Written by Connor Tong
On February 24, 2022, Vladimir Putin declared a full-scale military assault on Ukraine in what he claimed to be protection of the Ukrainian people from the ‘denazification’ and ‘demilitarization’ of its government. The ramifications of his actions will result in tragedy, not least the bloodshed and suffering of the innocent lives directly affected by the conflict. Furthermore, this also means that Europe and the rest of the world will be forced to bear the economic implications.
The first economic consequence is the resultant increase in commodity prices – namely oil and gas. Russia is the largest gas exporter in the world, providing approximately 40% of the European Union’s supply. Following Russia’s attack on Ukraine, Europe’s natural gas prices promptly jumped as much as 62%. With Russia playing a disproportionately large portion of their gas supply, Europe is likely to bear the brunt of the spike in gas prices. They are also the second largest oil exporter in the world. In fact, crude oil prices rose to more than 100$ a barrel for the first time since 2014. We expect to see an increase in transportation costs and as well as energy production costs as oil is a key material in heating buildings and electricity production.
Russia is also a key supplier of industrial metals such as nickel, palladium and aluminum. Notably, Palladium plays a key input material role in the production of phones, fuel cells, automotive exhaust and the like. Russia and Belarus – a Russian proxy – are both key players in potash, an input in fertilizers. Finally, with Russia being a large supplier of wheat and Ukraine being one of the top five exporters in corn production, it’s safe to say that prices of related products – livestock feed, cooking oil and corn syrup – will consequently see an increase as well.
The second economic ramification comes in the form of lower growth and financial market disruption as the West levy tough sanctions. Biden recently announced the enforcement of sanctions targeted towards Russia’s largest banks – VTB Public Joint Stock Company and Sberbank among others – essentially cutting them off from the global financial system.
Additionally, there have also been talks regarding sanctions that will ultimately impede Russia from participating in SWIFT – a service for executing international payments. While sanctions in the past against Russia may have proved to be somewhat futile – as in 2014 when Russia annexed Crimea – targeting their central bank may bite Russia where it hurts as it will ultimately lead to the freezing of upwards of 600$ billion in foreign-exchange reserves. Essentially, this move from the West prohibits Russia from engaging in any sort of financial transaction as well as deploying its ‘warchest’ of international reserves. Furthermore, should the West institute these sanctions, it is extremely likely that the Ruble will also experience a sharp devaluation. Ultimately, this would equate to a lower standard of living as the Ruble would be able to buy less in foreign countries. In this case, the Russian government will inevitably intervene by subsidizing companies and businesses in order to keep the economy running. Perhaps this might even mean printing more Rubles although hyperinflation may end up becoming a real possibility. For companies trying to issue debt in order to raise capital, a devaluation of the Ruble could pose a serious potential hurdle. Taken together, this severely limits the number of ways Russia will be able to inoculate themselves against the draconian measures that have been imposed by the West.
How might this affect the broader economy? For starters, inflation seems to be inevitable for the time being as commodity and natural resources prices spike. These events portend lower growth for companies and businesses as corporate investments and consumer spendings will likely stagnate. All things considered, the ball now seems to be in Russia’s court as they decide their next move following the tough sanctions imposed on them – although it is safe to assume leaning on China seems probable, given their amiable and mutually beneficial relationship.
For starters, China can help ease some of the pressure by maintaining normal trade relations with Russia. In fact, there have already been talks between the two leaders for the trade of semiconductors as China triestry to mitigate the impacts of the sanctions. The import of Russian oil will continue on as China National Petroleum Corp. and Rosneft Oil Co. of Russia just penned a deal to supply China with 200,000 barrels of oil per day for the next 10 years. As of last year, Russia was China’s second largest crude oil supplier, supplying them with just over 15.5% of their total oil supply. However, it must be noted that it’s unlikely that China will support Russia at the expense of their own economy. In the condition that supporting Russia through trading does end up inviting US sanctions on their own economy, Putin may very well end up having to find someone else to offset the impacts.
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