Russia’s invasion of Ukraine — notwithstanding its human and geopolitical cost — is not rattling investment and stock markets anywhere near levels seen during the Middle East oil crisis of the early 1970s, according to economists.
Financial markets might shy more from risk, and inflationary pressures resulting from the conflict will be added to what already is an inflationary environment.
Recent rises in inflation seen in both Europe and the U.S. are likely to settle, and economists predict Russian aggression will expose Europe more to financial challenges than it will the U.S.
This week, business consultancy Deloitte hosted a webinar titled “Ukraine Crisis: Assessing the Economic Impact.” Ian Stewart, Deloitte's chief economist in the United Kingdom, said from a financial viewpoint the two principal challenges are rising commodity prices and sanctions on Russia and any resultant trading fallout to Western companies.
“Russia is a major commodity producer, [but the] effect of Western sanctions and other measures have emerged as being much more forceful than the Russian government expected and what has happened in the past,” he said.
Growth
Ira Kalish, chief global economist at Deloitte Touche Tohmatsu, said Russia and Ukraine are large exporters of food. Russia also exports critical metals for use in semiconductors and car batteries. Costs will increase as supply chains are disrupted and compromised, he said.
Capital risk around uncertain energy supplies and prices might see investors look to further invest in bricks and mortar, including hotels, Kalish said.
“What central banks do will depend on what happens next with commodity prices. When sanctions started, futures markets were worried about changes in central bank interest rates, and there are negative growth impacts. Central banks need to be cognizant of this,” he said.
All of this happens at a point when inflation approaches 30-year highs in Western countries.
U.S. Federal Reserve Chairman "Jerome Powell still expects to raise interest rates, and multiple times," Kalish said. "Central banks will continue to tighten, but if things become too tight, they might ease off [to avoid] the possibility of a retraction."
Deloitte economists have scaled back forecasts for Europe, with gross domestic product projected to grow 3.5% compared to earlier expectations of 4%. The GDP growth forecast for the U.K. was scaled back from 4.3% to 3.9%. Kalish said that spread mirrors what he expects to see for the U.S.
Energy
Stewart said as gas is hard to ship, the effect of sanctions on Russian exports or if Russia turns off the taps will affect Europe much more than it does the U.S.
At press time, Russian gas pipelines remain in operation and Western governments continue to send money to Russia in exchange. Kalish said there is a $20 gap between a barrel of Russia-produced Urals oil and a barrel of Brent Crude, the West’s principal benchmark for oil prices.
The U.S. does not trade much with either Russia or Ukraine in general, not only in energy, but if oil prices went much higher the White House would need to reevaluate the situation, Kalish said.
“There is a severe disruption in oil, but the gas continues to flow. If the Central Bank was not sanctioned, Russia might have cut the gas to punish Europe, but it needs that revenue now. Will Europeans stop buying it? … [We] even could see rolling blackouts in Europe,” Kalish said, who added he did not expect to see recession in Europe because of the invasion.
According to Deloitte, Europe trades with Russia at roughly 10 times the pace the U.S, and that is why Kalish is not surprised that share prices on average have fallen by 20% in Europe as opposed to approximately 8% in the U.S.
He said because the West is already in an inflationary and tight labor market, tensions with Russia will fuel inflation further.
“There is not a whole lot the authorities in the U.S. and Europe can do to stem inflation, so now is the time to make investments in clean energy,” he said.
Agreements from last November’s 2021 United Nations Climate Change Conference, better known as COP26, might be rolled back as Europe seeks to lower 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 following COVID-19 should see a reduction, which might also stem inflation.
“This might require banks to be more diligent, but in 1973 there was a quadrupling of oil prices, and since then we have dramatically improved the efficiency of energy usage,” Kalish said.
Stewart said Russia has less leverage in the 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 extraction once again.
Stewart said renewable energy is an obvious answer but the storage of it “still needs to be cracked.” There might be a call to further concentrate on domestic energy supplies, he added.
Globalization
Stewart and Kalish said many people still distrust globalization, which they saw as keeping wages low and migration high.
Solidarity in the West on the Ukraine invasion, and anywhere up to 5 million Ukrainian refugees, will see globalization increase, even if Russia will no longer be a part of that.
“How will this [migration] affect European politics and society? In Europe, immigration is a good thing in a shrinking, aging workforce, but in the short term, there will be social and economic problems,” Kalish said.
Stewart said while Europe does trade with Russia, that trade has halved in the last decade, mostly because of what he called “Fortress Russia” policies.
“[Russia’s] economy is slightly smaller than Italy’s,” Stewart said, while Kalish likened it to South Korea.
Another change, Stewart said, is during COVID-19 “governments for the first time had policies to protect household balance sheets, an interesting precedent.”
Consumers increased their rainy day funds, too, Kalish said.
“Savings grew, so households have some flexibility. The severe fiscal stress will be on lower incomes, which governments might wish to address,” Kalish said.
Sanctions
Western sanctions already have resulted in a financial and liquidity crisis in the Russian economy.
Before the invasion began, Russian hoteliers were already bracing themselves to precipitous declines in occupancy and demand.
Stewart said the Russian ruble is down 50%, and its Central Bank has raised interest rates from 9% to 20% to stop a further fall.
“There is a flight of capital, and [we’ve seen] the closing of the Russian stock market,” he said.
With stocks crashing, individuals seeking to move personal incomes, Western companies stopping trading with Russia and the barring of Russia from the Society for Worldwide Interbank Financial Telecommunication system of financial exchange — known as SWIFT — will further make it very difficult for Russia to trade and for individual Russians to conduct normal lives, Stewart said.
“It is an extraordinary set of measures,” he added.
Russia still has access to its gold and Chinese yuan renminbi, and China might offer Russia an alternative system to SWIFT, Stewart said. But that will not fully stem the bleeding for the Russian economy.
“Russia cannot offset the loss in revenue,” he said. “There also is the fear to Western businesses to be sanctioned themselves if they do business with Russia. The [likely] severe drop in Russian [gross domestic product] has not been seen since the dark days of the 1990s.
“Russia was supposed to have grown 2.5% this year,” Stewart added.
A full occupation of Ukraine and any resultant guerrilla-style warfare, he said, would likely require the presence of up to 800,000 Russian troops, which is another very expensive proposition.