Following Vladimir Putin’s invasion of Ukraine,  how has the Ukraine War conflict impacted global economic recovery? Joko Widodo, the Indonesian president, opened the G20 meeting by warning of the risks of the crisis to Ukraine on the global economy, “This is not the time for rivalries and creating new tensions that disrupt the… recovery, let alone endanger the safety of the world, as is happening in Ukraine,”.

In order to understand how the conflict has impacted the Ukrainian and Russian economies, we need to first assess the lessons learned from 2014. Following the Crimea conflict in 2014, sanctions against Russia in the financial, energy, and defence sectors, negatively impacted the nation’s access to US capital markets. Trade with key partners was also impacted negatively on a global level and, as a result, consumption. The economic impact of sanctions was further exacerbated by a fall in oil prices in Q2 2014.

Initially, sanctions made it very difficult for foreign multinationals and investors to invest into Russia. Consequently, Foreign Direct Investment (FDI) into Russia as a share of GDP fell from 2.7% in 2014 to 1.8% of GDP in 2019. External corporate borrowing had been a key factor behind previous Russian economic recovery from the 2008-2009 financial crisis, when the total corporate and banking sector foreign debt had jumped from around $400 billion in mid-2009 to a record $660 billion in July 2014. Most of these loans came from Western financial markets. From 2014, Russian financing from banks part of the Bank of International Settlements fell by 75% ($120bn) after the introduction of the sanctions. Moreover, the stock of outstanding Russian Eurobonds, traditionally the largest source of funding other than the Russian banks, essentially halved from $150bn in 2014 Q2 to $80bn by 2022.

In terms of growth, the US and EU imposed several sanctioning measures against Russia. These included restrictions on specific firms and individuals with close ties to the Russian government, as well as sector-wide measures that curtailed trade in goods related to the defence and energy sectors. In response, Russia imposed counter-sanctions on imports of food from the US, EU, and other countries that joined the original sanctioning measures against Russia. There are a wide range of estimates of the impact on lost trade, however Julian Hinz, an empirical economist studying the conflict, and Matthieu Crozet, a professor of economics at the University of Paris, estimated that between December 2013 and June 2015, losses totalled $60.2 billion. This was on average $3.2 billion per month, with EU member states bearing 76.7% of all lost trade and 78.1% of non-embargoed trade. 

The ripple effect on domestic demand meant that it only returned to its pre-2014 level in 2019, prior to the Covid-19 shock, and is currently  at a similar level. In short, cumulative domestic growth was zero for the five years post the sanctions.

With the benefit of hindsight from the 2014 post-Crimea sanctions, we can certainly acknowledge how the conflict, which started in 2022, impacted the Ukrainian and Russian economies severely, with sanctions being a key cause. 

In Russia, sanctions of the present day have impacted the economy. On 24^th February 2022, European and US governments announced a comprehensive package of sanctions against Russia. Sanctions were imposed on Russian banks, companies, and PEPs (politically exposed persons) which had a significant impact on Russian exports. The most visible example was a boycott of Russian gas flowing to Europe, with the Nord Stream 2 pipeline crucial to Moscow being postponed indefinitely. In addition, the European Union threatened to reject Russia from the SWIFT messaging network used by 11,000 banks throughout the world for fast and secure money transfers. Expelling Russia from the SWIFT system of intra-bank messaging could prove devastating in the short term. It would terminate all international transactions, trigger currency volatility, and cause massive capital outflows.

In Ukraine, Russia’s sabre rattling already had a negative impact on the economy before the war. Inflation was already at a four-year high of 10.3% before the invasion, interest rates raised five times to 9.0% in 2021, and the national currency, the Hryvnia, plunged to a four-year low against the dollar in January.  Furthermore, it was expected to have led to an 8% contraction in GDP in 2022. Business and consumer sentiment dropped considerably; a survey conducted in late January 2022 by the European Business Association, two weeks before Washington warned that a ground invasion was near inevitable, found that 17% of over 130 member companies in Ukraine were already considering relocating to the west of the country, while 10% thought of leaving the country altogether.  Nearly all private domestic and foreign investment ceased.  In short, the impact of a full invasion and long-term occupation were catastrophic for the Ukrainian economy. 

More broadly, we ask how does a Ukraine conflict impact the global economic recovery? The Ukraine conflict  unleashed a series of repercussions starting with an increase in energy prices, which  drove inflation and a potential contraction in financial markets, to which Central Banks and the Federal Reserve  had to respond by increasing interest rates.

In the first phase, we saw disruption to energy supply chains, which had a series of domino effects. Russia had a sizeable output share in many hard and soft commodity markets as outlined below – particularly gas and oil. Europe was far more dependent on the import of these commodities than the US was, and was hence more vulnerable to higher global commodity prices and lower imports from Russia.

Over 40% of the EU’s natural-gas imports came from Russia  and that proportion is bound to increase if and when Nord Stream 2 goes into operation. If Nord Stream is affected, Putin could also double down and decide to cut or reduce gas deliveries to Europe as a counter-sanction. 

Russia is also a major oil producer, producing 9.7 million barrels per day last year, according to Rystad Energy. That is second only to the United States and amounts to more oil than Iraq and Canada produced in total. JPMorgan warned that if any Russian oil flows are disrupted by the crisis, oil prices could “easily” jump. In the unlikely event that Russian oil exports are halved, crude would surge to $150 a barrel, JPMorgan said.  The only way to prevent this would be if Russia exported its oil to non-sanctioning countries or if other oil producing countries like Saudi Arabia can increase their own production.

In the second phase, we saw oil and gas supply chain disruption trigger inflation in energy prices which  saw the emergence of  inflation through other sectors of the economy – industry, services, and consumer spending. Even if oil rallied to only $110 a barrel in an escalation of tensions, the year-over-year inflation rate would have climbed above 10%, according to an analysis by RSM, the highest percentage since 1981. That would have rippled through to consumer spending including domestic heating and electricity costs. In addition to energy, other commodities experienced price volatility. Russia is a major producer of metals, including aluminium and palladium and is also  the biggest exporter of wheat in the world. On the other hand Ukraine is also a significant exporter of both wheat and corn, therefore when both shut down there was a huge gap in the market.

In the third phase, increasing inflation raised concerns about the potential of hyperinflation. This prompted central banks globally to increase interest rates. When inflation spiked above 10%, the Federal Reserve came under pressure to intensify efforts to get prices under control, and they did. That meant a faster pace of interest rate hikes of 2-3-4% to cool off inflation. This led to  increased borrowing costs for consumers on everything from mortgages and car loans to credit cards in the USA and forced other central banks in Europe and around the world to follow suite. 

Finally, the increased inflation and interest rates slowed down the global economy by intensifying inflation and increasing uncertainty. The RSM analysis found that a jump to $110 oil could have dented the US GDP by one percentage point.

Despite these negative impacts on the global economy’s recovery, there are some mitigating factors which helped prevent it from falling into a recession. Europe cannot implement full sanctions on Russian oil and gas. The  importance of Russia as an energy supplier to Europe, in particular, makes it difficult to envisage a scenario where Europe sanctions 100% of imports of Russian oil and gas. Germany in particular closed down its alternative energy sources, in particular nuclear, following the Fukushima nuclear disaster in 2011, and therefore has no alternative sources to replace Russian gas in the short term. Furthermore, it recently invested heavily to build significant pipeline infrastructure (Nord stream) to import Russian gas, and it doesn’t have alternative capacity for example importing Liquid Natural Gas through shipping terminals. It is therefore unlikely that the West will stop buying 100% of Russian oil and gas in the short term. Therefore, oil prices are unlikely to climb above $110/ barrel on a permanent basis. 

Governments and Central Banks can use interest rates to control inflation and economic slowdown. The sharp rise in oil prices raises the threat of stagflation – where advanced economies struggle with even higher inflation and a sharp economic slowdown – similar to the pattern that played out in the 1970s after the first oil shock. US Fed officials pushed back on the idea that they would launch a pre-emptive strike on inflation by hiking interest rates by 50 basis points, quite a few months ago. However, there is a strong likelihood that the US Federal Reserve and other Central Banks utilise interest rate hikes to tame inflation, despite the fact that this may create political shock waves across the electorate.