Putin’s war is bad for us

putin

Even as the war in Ukraine rages and the end game is not at all clear, some economic consequences are already evident. The immediate effects are a sharp rise in the global prices of oil and natural gas, due to war-induced supply disruptions and economic sanctions imposed on Russia by the Western powers. This is contributing to a further rise in inflation, which had already reached record levels in many countries (including US, UK) as a result of Covid-induced supply chain disruptions. There is also no doubt that the growth rates in many countries will go down as a result of the trade and financial disruptions caused by the war. In addition, as inflation picks up, the most likely response of the central banks would be to raise interest rates which, in turn, will further dampen GDP growth rates.

Travel, especially air travel, has already become much more expensive as the price of aviation fuel has gone up and the closure of usual flight routes means longer travel time and higher costs.

Among the major economies, the biggest sufferer in economic terms would be Russia, which has already been forced to double the policy interest rate from 10% to 20% as it would not be able to borrow from Western financial markets and there is fear of capital flight from Russia. The Russian stock market has been closed indefinitely and is sure to tank as and when it is opened. The Russian government is reportedly using $10 bn from its sovereign wealth fund to buy up shares in domestic companies to prop up their values. The credit rating of Russian sovereign debt by international credit rating agencies has been reduced to junk status. Russia is likely to experience negative growth for several quarters, depending on how long the war continues and the shape it takes.

At the same time, the higher prices of oil, natural gas, metals and the need for more defence supplies (to replenish stocks) would benefit some Russian firms and shareholders. Though, under Western sanctions, it may temporarily find it difficult to draw on ‘blocked’ Western bank accounts, Russia has $630 billion of foreign exchange reserves, sufficient to pay for two years’ imports, which cannot be confiscated.

Also, if the Russian government and firms are not able to make payments abroad, foreign firms and governments would not be able to get payments for sales of goods to Russia, on top of losing the Russian market. These effects are in addition to the sharp rise in the price of oil, gas, wheat, metals (Russia is a major global producer and exporter of these products, specially to rest of Europe) in the Western world. So, financial sanctions, unlike Russian bombs and missiles rained on Ukraine, cause destruction both ways and hence cannot be sustained indefinitely.

Trade and economic cooperation between Russia and China will expand, especially as China realises the likelihood of facing similar economic sanctions in case it plans to invade Taiwan in future. Russia and China are complementary economies to a large extent as Russia can supply oil, gas and wheat to China in exchange for a variety of consumer goods. So, Russia and China together as an economic bloc would be able to soften the blow of any trade or economic sanctions on either of them.

Russia can also access China’s alternative international payment system (known as Cross-Border Interbank Payment System or CIPS) if it is kept out of the SWIFT system. Over time, this may weaken the role of the US Dollar and strengthen the role of the Chinese Yuan as one of the reserve currencies of the world.

With the hike in price, oil and natural gas exporting countries (like Russia, Saudi Arabia, Qatar, Iran, Kuwait, UAE) will gain while big importers (like India, China, Japan, South Korea) will lose. The US, with net zero imports, would not be affected either way.

Many Western countries, such as Germany, have been induced to increase their defence spending. There will be a bonanza for armament industries, construction firms and producers of construction materials as reconstruction work will have to be undertaken in war-ravaged Ukraine and elsewhere. Higher defence spending does not reduce GDP but reduces total economic welfare for the citizens as more resources are diverted from ‘butter’ to ‘guns’.

Another longer-term consequence of the war would be efforts to reduce dependence on Russian oil and gas by the Western nations. This is not an easy task and would be highly costly for Europe as currently Russia supplies EU with about 40% of its natural-gas imports and about a quarter of its crude oil imports. It would be particularly difficult for natural gas, which needs pipelines that takes years to build. The firms in alternative energy areas like solar, wind and nuclear power would get a further boost as many European countries would like to use them as alternatives to Russian supplies of fossil fuel.

The migration of several millions of people from Ukraine to the rest of Europe will have implications like imposing fiscal costs on relief and rehabilitation work, in addition to impacts on wages and employment from the additions to labour supply in the host countries.

For India, a major importer of oil and gas, the sharp rise in international oil and gas prices will mean bigger balance of payments deficit, a fall in the price of the rupee, a rise in inflation (as both dollar price of oil and rupee price of dollar rise) and an additional budgetary problem for the government as taxes would have to be reduced to keep oil and gas price rise in check. Less (net) tax revenue will mean reduced government expenditure on infrastructure development, which is the key to step up economic growth. India may also have to switch some of its defence purchases from Russia to the West if the global political sentiment remains anti-Russia and Putin continues at its helm. This would impose further budgetary costs on the government as Russia is the cheapest source of supply of much defence equipment and spares.

Higher interest rates in the US and the EU, along with heightened global uncertainty, will induce more flight of funds from India, falling stock index, and greater volatility in stock prices and exchange rate.

Lastly, whatever be the economic consequences, the human cost of death, suffering and destruction of homes, families and livelihood would be beyond what any economic calculus can measure.

(The writer is a former Professor of Economics, IIM, Calcutta, and Cornell University, US)