The consequences of the Ukrainian war: economic impact

12 mins read
Credits: Twitter/@Resilinc

Wars are not fought only with soldiers, but also with money. Since the dawn of time, economy has played a primary role both for those who fight a conflict and for all neighboring countries. The clash between Russia and Ukraine is no exception, however due to the highly globalized nature of world economy, the long-term consequences, that we will be forced to face, could turn catastrophic. 

BOOMERANG SANCTIONS

In the aftermath of Russian attack on Ukraine, the entire Western world has mobilized its resources to isolate Moscow. In an attempt to bring down the government and lead to a quick resolution of the conflict, several sanctions packageshave been approved, in order to exclude Russia from global trades and not only. 

In particular, the measures adopted so far have been conceived to weaken Russia’s ability to finance the war with the imposition of high financial, social and political costs through individual sanctions, media restrictions, diplomatic measures and economic limitations  for Russian economy in several fields of export of goods, services as well as imports. 

The stop to luxury goods; the suspension from the IMF, World Bank or other financial institutions; the revocation of the “special conditions” recognized by the WTO; the iron and steel block along with other raw materials. These are some of the sanctions that the EU countries, and not only, have intended to adopt in order to strangle the Russian economy, pushing it to a default. However after 6 months and no sign of receding someone begins to wonder if these calculations were wrong.

Already in early March, the Financial Times reported how the BlackRock fund complained it had lost 17 billion due to lost revenue from Moscow, after having suspended all purchases of Russian assets from February 28th. This massive destruction in value reflects the size of BlackRock ($10 trillion in assets) and also the damage that war has begun to cause to the financial system. 

In line with this trend, at the end of April the IMF revised its growth estimates for 2022. In its report, it records as industrialized nations and heavily dependent on imports of raw materials or energy, such as Germany and Italy with large manufacturing sectors, are those that risk the most in Europe. Even countries like Hungary, heavily dependent on Russian oil, Slovakia or also Latvia are beginning to face difficulties due to rising costs in some key sectors of the economy.

In general, due to increases of energy and raw materials costs, there is a growing risk that several production activities will be forced to shut down their activities, perhaps even to ration both energy and national production. The result would be disastrous for the European economy, which is already dealing with the rising inflation. 

RUNAWAY INFLATION

Although the inflation problem was already on the horizon during the post-pandemic recovery, with the Russian invasion prices began to run in the European economic zone. Currently the annual inflation rate in EU is expected to be 9.1% in August 2022, up from 8.9% in July 2022[1]. Due to this inflationary wave, Europe is the economic area that suffers the most compared to the US, China and other Asian countries. 

In an attempt to halt the inflation rush along with the increases in the cost of energy, the ECB have raised interest ratesin an attempt to curb prices. Similarly, even the American FED together with the other major central banks likeSweden, Norway, Canada, South Korea and Australia have raised their interest rates in an attempt to cut off the inflationary curve. 

Although the move was described as a necessary tool, it is a double-edged sword, as it is increasing the risk of recession, or even stagflation. If an “exit strategy” is not found to lower the rates, the entire Eurozone and the dream of a unitary pan-European area would be irremediably compromised. The whole building of a single European currency could fall, leading countries like Germany to abandon the political community of Brussels, thereby producing a domino effect.

Moreover, this impending economic crisis for Europe appears not to be confined only to the old continent, but it is going to trike also to the rest of the world. At the beginning of June the World Bank has talked about a global crisis, due to the post-Covid pandemic. However, since the conflict in Ukraine continues, it is expected that it will be difficult for many countries to avoid recession. 

THE PERFECT STORM

Already in May, the Financial Times had noted how world should prepare for a global financial economic crash. The prolongation of war is causing a shock, as the lack of energy supplies threatens to squeeze the incomes of both households and businesses, while essential goods become more expensive. Of the same opinion was the CEO of JPMorgan, Jamie Dimon, who warned to prepare for a “hurricane” whose extent is unknown. Even the entrepreneur and businessman, as well as the richest man in the world, Elon Musk has expressed his concerns about the trend of the global economy, which risks facing the third crisis in just over a decade. 

The worldwide markets, already exhausted by the pandemic crisis, could soon find itself more fragmented due to the choices made by international businesses and governments in order to reduce the collateral effects. In other words, world economies might become less globalized and more “national”, leading to unprecedented changes in supply chains. It is no coincidence that in the interview Jamie Dimion stated he is preparing for future scenarios by taking a very conservative approach to his balance sheet. A restrictive monetary policy strategy that major banking institutions such as the FED seem to follow in order to reduce the liquidity in the system and reduce the prices.

If the hurricane materializes, according to the worst of four scenarios drawn up by the Swiss bank UBS, it will bring enormous volatility of the currency, with a high chance of repercussions on other markets, including Europe, according to a pattern already experimented with the 1929 Wall Street crash and the financial crisis of 2008. The only difference is that the next economic earthquake could be more difficult to trace, since the risks in the last crisis were limited only to banking sector.

TO A NEW TRANSITION

In opposition to this looming storm, a new architecture, no longer based on dependence of US dollar is attempting to emerge. The reasons, as well as the crisis unleashed by the war in Ukraine, are also to be found in a growing desire to get rid of Western currencies, such as the US dollar or the Euro, in order to favor other payment systems and to avoid any form of exclusions from international markets as happened to Russia or countries like Iran, Venezuela and Siria.

Although several nations initially condemned Russian military action, a certain trend seems to emerge not only to stem the consequences of a global recession, but also and perhaps above all because of the European and American reactions to the war. Russia’s exclusion from the SWIFT system and from other global economic and credit institutions, as well as the use of sanctions like an indirect weapon have pushed some nations to consider other payment methods. 

A recent example occurred in the Middle East, where two key economies are moving towards. Saudi Arabia is considering to use Yuan as payment method for oil supplies to China, while the Bank of Israel added Yuan to its basket for foreign reserves along with Canadian, Australian, Japanese currencies to reduce allocation for dollar and euro. Similarly to these shifts, in late March Russia and India were working to create a bilateral transaction mechanism, which would allow payments in national currencies through the Russian Financial Message Transfer System (SPFS). 

The aim of this new economic architecture would entail a new financial and monetary system capable to open the doors to all those states that can’t or don’t want to use more the current western transaction structure. If organizations such as the BRICS or the SCO are capable of organizing a network of not only commercial exchanges, but also of political and strategic cooperation in the next few years, the world we know today will be radically different.

Evidences of this change can be noticed in the joint patrols between Russia and China, along with the desire to deepen ties and cooperation between them, but also in the willingness of several countries such as Argentina, Turkey, Egypt, Saudi Arabia and others to join the BRICS or the SCO, thus moving away from the US and its allies. To better understand what challenges and to draw a conclusion to our research, in the fourth and last part we will attempt to outline how this new structure could develop and how the world could find itself divided in the coming years.


[1]   Author’s note: the information and the graph on the web page (Eurostat) regarding the inflation trend may in the future not correspond to the information in the article as it is continuously updated.

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