Russia’s invasion of Ukraine has been deeply disturbing and has had a tragic effect on the people in Ukraine. From an economic perspective, the war has destroyed Ukraine’s economy and much of its infrastructure. The war costs and international sanctions have severely damaged Russia’s economy as well, but the impacts are not confined to these countries. The conflict has added new risks to a world economy that was already struggling with rising inflation, bottlenecks in supply chains, and the lingering effects from the pandemic.
The immediate effect of the war on the global economy will be even higher inflation, weaker real GDP growth and a disruption to global financial markets. The extent of these impacts will depend on the length of the war and whether it spreads beyond Ukraine’s borders. Our view is that military actions remain inside Ukraine, but that the interruption in commodity trade from those two countries will be longer-lasting. We have reduced our global growth forecast for 2022 from 4.0 to 3.5 per cent, but the balance of risks remain on the downside.
The main link between Russia and Ukraine and the world economy is through oil, natural gas and other commodities. Russia and Ukraine exports comprise about 12 per cent global oil production, 13 per cent of titanium production, 14 per cent of wheat production, close to 20 per cent of natural gas production and 70 per cent of neon gas production used in the manufacturing of semiconductors. The latter implies that the shortage of semiconductors that emerged during the pandemic will likely persist for longer. Natural gas exports are an important source of energy for Europe, while many emerging markets depend on Russia and Ukraine for their wheat.
The effects of the war on individual countries will vary depending on the trade exposure to Russia and Ukraine. The United States and Canada will face a relatively minor disruption to their economies because trade with Russia and Ukraine is negligible. Of course, this assumption depends crucially on our view that the war remains contained to Ukraine and doesn’t persist for several years. The same can’t be said for Europe, which depends on Russia for a large share of its supply of natural gas. For instance, Germany obtains around 50 per cent of its natural gas from Russia. Italy is also reliant on Russian natural gas, as are several countries in Eastern Europe. Europe’s economic ties to Russia via international trade, foreign direct investment, capital flows are larger than America’s but small enough that they can absorb the disruption and potential losses. A gain of real GDP in the 3.0 per cent range for the E.U. is still anticipated this year.
In the Asia Pacific region some commodity exporters like Australia and New Zealand will benefit from higher prices. Countries like India and China are net oil importers and could pay much more for their energy needs, though may take Russian oil at a discount. China’s situation is challenging because the government has decided to help Russia by purchasing more of its oil and also help to offset some of the financial sanctions designed to hurt Russia’s economy. We expect the Chinese economy to expand by around 5 per cent this year, down from a gain of 8 .1 per cent in 2021. Inflation has generally been well contained in the Asia Pacific and, consequently, most countries should be able to manage rising commodity prices.
High raw material and food prices will have serious implications for many developing economies, especially those that are importers of energy and food. COVID-19 has had a devastating impact on many of the world’s poorer citizens and the war will add to rising food and energy prices, impacting living standards in many countries in Africa and South and Central America.
The Russian economy will pay the steepest price and will likely slip into recession over the near term with real GDP declining by as much as 15 per cent in 2022. The decision to restrict Russia’s access to the SWIFT international payments system and freeze central bank holdings of greenbacks, pounds and euros will make it difficult for Russian policymakers to defend the ruble, which has plunged by more than 50 per cent since the start of the war. In response to the tumbling ruble, the central bank increased interest rates to 20 per cent, a development that will hurt consumer and business investment spending. Russian firms will find it difficult to pay for what imported goods they can get. The sudden withdrawal of many global companies will make it difficult if not impossible for Russians to maintain equipment already in the country. The government will likely have trouble making payments on its debt, thereby raising the spectre of a debt default, which would further restrict Russia’ access to global credit markets.
The short-term implications from the war on the global economy are extremely difficult to anticipate simply because predicting the outcome of conflicts is impossible. But there are some longer-term impacts from the war that are somewhat easier to project. The trend away from globalization was in place prior to the war due to the rise of former President Trump, Brexit and the gradual erosion of democratic institutions and a free press in countries like Poland and Hungary. The war will speed up the deglobalization of the world economy and its division into economic blocs as Russia pivots more to the East and increases trade and financial ties with China. In fact, China may look at the severe sanctions placed on Russia and conclude that it must ramp up its move towards greater self-sufficiency. World exports as a share of GDP were about 31 per cent in 2008 but have slipped to 26 per cent today. This share will continue to drop.
Bottom Line: the war between Russia and Ukraine will profoundly change the way the world economy operates for decades to come.