the U.S. and Europe, such as being kicked out of the Swift system of international payments. Of course, that’s a far-fetched scenario: when E.U. officials performed a simulation of 19 strategies to stress-test the bloc’s energy security last year, they didn’t even consider it. Nonetheless, the ECB predicts that a 10% gas rationing shock would reduce euro-area GDP by 0.7%.
Increasing that figure to 40% — the proportion of Europe’s gas from Russia — suggests a 3% economic damage. Given the upheaval that such a historic energy shortage will undoubtedly cause, the actual amount might be far higher. That would indicate a recession and no rate hikes from the ECB shortly. The growth shock for the United States would be significant as well. Furthermore, maximum penalties might have unforeseen repercussions, including disrupting the global financial system and causing spillovers for U.S. banks. As a result, the Fed’s priority would shift to growth preservation. However, if increased prices lead to entrenched consumers’ and companies’ inflation expectations, the worst-case scenario for monetary policy would emerge the need to tighten forcefully even in a sluggish economy.
Of course, the alternatives aren’t limited to the ones listed above from 1-3 scenarios. They’re focusing on the world’s largest sophisticated economies, but commodity price hikes will affect countries all around the world, including bare essentials like wheat and energy. Saudi Arabia and other Gulf oil exporters, for example, may gain. However, for most developing countries, which are already recovering at a slower pace, the combination of rising prices and capital outflows could be devastating, escalating the danger of post-Covid debt crises. Turkey, a major energy importer with a depreciating currency and surging inflation before the Ukraine conflict, is a case in point.
Then some threats are difficult to measure, such as Russian cyberattacks. According to the New York Fed, an assault affecting payments systems at the five most active U.S. lenders could affect 38 percent of all banking assets, leading to liquidity hoarding and insolvencies in the worst-case scenario. One thing appears to be specific: Russia will be the most hit of the major economies. President Vladimir Putin’s expansionist foreign policies will almost certainly cost him a weakening domestic economy.
