Impact of the Russia-Ukraine War on the Global Economy: What We Know So Far  

Almost a month has passed since Russia’s unprovoked invasion of Ukraine. Sadly, the war and humanitarian crisis are not over. Governments, private companies, and financial institutions have responded to the war by imposing harsh sanctions against Russia. The domino effect of these sanctions has already begun, taking a huge toll on the global economy. During our session titled The Cost of War: Decoding the Economic Crisis on EU, Ukraine, and Russia, we were fortunate to host Artem Kochnev and Olga Pindyuk, economists from The Vienna Institute for International Economic Studies. 

Both Kochnev and Pindyuk have been doing extensive research on the Ukraine-Russia conflict over the past few years and are subject matter experts on the economic history of Eastern Europe, foreign trade, and financial markets. They give us a clearer picture of the current economic situation, its impact on major sectors, and strategies for leaders to maintain macro-financial stability in an increasingly volatile environment. 

 

Ukraine’s Economy Comes to a Halt 

“Available data shows that more than 50% of the economy has completely stopped operating. This has happened in regions that are currently under direct military attack, as well as in regions with infrastructure destruction,” Pindyuk says. 

The Ukrainian city of Odesa, a major port and transport hub, ceased operations when the war began. Once known as the pearl of the Black Sea, Odesa has transformed into a fortress to prepare for a possible Russian attack. 

Pindyuk refers to the economic situation in Donetsk and Luhansk where the military conflict began in 2014, to assess the possible scale of economic loss of the current war. “In the first two years, the territory which was under attack and ended up not being controlled by the government of Ukraine lost almost 70% of GDP,” she says.  

However, the cost of an economic downturn and destruction of physical infrastructure is nothing compared to the loss of human capital. Pindyuk laments that the biggest loss is the “death, health deterioration, displacement, and worsening of living standards of the vast amount of people currently residing in Ukraine.” 

In terms of economic recovery, Kochnev says it depends on the length of the war. The shorter the war, the quicker the recovery, and vice versa. “The longer the time passes, the higher the chance that the skillful population; people who know how to do business, create products, and organize basic public services, will never come back,” he adds.  

The EU’s Support for Ukrainian Refugees 

Over 3 million people have already fled Ukraine – marking the biggest exodus in Europe since World War II. Poland has welcomed most of the refugees, approximately 2 million people. Refugees have also entered Slovakia, Hungary, Romania, and Moldova through the border checkpoints in Western Ukraine. Fortunately, Ukrainians who fled to the EU are allowed to live, work and study for up to 3 years in EU member countries under the newly enacted temporary protection directive.  

Pindyuk says the EU job market will benefit from the influx of Ukrainian citizens and mitigate the aging population issue in the region. “There is a vast network of Ukrainians who are already residing in the EU. If the refugees are here to stay, the chances of integration into the job market are quite high, especially given the fact that the Ukrainian population is on average, quite well educated,” she adds.  

 

Russians Brace for a Major Recession 

“According to a recent study by the Central Bank of Russia, the country is going to experience a major recession this year,” Kochnev says. This is inevitable due to the combination of sanctions, high interest rates, rising inflation, and weak consumer confidence. “The consumer prices in Russia are skyrocketing by European standards. The median increase expected by the forecasters is about 20%,” Kochnev warns. Panic buying has been widespread as Russians grapple with shortages of imported goods and an impending cost-of-living crisis. Prices of food products such as sugar and bananas have already increased by 15%. 

Kochnev adds that “sanctions first hit the financial markets in the Russian economy, and we have seen a very strong depreciation of the national currency.” The Russian currency has already depreciated more than 100% (200 rubles per US dollar). A whopping Rb2.5tn was withdrawn from the Russian banking system during the first week of the war. Furthermore, many Russians who earn income in foreign currencies have been unable to receive payments since Visa, Mastercard, Western Union, and PayPal revoked their services. 

“The sanctions regime is not going to be uplifted in the near future. I would not expect a quick and robust recovery [for the Russian economy]. It will be a sluggish recovery at best,” Kochnev says.  

 

Significant Effects on the Global Market 

Although Russia and Ukraine are relatively small economies, they account for significant shares of agricultural commodities traded globally, namely wheat and corn. “Ukraine alone exports about 10% of foreign wheat in the world and 16% of all corn. Together with Russia, they account for 30% of global wheat exports. The majority of these exports are geographically concentrated in the Middle East, Southeast Asia, and China,” Pindyuk explains. 

Countries in the EU may feel the pinch of more expensive goods, but Pindyuk points out that less affluent countries may suffer through “increased poverty rates and political risks due to worsening of living standards.” Pindyuk adds that Ukraine and Russia are big players in global metal markets, and the effects can already be seen in prices for many different metals and commodities.  

In addition, the future of energy in Europe hangs in the air with growing restrictions on Russian oil and gas imports. Kochnev expects “an increase in prices of key energy supplies, given the announced plan of the European economy to diversify their energy inputs away from the Russian suppliers.” 

Russia makes up around 40% of the EU’s gas imports. Gas prices in the EU and UK surged at the beginning of the war due to supply shortage worries but seem to have stabilized for now as Russia and Ukraine hold more peace negotiations. Nonetheless, this has not trickled down to consumers as they are still dealing with high energy bills and petrol prices.  

Earlier this month, the EU introduced a plan to remove its dependence on Russian fossil fuels by 2030 by focusing on renewable energy sources and increasing energy efficiency. However, the effects of surging gas prices are already in motion. “Our simulations showed that doubling the gas price would lead to an increase in inflation rates by 3.5%,” Kochnev explains.  

 

Mounting Inflation Rates in the EU

Consumer prices in the Eurozone unexpectedly increased by 0.9% on a monthly basis since the beginning of the year. Economists are predicting inflation will rise above 6% this month due to severe disruptions to the energy and commodity markets. Based on the official forecast by the European Central Bank, EU residents must prepare for an inflation rate of 8.5% by the end of the year. If this happens, Kochnev says it will be the EU’s highest inflation rate in decades.  

Inflation will impact each of the EU’s 19 countries differently. “Poorer countries are going to be hit a little bit stronger, and richer countries probably are going to fare a little bit better,” Kochnev says. Russian regulators and authorities are also keeping a close eye on the financial assets of European companies in the Russian economy. “They account for a significant chunk of the Russian financial market, at least in banking. Russia doesn’t want to lose management competencies to foreign companies. They don’t want to disrupt the consumer patterns in Russia, in addition to what has already happened,” Kochnev adds. 

In terms of trade, Pindyuk says there is no need to panic yet as “the effects are going to be quite small based on our estimates.” Based on her research, there will be a small decline in exports of air transport, mining services, other transport, machinery, and pharmaceuticals.  

What Happens if Russia Surrenders?

Kochnev talks about the effects on investors in the EU if Russia defaults on the war. He reminds us that Russia lacks foreign currency due to ongoing financial sanctions, especially the euro, which is the major currency of Eurobonds issued in the last six years.  

“Russia has a very low likelihood of paying its debt obligations in foreign currency. If you have certain obligations in the Russian government or Russian companies, you will probably have to drop their valuations down to zero. You will have to cut your books and recognize certain losses, and then struggle for several months or years to recover those assets, transforming them from ruble to euro,” he adds.  

On the other hand, Kochnev cautions EU citizens that inflation rates are not likely to normalize this year. “The recovery in the EU after the COVID crisis has not finished yet. It is fair to say that inflation will stabilize in the second half of 2023,” he says.  

 

Navigating the Growing List of Sanctions 

According to Kochnev, compliance executives are working around the clock as sanctions against Russia and supporting regulations are being updated on a daily basis. Unfortunately, these sanctions are “not always very carefully elaborated, at least when it comes to the EU regulations.” 

Kochnev splits the sanctions into five categories to provide a useful framework for compliance departments:  

• Symbolic — For example, media restrictions. “They are not going to have a very big economic impact; they just make the life of the Russian government a bit more complicated.” 
• Individual — “Government officials, members of Parliament, and top businessmen, account for the largest number of overall sanctions.” 
• Finance — “These are banks and operations with the Russian Central Bank and state-owned enterprises. This had a particular impact on the Russian financial markets.” 
• Export bans — This includes arms, gas and oil equipment, and luxury items. “Gas and oil equipment is very significant because it affects the ability to modernize and explore new gas and oil sites and mining locations.” 
• Import bans (fuels and metals) — These account for 60% to 70% of Russia’s exports. “So far, fuel restrictions were introduced by the United States and Canada because they do not import as much from Russia. The EU also recently introduced a ban on metals.” 

 

Three Key Risks for Industry Leaders 

If your organization conducts business with Russia, what possible risks might you face? Kochnev breaks down the risks in three areas: 

Compliance

“The sanctions list is being updated at least every day. This will be critical in the areas of banking, business and deposits, and investments in European banks. Check for the secondary effects of sanctions, taking the U.S. as the best-case scenario.” 

Regulatory

“In European jurisdictions, trade has stopped in both Russia and in Ukraine. You will have to follow up on how to conduct new ways of trade and transfer money from one account to another if you have assets in these jurisdictions.” 

“You will have to assess very quickly and carefully. What might asset freezing potentially mean? What are legislators in Russia and Ukraine going to do with imposing restrictions on moving capital and blocking accounts of certain companies?” 

Macro

“Due to rising inflation rates, you will either have to reduce your limits when it comes to trading. If you are part of finance, you will need to start actively hedging. Sitting and not doing anything will probably expose you to huge risks and losses in your trading book. You will need to find certain investments that can compensate the losses.” 

 

While it’s still too early to gauge the full impact of the war on the global economy, the crisis has shown that organizational resilience and agility are more important than ever. Industry leaders must monitor the war closely and proactively make changes to their business when necessary.