Thursday, December 1 2022

By Miguel Otero Iglesias and Federico Steinberg*

War, in addition to causing death and destruction, is harmful to economies: it destroys physical and human capital, increases uncertainty and stifles investment and consumption. But in addition to the direct economic impact of the war in Ukraine – which will cripple the Ukrainian economy and, due to Western sanctions, the Russian economy – we must also mention the uncertain effect of the turbulence on fuel and materials raw. markets, with consequences that are still very uncertain for Europe, as well as the impact of other economic measures that could be adopted in the future if the conflict persists. All of this will steer the global economy, at best, towards weaker growth and higher inflation; and, in the worst case, to a sharp slowdown in growth that could turn into recession in many European countries (and elsewhere) due to financial and commodity market shocks.

The war is unfolding against the backdrop of a global economic recovery after leaving behind the worst of the COVID-19 pandemic, with price growth not seen in decades and major bottlenecks in supply chains. global supplies. Naturally, the main economic impact of the war will be suffered by Ukraine. Having said that, it is also very likely that the sanctions imposed on Russia will create a financial crisis and an acute recession of the Russian economy, which is a little larger than that of Spain and represents only 1.7% of the global GDP, but is systemically important in some sectors.

Beyond that, it is risky to speculate on the economic impact of the invasion. It will depend on how long the conflict lasts and how Russia responds to Western sanctions, including on fuel. 40% of the gas imported by the EU is supplied by Russia, and this figure rises to 100% for Bulgaria, 80% for Poland, around 60% for Austria and Hungary, 50% for Germany and 40% for Italy. But, of course, the price of gas has increased by more than 50% in the last week, which will affect all European economies.

And the same can be said for rising oil prices. It should also be noted that Russia (and to a lesser extent Ukraine) is a major exporter of wheat, copper, nickel, platinum, palladium and titanium. Rising food prices linked to the shortage of wheat could trigger social tensions in emerging and developing countries, as happened in 2010, when the aforementioned minerals are used in the manufacture of cars, electronic equipment and aircraft, whose supply chains are already strained. considerable strain for months.

In recent days, many historical comparisons have been drawn between the Russian invasion of Ukraine and some of the darkest episodes Europe has seen in the 20and century. Beyond the similarities, what is unprecedented is the nature of the economic sanctions against Russia, made possible by the pace of economic, financial and technological globalization in recent years. The measures are so drastic that they could lead to the complete isolation of the Russian economy, while having a negative effect on the countries imposing them. Their goal – in addition to showing the strength of the allies, who have always made clear that they will not engage in direct war with Russia, but have demonstrated that economics can be almost as destructive as weapons – is to reduce support for Putin. among Russian elites and public opinion. But such moves could trigger an even harsher Russian reaction, both militarily and economically and energy-wise, compounding the economic damage.

Beyond the traditional trade sanctions, which had already been imposed after the Russian annexation of Crimea in 2014 but had a limited impact, what is truly innovative came in the financial field.

First, after some reluctance on the part of Germany and Italy, which are highly dependent on Russian gas and fearful of supply embargoes which have not yet materialized, it was decided to withdraw certain Russian banks in the SWIFT system. SWIFT enables commercial banks almost anywhere in the world to make transfers, so excluding them from the system means cutting them off from financial globalization.

Naturally, this also hurts Western banks and businesses, which can no longer receive payments from Russia via SWIFT as they once did. However, the West decided to keep SWIFT access for banks more focused on the energy sector, so as not to impede the flow of cash used to pay for gas purchases; this has created a somewhat Kafkaesque situation where the ruble depreciates massively due to the sanctions, while on the contrary, with rising gas and oil prices, Russia increases its income in dollars.

Second, in perhaps the most surprising and drastic measure, much of the Russian central bank’s foreign assets have been frozen. This step is unprecedented in the history of economic sanctions. Russia had prepared for a possible war and had accumulated $630 billion in reserves, and it was argued that it could use them to cushion the economic impact of sanctions and reduce exchange rate volatility resulting from the conflict. ; but with the freezing of almost two-thirds of the Russian central bank’s foreign assets (whether in commercial banks in the form of financial assets or in the form of deposits in other central banks), its ability to operate on foreign exchange markets were significantly damaged at the same time as its currency and part of its financial system began to leak. Russia has gone on the defensive by shutting down its stock market to stave off panic, raising interest rates to 20% to keep Russians’ savings in their banks and asking big exporting companies, many of whom are exporters fuel companies with large amounts of cash sell their dollars on the market to compensate for the fall in the ruble (Russia receives some 700 million US dollars every day from the sale of its energy products abroad). In other words, the intervention that would normally fall to the Russian central bank to stabilize the economy is now done by companies. Either way, it is likely that the ruble will continue to depreciate and inflation in Russia will continue to rise.

Third, the sanctions include asset freezes and travel restrictions imposed on many prominent Russians, including President Putin himself and his foreign minister, Lavrov, and many oligarchs close to the Kremlin, who can no longer profit of their global jet-set lifestyle. quite the same way. For its part, Germany announced the suspension of the Nord Stream 2 gas pipeline and the West as a whole announced the ban on technology exports to Russia. Airspace was closed to Russian airlines and BP and Shell announced the sale of stakes worth $25 billion and $3 billion in Russian energy companies Rosneft and Gazprom, respectively. In response, Russia banned the sale of assets by foreigners in Russia and also imposed capital controls to ensure that foreign capital cannot be expelled from the country.

Finally, the sanctions have been extended to many socio-cultural spheres, where they have an impact, half-economic, half-symbolic, which should not be underestimated. It’s not just that Russia won’t be able to take part in this year’s Eurovision Song Contest. The International Olympic Committee has recommended that all sports federations ban the participation of Russian and Belarusian athletes in their competitions, Russian teams have been banned from basketball competitions, and FIFA and UEFA have banned Russian teams from participate in their competitions, which means Spartak Moscow have been eliminated from the Europa League and the Russian national team will not be able to participate in the play-offs for a chance to participate in the Qatar World Cup in December.

Additionally, UEFA terminated Gazprom’s sponsorship contract and announced that this year’s Champions League final would not be held in Saint Petersburg as originally planned. Here too, the sanctions have an economic impact, they are extremely tough and unprecedented, with the clear intention of making the vast majority of the Russian population recognize the gravity of the situation and put pressure on Putin to end the war.

The effectiveness of economic boycotts has always generated much debate. Various studies suggest that sanctions change the behavior of countries in only 40% of cases. As already pointed out, however, sanctions of this magnitude have so far never been applied and even neutral countries like Finland, Sweden and Switzerland (just that) have signed the boycott. It remains to be seen how the other major powers, such as China and India, will react. Specifically, China could offer Russia to use the CIPS interbank payment system to circumvent the SWIFT exclusion. In any case, the sanctions constitute a major setback for the Russian economy and could trigger an aggressive reaction on its part, such as cuts in gas supplies to certain countries. For all these reasons, it is likely that the coming days will also be of major significance in the economic arena of war.

*About the authors:

  • Miguel Otero-Iglesias is a senior analyst at the Royal Elcano Institute and a professor at the IE School of Global and Public Affairs. He is also an associate researcher at the EU-Asia Institute of ESSCA School of Management in France.
  • Federico Steinberg is Senior Analyst at the Royal Elcano Institute, Lecturer in Political Economy at the Universidad Autónoma de Madrid and Special Advisor to the High Representative for Foreign and Security Policy and Vice-President of the European Commission Josep Borrell

Source: This article was published by Elcano Royal Institute


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