The Conference Board of Canada’s Chief Economist Pedro Antunes offers the following insights on the economic impact of the Russian government’s decision to invade Ukraine on Canada:
Vladimir Putin’s war is a tragedy that has resulted in thousands of innocent civilian lives lost and millions displaced. Ukrainians and Russians are being killed in battle, and Ukraine’s cities and infrastructure are being turned to rubble. The economic fallout for both countries is devastating, and the effects will be felt globally.
For many countries, including Canada’s important trading partners, the war will have a significant negative impact on consumption and real GDP. Higher inflation will also negatively affect household spending in Canada. However, Canada’s resource producers will see an associated spike in resource prices—providing an exceptional boost to profits, private investment and government revenues. If governments add to spending in response, we find the net impact for Canada almost neutral—just slightly positive in 2022 but turning negative in 2023.
Assumptions and insights from our analysis using The Conference Board of Canada’s National Forecasting Model
Massive Commodity Price Shock
With very few exceptions, the global community has applied massive economic and financial sanctions on Russia. Russia’s banking sector is unable to operate internationally, the stock market is closed, foreign funded investment projects are halted, many foreign affiliates operating in the country are stopping their business activity and even the central bank is unable to access its foreign reserves. In addition to an economic collapse within Russia, the situation is causing a curtailment, if not altogether halt, to Russian exports.
Russia is a globally important exporter of a wide range of products and commodities. It is a major exporter of energy, in the form of natural gas, crude oil, coal and refined petroleum. Together, Russia and Ukraine are major exporters of wheat, corn, oilseed, potash, aluminum, copper, nickel, and neon. Overall, a very similar basket of products that Canada produces and exports.
Sanctions Will Persist
Curtailed exports from Russia and Ukraine have resulted in a massive and sudden global commodity price shock that tops anything we’ve seen in recent decades. Following on the heels of a 52.6 per cent annual increase last year, the Bank of Canada’s Canadian basket of raw material prices is up another 48 per cent above the 2021 average price in the third week of March. These increases outpace the commodity price boom of 2007–08. (See Chart 1).
(Bank of Canada commodity price index, to March 9, 2022, 1972M1 = 100)
(The Conference Board of Canada, estimate for month of March 2022)
It is impossible to know how the situation in Ukraine will unfold but unless Putin is overthrown, the sanctions are expected to persist. For this analysis, we thus assume that Russia’s trade and exports will continue to be hampered through this year and next, and that commodity prices remain elevated, though ease from current levels. WTI oil prices, for instance, are assumed to peak at US$110 in the second quarter, but then ease to average roughly $US85 a barrel next year.
Inflation Ratchets Up, Households cut Back
The boost to energy, food, metal and mineral prices adds to already hot global and Canadian inflation. We estimate that 1.2 percentage points will be added to inflation in Canada this year and 0.9 percentage points added in 2023, in comparison to a counterfactual scenario that assumes no war took place. The higher rate of inflation reduces household purchasing power but also pressures the Bank of Canada to increase rates more quickly—just 0.3 percentage points in 2022, but next year, the Bank Rate would be up 0.7 percentage points. The combination of higher inflation and higher rates results in a negative hit to real consumer spending in both years, down 0.3 per cent in 2022, and down 0.7 per cent in 2023.
Exceptional Boost to Export Values
While households struggle with inflation, the rapid ramp up in raw material prices benefits Canadian food and raw material producers and exporters, providing a massive increase in revenues and profits. Canada’s terms of trade (the ratio of export prices to import prices) improves by 3.5 per cent in 2022—adding nearly $77 billion (2.9 per cent) to nominal GDP in 2022 and $46 billion to corporate profits.
Increased profits will incent mining and agricultural production, but the gains are limited by capacity. In addition, higher profits will prompt more capital investment and provide a strong boost to construction activity. The effects of the war will boost goods production while dampening demand for wholesale, retail and many other private services, especially next year as inflation and higher rates eat away at household spending. Manufacturing is also negatively affected, mostly in 2023 as the war impacts demand from our trade partners. Overall, real GDP is up by 0.2 per cent in 2022, but down by 0.1 per cent in 2023. (See Chart 2.)
(impacts by industry, real GDP, per cent change)
Source: The Conference Board of Canada
Governments Expected to Spend Some of the Windfall
The Federal and aggregate provincial/territorial governments will benefit from a significant rise to nominal revenues associated with the largesse of the increase in nominal GDP. We estimate that roughly $10 billion is added annually to revenues for both these levels of government. However, rising wage pressures and other costs will also put pressure on spending. As such, we assume that both levels of government will also bolster nominal spending such that their balances only improve by a modest amount by 2023—the federal deficit is reduced by $2.9 billion, while the provinces and territories see a $1.1 billion improvement in their aggregate deficit. This assumption helps bolster real public sector activity and keeps overall employment from declining. Canada-wide employment is essentially unchanged in 2023 when comparing the war and counterfactual scenarios.
This analysis was produced using The Conference Board of Canada’s macro-econometric model of the Canadian economy. The model includes 1,700 variables covering the National Income and Expenditure Accounts, as well as detailed indicators related to population, labour, productivity, wages, prices, investment, financial markets, capital flows, and government finance.