Economists say Russia’s invasion of Ukraine – despite its human and geopolitical cost – does not shake investment and stock markets to levels close to levels seen during the early Middle East oil crisis of the 1970s.
Financial markets could become more risk averse, and inflationary pressures resulting from the conflict will add to what is already an inflationary environment.
Recent increases in inflation seen in Europe and the United States are expected to subside, and economists predict that Russian aggression will expose Europe to financial challenges more than the United States
This week, business advisory firm Deloitte hosted a webinar titled “Ukraine Crisis: Assessing the Economic Impact.” Ian Stewart, Deloitte’s UK chief economist, said that from a financial perspective the two main challenges are rising commodity prices and the sanctions on Russia and the resulting trade fallout for Western companies.
“Russia is a major producer of raw materials, [but the] the effect of Western sanctions and other measures came out to be much more powerful than what the Russian government expected and what happened in the past,” he said.
Ira Kalish, chief global economist at Deloitte Touche Tohmatsu, said Russia and Ukraine are major food exporters. Russia also exports critical metals for use in semiconductors and car batteries. Costs will rise as supply chains are disrupted and compromised, he said.
Capital risk from uncertainty in energy supplies and prices could tempt investors to invest more in bricks and mortar, including hotels, Kalish said.
“What central banks do will depend on what happens next with commodity prices. When the sanctions started, futures markets were worried about changes in central bank interest rates, and there is negative impacts on growth. Central banks need to be aware of this,” he said.
All of this is happening at a time when inflation is approaching 30-year highs in Western countries.
US Federal Reserve Chairman “Jerome Powell still expects to raise interest rates, and more than once,” Kalish said. “Central banks will continue to tighten, but if things get too tight, they could loosen [to avoid] the possibility of withdrawal.
Deloitte economists have lowered their forecast for Europe, with gross domestic product expected to rise 3.5% from earlier expectations of 4%. The GDP growth forecast for the UK has been revised down from 4.3% to 3.9%. Kalish said this spread reflects what he expects to see for the United States.
Stewart said that with gas being difficult to ship, the effect of sanctions on Russian exports or if Russia closes the taps will affect Europe much more than the United States.
As of press time, Russian gas pipelines remain in service and Western governments continue to send money to Russia in exchange. Kalish said there was a $20 difference between a barrel of Urals oil produced in Russia and a barrel of Brent Crude, the main Western benchmark for oil prices.
The United States doesn’t trade much with Russia or Ukraine in general, not just on energy, but if oil prices go up a lot, the White House should reassess the situation, Kalish said.
“There is a severe oil disruption, but the gas is still flowing. If the Central Bank weren’t sanctioned, Russia might have cut the gas to punish Europe, but it needs that revenue now. Will Europeans stop buying it? … [We] might even see power cuts in Europe,” said Kalish, who added that he did not expect to see a recession in Europe because of the invasion.
Europe trades with Russia at about 10 times the rate of the United States, according to Deloitte, and that’s why Kalish isn’t surprised that stock prices have on average fallen 20% in Europe from around 8%. in the USA.
He said that because the West is already in an inflationary and tight labor market, tensions with Russia will further fuel inflation.
“There’s not much US and European authorities can do to stem inflation, so now is the time to invest in clean energy,” he said.
The agreements of the United Nations Climate Change Conference last November 2021, better known as the COP26, could be canceled while Europe seeks to reduce its dependence on Russian gas.
“The leader of the German Green Party was even recommending a return to nuclear power, which is extraordinary,” Kalish said.
Stewart said pent-up demand after COVID-19 should see a reduction, which could also stem inflation.
“It might force banks to be more diligent, but in 1973 oil prices quadrupled, and since then we’ve improved the efficiency of energy use dramatically,” Kalish said.
Stewart said Russia has less clout in oil markets today.
“Russia is not the player [the Organization of Petroleum Exporting Countries] was in the 1970s,” Stewart said.
Countries are also considering coal mining again.
Stewart said renewable energy is an obvious answer, but its storage “still needs to be cracked.” There could be a call to focus more on domestic energy supplies, he added.
Stewart and Kalish said many people are still wary of globalization, which they see as keeping wages low and migration high.
Solidarity in the West in the face of the invasion of Ukraine, and up to 5 million Ukrainian refugees, will see globalization increase, even if Russia will no longer be part of it.
“How is it [migration] affect European politics and society? In Europe, immigration is a good thing in a declining and aging workforce, but in the short term there will be social and economic problems,” Kalish said.
Stewart said that while Europe traded with Russia, that trade had halved over the past decade, mainly because of what he called “Fortress Russian” policies.
“[Russia’s] The economy is slightly smaller than Italy’s,” Stewart said, while Kalish compared it to South Korea.
Another change, Stewart said, is that during COVID-19, “governments for the first time had policies to protect household balance sheets, an interesting precedent.”
Consumers have also increased their funds for rainy days, Kalish said.
“Savings have increased, so households have some flexibility. Severe fiscal pressure will hit lower incomes, which governments may wish to address,” Kalish said.
Western sanctions have already led to a financial and liquidity crisis in the Russian economy.
Before the start of the invasion, Russian hoteliers were already preparing to precipitous declines in occupancy and demand.
Stewart said the Russian ruble was down 50% and its Central Bank had raised interest rates from 9% to 20% to stop a further decline.
“There is a flight of capital, and [we’ve seen] the shutdown of the Russian stock market,” he said.
With stocks crashing, individuals seeking to shift their personal incomes, Western companies ceasing to trade with Russia, and Russia’s exclusion from the Society for Global Interbank Financial Telecommunications’ financial exchange system – known as name SWIFT – will make it even harder for Russia to trade and for Russians to lead normal lives, Stewart said.
“It’s an extraordinary set of measures,” he added.
Russia still has access to its gold and the Chinese yuan renminbi, and China could offer Russia an alternative system to SWIFT, Stewart said. But this will not completely stem the bleeding from the Russian economy.
“Russia cannot compensate for the loss of income,” he said. “There is also the fear of Western companies themselves being sanctioned if they do business with Russia. the [likely] sharp drop in Russian [gross domestic product] hasn’t been seen since the dark days of the 1990s.
“Russia was supposed to be up 2.5% this year,” Stewart added.
A full occupation of Ukraine and any resulting guerrilla warfare, he said, would likely require the presence of up to 800,000 Russian troops, which is another very expensive proposition.
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