The invasion of Ukraine by Russia has sparked the most threatening conflict between Russia and NATO partners since the end of the Cold War. Russia and Ukraine were both members of the Soviet Union till 1991 when the Soviet Union disintegrated, and Ukraine proclaimed independence. The dispute stems from Ukraine's choice to strengthen connections with the European Union and NATO, steering clear of Russia, with whom it shares strong social and cultural ties dating back to the Middle Ages. Ukraine is at a critical geographical location, right in the middle of Europe's power struggle. Moreover, Russia and Ukraine have repeatedly accused each other of violating the Minsk agreements, which Germany and France mediated and aimed to cease the conflict and secure a peaceful resolution. Fulfilling Minsk would have given decentralized control to Russian-speaking breakaway provinces, perhaps providing the Kremlin veto power over state policy shifts like joining the EU or NATO.
In 2014, the military conflict in Eastern Ukraine began. According to the International Crisis Group, the conflict killed around 14,000 people between 2014 and early 2022. For over eight years, Ukrainian government forces fought separatists backed by Russia for the administration of parts of Donetsk and Luhansk, also referred to as Donbas. Between September 2014 and February 2015, Russia, France, Ukraine, and Germany signed various iterations of the Minsk agreements, which halted advance force movement and significantly reduced violence. However, the agreements were never executed, and the combat became a trench war, with 75,000 troops fighting along a 420-kilometer front line. The war destroyed the region's economy and major industries, forcing millions of people to relocate, and making the combat zone one of the world's most mine-infested locations.
The Russian government's decision to determine the two separatist republics' independence in February 2022 effectively ended discussions for Minsk compliance. Three days later, Russia launched a military invasion of Ukraine on numerous fronts. As Western nations criticized Moscow's actions, Ukraine's President proclaimed martial law and promised retaliation. In addition, the Russian President clearly stated in a speech days before ordering the attack, that he considers Ukraine to be in Russia's fold, a position it has held since the days of the Russian Empire in the 18th century and throughout the nations' shared heritage in the Soviet Union.
Economic Consequences of the Conflict
The war between Russia and Ukraine is aggravating supply and demand conflicts, negatively affecting consumer sentiment, and affecting global economic growth against a volatile backdrop of rising global inflation owing to increased food and energy prices and interrupted supply chains following the COVID-19 outbreak. In April 2022, the IMF lowered its global growth forecasts for 2022 and 2023, claiming that the economic fallout from Russia's attack on Ukraine will proliferate widely, adding to inflationary pressure and intensifying key policy concerns. Similarly, the World Bank dropped its global growth prediction for 2022 by almost a whole percentage, from 4.1 percent to 3.2 percent.
Real GDP Growth Projections, Percentage Change, 2021-2023
Emerging European Economies
Source: IMF, World Economic Outlook April 2022
The US, the United Kingdom, Canada, and the EU have all placed sanctions on oligarchs, Russian banks, and energy companies. These sanctions, according to the IMF, will have a severe effect on the Russian economy, with the country's GDP expected to decrease by 8.5 percent this year and 2.3 percent in 2023. However, the IMF predicts an even worse outlook for the Ukrainian GDP. The Ukrainian economy is predicted to collapse by 35% by 2022. Moreover, even if the war were to finish quickly, the loss of life, damage to capital equipment and flight of citizens would significantly restrict economic growth for many coming years.
World Real GDP Growth Projections, Percentage Change, 2021-2023
Source: World Economic Outlook April 2022
- Inflation Concerns
In general, Russia's invasion of Ukraine has exacerbated supply shocks in the world economy while also posing new obstacles. Russia is a key source of gas, oil, and metals, as well as wheat and grain, which it shares with Ukraine. The IMF warned that reduced supplies of certain products have driven up their costs dramatically. This is predicted to harm low-income households worldwide and lead to greater inflation for longer than projected. According to the IMF, inflation in the US will hit 7.7% in 2022 and 5.3% in the eurozone. Moreover, investors are selling bonds as price increases, driving yields higher. The yield on the standard 10-year Treasury note hit 2.94 percent in April 2022, the highest level since 2018.
Furthermore, the Federal Reserve of the United States aims to raise interest rates six more times in 2022, while the European Central Bank announced that its asset purchase program would finish in the third quarter of 2022. If inflation remains high, though, monetary pressure may be increased. Concerns regarding the 5 million Ukrainian refugees who have found refuge in neighboring countries such as Romania, Poland, and Moldova, as well as the resulting economic strains on these countries, are again raised in the new IMF economic outlook. According to United Nations High Commissioner for Refugees, deaths were caused, and civilian infrastructure has been destroyed as the situation in Ukraine has escalated, forcing many to evacuate their homes in search of safety, security, and support. Over four million Ukrainian refugees traveled into neighboring nations in the first five weeks, and many more were compelled to relocate within the country.
Total Refugee Influx from Ukraine in Neighboring Countries
- Main Components Of Inflation
Each of the primary components adds to inflationary pressures in the euro region in a different way. Services is the biggest segment in terms of weights for 2022, accounting for about 41.7 percent of household final monetary consumption expenditure in the eurozone countries. Non-energy industrial items come in second with roughly 26.5 percent. Food, alcohol, and tobacco contribute 20.9 percent, 10.9 percent, and 20.9 percent, respectively. They account for less than a third of euro area spending, but because their prices vary much more than the other elements, they can considerably impact overall inflation.
Weights Of The Main Components of the Euro Area HICP – 2022
According to the European Union statistics agency, Eurostat, inflation in Europe reached a new high, indicating that rising energy prices fueled by Russia's war in Ukraine are constraining consumers and increasing the pressure on the central bank to increase interest rates. In March 2022, consumer prices in 19 euro-area countries increased by 7.5 percent yearly. It is sixth month in a row that eurozone inflation has exceeded 1%, taking it to the top level since the euro was introduced in 1997. Consumer costs are on the rise throughout the world, making it increasingly difficult for individuals to purchase everything from groceries to electricity bills. Energy costs are the primary driver of inflation in Europe, with prices rising 44.7 percent in March, up from 32 percent in February, according to Eurostat.
Euro Area Annual Inflation, in Percentage, April 2021 and April 2022 (E)
- Rising Energy Prices
According to International Energy Agency (IEA), in the global energy markets, Russia has a prominent role. It is one of the three leading crude producers in the world. Additionally, oil and natural gas income accounted for nearly half of Russia's federal budget, accounting for 45 percent in 2021. Russia is also the world's second-biggest natural gas producer and has the world's greatest natural gas reserves. In 2021, the country recorded 762 billion cubic meters of natural gas and exported 210 billion cubic meters via pipeline. Hence, with Russia as the top oil producer and Europe as one of its top customers, one of the significant consequences of Russia's war with Ukraine has been a surge in oil prices, which has pushed the price of oil to nearly $140 per barrel for the first time in a decade.
Energy Exports From Russia (2021)
Source: U.S. Energy Information Administration
According to the International Energy Agency's April quarterly assessment published in April 2022, global natural gas demand is expected to fall negligibly in 2022 as a result of rising costs and market disturbances caused by Russia's attack on Ukraine. The IEA's earlier prediction of a 1% rise in the previous quarterly update published in January contrasts with the predicted modest drop in global gas consumption. The prediction has been revised downward by 50 billion cubic meters. In 2021, global natural gas consumption increased by 4.5 percent.
Russia's invasion of Ukraine has contributed to the already tense natural gas market, particularly in Europe, by adding further strain and uncertainty. While there are currently no legislative limits on importing Russian natural gas into the European Union, the war has encouraged EU governments to minimize their reliance on Russian fossil fuel supplies as soon as feasible. According to IEA data, in Europe, natural gas consumption is predicted to drop by over 6% this year. In Asia, growth is forecasted to slow to 3% in 2022, compared to 7% in 2021. Because they rely mostly on domestic gas production, economies in the Americas, Africa, and the Middle East are projected to be less adversely impacted by gas market volatility. They are, however, affected by the broader economic consequences of Russia's attack on Ukraine, such as inflationary pressures, weakened purchasing power, and reduced investment due to damaged business confidence.
The War's Repercussions On Economic Policy
The adverse supply shock generated by increasing oil and gas prices, energy independence initiatives, the influx of refugees, and increased defense spending will have substantial economic policy ramifications for the European Union and its members. According to the Bruegel Organization, in 2022, their immediate budgetary effects might be 1.25% of GDP. Additionally, compared to our February prediction, the National Institute of Economic and Social Research expects Eurozone GDP growth to shrink by 0.9 percentage points in 2022 and 1.5 percentage points in 2023. Its March projections estimate inflation to rise to 5.5 percent in 2022 and 2.1 percent in 2023, compared to its February estimates of 3.1 percent in 2022 and 1.3 percent in 2023.
Euro Area Real GDP Growth Projections, Percentage Change, 2021-2023
Source: World Economic Outlook April 2022
Furthermore, INSEE used macroeconomic models to evaluate the short-term impact of current energy price rises without considering any economic policy reaction. As a result, the French GDP will fall by 0.7 percent in 2022, compared to what it would have been without the shock. The OECD estimates 1.4 percent for the eurozone as a whole; the discrepancy is due to more conservative assumptions and the notion that France is less vulnerable than the eurozone average.
The Office of Budget Responsibility (OBR) projected inflation to reach 9% by the end of 2022, a significant increase from its October 2021 prediction of marginally over 4%. Furthermore, the GDP will rise by 1.6 percent this year, down from the October prediction of 3.2 percent. According to OBR projections, these negative influences will reduce average discretionary earnings in the UK by 2% when adjusted for inflation. Aside from oil pricing, Russia and Ukraine are also important wheat producers and suppliers of several raw goods. The conflict also increases the risk of business management and investment market instability. The Institute for Government forecasts that UK sanctions on Russia will have only a minimal impact on the UK economy. Moreover, the Bank of England raised the interest rate by 0.25 percentage points to 0.75 percent in March 2022. The Monetary Policy Committee (MPC) agrees with the Office for Budget Responsibility's prediction that inflation will be around double digits in 2022.
On the fiscal front, the Chancellor's spring budget statement lays out several steps to combat the erosion of living standards caused by rising inflation, compounded by the war in Eastern Europe. Among other things, a 5% drop in petrol duties per liter for the coming year, a rise in the base income free from National Insurance duties, and a 1% decrease in the basic income tax rate beginning in 2024 are expected.
German business executives are increasingly concerned about the effect of Russia's conflict in Ukraine on the German economy, Europe's largest, where inflation, interrupted supply chains, and high oil prices have sparked recession worries. The Center for European Economic Research's monthly measure of economic sentiment fell 93.6 points in March to minus 39.3 points. Furthermore, Germany's chancellor, Olaf Scholz, declared in February 2022 that the country's reliance on Russian energy would be reduced. The country had put a halt to Nord Stream 2, a new Russian gas pipeline that would have been capable of supplying Europe with 55 billion cubic meters of gas per year when the continent's gas production was dropping. As per the Bundesbank, if the war in Ukraine intensifies and a ban on Russian coal, oil, and gas leads to limitations on power suppliers and industry, the German economy might decrease by about 2% this year. According to Germany's central bank, the projection equates to a 5% drop in output compared to a March 2022 baseline. In addition, the German government plans to increase the use of renewable energy sources dramatically. It also intended to phase out coal-fired power production and nuclear electricity simultaneously. Hydrogen power is being explored, although it is not yet at a stage where it can provide substantial amounts of electricity. Terminals for liquefied gas from the United States are being built to reduce reliance on Russian gas.
Italy imports 95% of its gas, with Russia accounting for more than 40% of it. According to Italy's official position, becoming independent of Russian gas will require between 24 and 30 months, as stated by the Ministry for Ecological Transition. Italy, which imports the bulk of its wheat and grain, is also prone to be affected. The Coldiretti agricultural association claimed that the war is exacerbating the issues of the national agriculture industry, which is already suffering the consequences of price instability.
Moreover, in February 2022, according to a declaration issued by the Italian Council of Ministers, Italy declared a state of emergency in response to Russia's invasion of Ukraine and would deploy arms and aid to the country. The government directive also called for a 16,000-place boost in the reception network, a €10 million budget, and the ability for Ukrainian refugees to be sheltered in reception centers even if they have not asked for political asylum. Furthermore, in March 2022, Italy discontinued connections with Russia in the field of research and is preparing to host Ukrainian scientists. The administration launched programs to support researchers from the nation, while ties with Russian institutions have been suspended.
In March 2022, Spanish Prime Minister Pedro Sanchez presented a $17.5-billion economic plan that involves state aid and loans to assist firms and individuals cope with rising energy bills as a result of Russia's conflict in Ukraine. The package includes tax cuts of $6.5 billion and a further $10.9 billion in help from the state-owned development fund ICO. The administration wants to cut the price of petrol and diesel by 20 cents per liter for everyone. The government would provide 15 cents per liter, while oil firms would spend 5 cents. The measures will be in effect until June 30 and will likely be authorized by the Cabinet. Additionally, the state had already reached an agreement with officials of the CNCT, the Spanish trucking industry's umbrella organization, on subsidies worth around 1 billion euros.
Real GDP Growth Projections, Annual Percentage Change, 2021-2023
Source: IMF, World Economic Outlook April 2022
A Surge In Defense Expenditure
Despite the consequences of the pandemic on economic growth, military spending in Europe and Russia increased in the run-up to Moscow's incursion of Ukraine, according to data released by the Stockholm International Peace Research Institute (SIPRI) in April 2022. Increased military budgets are anticipated to have the greatest impact in the future years. However, expenditure was already on the upswing in 2021 as tensions rose in the run-up to Russia's incursion. In 2021, global military expenditures surpassed $2 trillion for the first time, hitting $2,113 billion, up 0.7 percent from 2020, as spending increased for the seventh consecutive year. Since Russia invaded Crimea in 2014, total defense expenditure in Europe has risen dramatically to $418 billion. Military spending increased by 3.0% in 2020 and was 19% more than in 2012, according to SIPRI.
Furthermore, the European Council approved two measures granting Ukraine €500 million in military assistance and equipment as part of its financial help. The EU will pay €450 million, funded by the European Peace Facility, for military weapons geared to deploy lethal force in a historic move. A further €50 million is allocated to non-lethal equipment and supplies, including personal protection equipment, first-aid kits, and fuel. The majority of European union member states are supplying arms or military assistance to Ukraine.
- Moreover, the German Chancellor declared just four days after Russia's war began that his administration would increase defense spending by €100 billion in 2022 alone, bringing defense spending from 1.53% of GDP to over 2%.
- Belgium followed suit a few days later, stating on February 25 that it would increase its defense spending from €4.2 billion to €6.9 billion by 2030.
- Romania said in March 2022 that, beginning in 2023, it will increase its defense expenditure from 2.02 percent to 2.5 percent of GDP. The defense budget for 2022 is RON25.9 billion, up 14 percent over 2021.
- On March 3, Poland's deputy prime minister announced that his nation, which shares borders with Ukraine, will raise defense spending from 2.1 percent to 3 percent of GDP.
- Italy, which spends only 1.41 percent of its GDP on defense, jumped on board on March 16 when parliament dominantly voted to increase defense spending to 2% to assure the country's military capability and capacity to safeguard national interests, including in terms of energy supplies.
- Norway is the most recent country to announce an increase in defense expenditure, announcing that it would spend an additional NOK3 billion in 2022 to strengthen its armed troops along its 120-mile land border and the 1,087.49-mile marine border with Russia.
- Sweden will likewise increase military spending from 1.3 percent of GDP to 2% outside of NATO.
Military Expenditure, Europe, US $ Billion, 2017 to 2021
EU Economic Sanctions
The EU implemented a comprehensive and tough range of restrictive sanctions in retaliation to Russian President Vladimir Putin's unexpected and unjustifiable military aggression against Ukraine. For instance, to prevent Russia from accessing its $630 billion in foreign currency reserves, the central bank's assets have been blocked. The ruble lost 22 percent of its value, as a result, driving up the cost of imported products and driving up Russia's inflation rate by 14 percent. The ruble has now recovered, owing primarily to Moscow's support efforts. The US has prevented Russia from paying its debts with the $600 million it has in US banks, making it more difficult for Russia to fulfill its foreign debts. Aside from the proposed EU sanctions, the United States has banned all Russian oil and gas imports, and the United Kingdom will wipe out Russian oil supplies by the end of 2022. Moreover, the Nord Stream 2 pipeline project from Russia has been put on hold in Germany. The EU has also stated that Russian coal shipments will be stopped by August 2022.
Furthermore, Coca-Cola, McDonald's, and Starbucks are among the more than 1,000 international corporations that have either discontinued or abandoned their operations in Russia. Nestle has pulled some of its brands, such as KitKat and Nesquik, but claims it will continue to sell "critical items." Additionally, all Russian flights have been prohibited from the United Kingdom, the United States, the EU, and Canada. Private jets rented by Russians are also prohibited in the United Kingdom. In April 2022, the European Union proposed more measures against Russia, including the prohibition of Russian oil imports by the end of 2022. In response to these sanctions, more than 200 commodities, including telecommunications, medical, automobile, agricultural, electronic devices, and timber, have been prohibited by Russia until 2022. It also prohibits Russian enterprises from delivering dividends to foreign shareholders and restricts interest payments to foreign investors who purchase government securities. It has prevented international investors from selling Russian equities and bonds valued at billions of dollars.
USA Economic Sanctions
The United States and more than 30 countries and partners worldwide have imposed the most comprehensive, coordinated, and broad-based economic sanctions in history. Over 600 private enterprises have already abandoned the Russian market. Russia's supply chains have been badly impacted. Russia will almost certainly lose its standing as a major economy, and it will proceed down a long path of economic, economic, and technical isolation.
The US Treasury Department's Office of Foreign Assets Control imposed several fresh penalties against Russia in February 2022. The release of I Russia-related Directive 4, which expands limitations on Russian state-controlled financial directives under Executive Order 14024, and Russia-related General License No. 8A, which amends and replaces earlier General License No. 8. To implement EO 14024, OFAC added significant Russian state-controlled financial firms and their subsidiaries to the Specially Designated Nationals and Blocked Persons List, as well as the Russian Harmful Foreign Operations Sanctions Regulations. In addition, The US Department of Commerce's Bureau of Industry and Security implemented export, re-export, and transfer limitations on luxury products to all target consumers in Russia and Belarus, as well as to specific Russian and Belarusian billionaires and malign actors around the world, in March 2022. This move is part of a fresh wave of sanctions against Russia and Belarus issued by the White House, which are being carried out in collaboration with other G7 nations.
Furthermore, in May 2022, the sanctions include the removal of Western advertisements from Russia's three most popular television stations, Russia-1, Channel One Russia, and NTV, which the US claims have been at the forefront of spreading false information about Russia's invasion of Ukraine. The sanctions also include a ban on American accounting and advisory firms offering services to Russians, as well as additional limitations on Russia's industrial sector. Moreover, in April 2022, the US announced fresh sanctions against Russia, targeting businesses, Russia's media machine, and its military complex. Supplies of US services to Russia, such as accounting and management consulting, are prohibited under the new restrictions. Industrial motors, bulldozers, and other products that could be employed by Russian defense companies are prohibited from export. Another 2,600 Russian and Belarusian citizens, including military leaders and officials from Sberbank and Gazprombank, face visa restrictions.
The conflict between Russia and Ukraine has wreaked havoc on financial markets and raised concerns about the worldwide economy's recovery. Higher commodity prices exacerbated the likelihood of long-term high inflation, putting the economy at risk of stagflation and societal instability.
Certain industries, such as automotive, transportation, and chemicals, are more vulnerable. While high commodity prices were already among the risks listed as potentially delaying recovery, the intensification of the conflict makes it more likely that commodity prices will stay high for a longer period. As a result, the threat of persistently high inflation grows, raising the risks of stagflation and societal instability in both advanced and emerging economies.
Higher gasoline prices would also affect airlines and maritime freight industries, with airlines being the most vulnerable. For instance, fuel accounts for around a third of their entire costs. Furthermore, European countries, the United States, and Canada have denied Russian airlines access to their borders, and Russia has responded by banning European and Canadian flights from its airspace. Because airlines will have to take longer routes, this will result in greater expenses. As a result of the pandemic's impact on profits, airlines will eventually have a small margin for cost increases. Rail transport will also be disrupted: European businesses are prohibited from doing business with Russian Railways, which will undoubtedly disrupt freight traffic connecting Asia and Europe via Russia.
ABOUT THE AUTHOR
Anamika Khanduri is a Market Research Analyst at Knowledge Sourcing Intelligence LLP. She is well-skilled in qualitative research. Her field of expertise is obtaining and analyzing data on worldwide market, consumers, and competitors. To read more articles by her and for more information regarding multiple global markets, visit www.knowledge-sourcing.com.