Ukrainian flag

A Bear Unleashed

By: Pedro Antunes, Sohaib Shahid, Ted Mallett

The shock of Russia’s invasion of Ukraine has upended conditions far and wide. What people had hoped was only bluster and brinksmanship from Vladimir Putin quickly turned into the unthinkable when his troops crossed the border on February 24. The tragedies the Ukrainian population are having to endure are difficult for outsiders to comprehend. The international community quickly slapped sanctions on key elements of the Russian economy, but their effects so far pale in comparison with the direct human costs within Ukraine’s borders.

It is impossible to know how long or how far this conflict will last militarily. Its aftereffects, however, will be generational. Russia has shaken the world order by choosing to go down a one-way path. The smooth function of societies and international market economies rely on trust—and by betraying that, Russia has likely done immeasurable damage to its own long-term interests.

There are many more unknowns than knowns at this point, but here are some of the topic areas we are monitoring in Canada.

Russia’s Financial Market Unravelling

  • Russia is the world’s 11th-largest economy, with only 4/5ths of Canada’s GDP in 2021 according to the IMF. Even so, broad-based sanctions will hit segments of the world economy hard and certain individuals and businesses proportionately harder. At great cost, many global businesses are walking away from substantial investments with Russian entities.
  • Targeted locking out of Russian businesses and banks to the SWIFT network will hinder, but not stop their abilities to finance exports and imports. The cutting off of Russian central bank’s reserves, which are mainly held outside the country, has already severely devalued the Ruble and doubled interest rates inside the country.
  • Unlike European banks, Canadian banks are not major creditors to Russian banks, so Canadian bank loan portfolios are expected to remain safe. Still, Canadian banks do own Russian foreign currency deposits. The sanctions mean that Canadian banks would be required to freeze those deposits. Longer term, this move may have strong implications for how non-western economies view Canada, the United States and Europe. Going forward, some non-western governments might start moving their reserves out of the West (including Canada) and into those of their “allies,” potentially creating a bifurcation in global reserves.

Oil prices jump—Ruble takes a hit

Feb 1 Feb 3 Feb 7 Feb 9 Feb 1 1 Feb 15 Feb 17 Feb 21 Feb 23 Feb 25 Mar 1 0.8 0.9 1.0 1.1 1.2 1.3 1.4 85 90 95 100 105 1 10 1 15 US cents per Ruble (left) Brent Crude $US/bbl (right)

Source: Moody’s Analytics.

Commodities Become the Centre of Attention

  • Oil and gas are at the top of the list of international repercussions. Russia accounts for 12 percent of worldwide oil production and 17 percent of its natural gas. Sanctions will make it more difficult for Russia to sell its products on open markets, causing a rush on other sources—including Canada. Oil prices have climbed above US$100, and a further climb is probable.
  • Russia and Ukraine are also responsible for almost 1/3 of the world’s wheat exports, 1/6 of worldwide corn and a whopping 3/4 of total sunflower oil supplies. Prices are up substantially, and with uncertainty over how much can get planted in either country this spring, Canadian producers will likely see solid demand for grains and oilseeds.
  • Metals will also face export restrictions and price effects. These include commodities commonly supplied by Canadian producers: copper, nickel, aluminum, palladium, etc.
  • Canadian resource industries and regions connected to these major commodities will see surging demand and prices.

Canada’s Direct Trade with Russia is Minimal, but Impacts to be Felt Nonetheless

  • Canadian merchandise exports to Russia peaked in 2013 at $1.4 billion but had fallen by more than half by 2021. Imports are also minor, accounting for only 0.35 per cent of the total. Trade with Ukraine is even smaller, with imports and exports combining to only $450 million in 2021. By comparison Canada trades that in a single day over the Ambassador bridge in Windsor-Detroit.
  • Still, the repercussion on the global economy will impact the United States, Europe and other important trade partners.
  • Russia produces 70 per cent of the world’s neon, which is a critical component in the production of semi-conductors. Automotive and consumer electronics production—already damaged by spinoff COVID-19 effects, would therefore be impacted further.

Higher Inflation will Erode Spending Power

  • The commodities price surge will combine with the existing supply chain crunch to give an ill-timed boost to consumer and producer price inflation—especially on food and energy products which were already at multi-decade highs. A higher and longer bout of inflation poses significant economic risks. If consumers and businesses grow to expect permanently higher inflation, our simulations show the potential for significantly slower economic growth and higher unemployment—perhaps a return to 1970s-style stagflation.
  • Higher or more persistent inflation will weigh on the Bank of Canada’s interest rate setting timelines. The Bank will continue tightening but will have to keep a more careful eye out for the potential of weakened consumer demand.

Another Setback for the Travel Industry

  • International tourist travel was expected to surge this year after two long years of repressed demand due to COVID. Most transatlantic travel to and from Canada is to Western Europe, but consumers may be more reluctant to commit to overseas vacations or may change their destination plans. In the past, the Gulf War, SARS and post-9/11 all had impacts on Canadians’ international travel behaviours.

Additional Fiscal Pressures to Come

  • Canada has indicated support for refugees coming to Canada so there will likely be settlement and support costs at all levels of government.
  • It is too early to tell, but if Western European government response is any indication, Canada’s defense spending may get higher priority in the longer term.