Opinion: Putin’s war on Ukraine is shattering the global economy – expect lower incomes, persistent inflation and lower global investment returns

Europeans and Americans are happy with the bill coming from Russia’s war against Ukraine. But the financial cost of war will disrupt business and personal finances, savings and investment returns around the world for some time.

First, there are the direct costs. The US government’s proposed $33 billion aid package for Ukraine is the latest installment of generous Western aid. Since Ukraine needs about $5 billion a month, more will be needed. The 5 million war refugees now scattered across Europe will need assistance until they can return or be resettled. Rebuilding Ukraine’s infrastructure and industry requires an estimated $600 billion so far, and Western backers, most notably the US and Germany, will have to come up with that money. Many Western countries are also increasing their defense budgets in response to the deteriorating geopolitical outlook.

This spending reduces funds that would otherwise be available for countries’ health, education, social services and infrastructure. It has to be financed through taxes or government bonds. With public finances already in a fragile state, still recovering from the coronavirus pandemic, this will weigh on debt and put pressure on interest rates.

Second, Russia and Ukraine are important suppliers of raw materials. Russia is the second largest producer of natural gas NG00, -0.64% (17% of world production) and the third largest producer of oil CL00, +0.59% (12%) and a major supplier of aluminum (6%). Copper HG00, +0.03% (3.5%), Nickel (7%), Platinum PL00, -0.43% (12%), Palladium PA00, +0.40% (40%) and Titanium (50 %). Russia is a major fertilizer producer, generating around 18% of potash and 20% of ammonia production. Russia and Ukraine both supply 90% of the neon gas used in lasers used to make semiconductors. The two countries produce more than a quarter of the world’s wheat, as well as large quantities of grains and oilseeds for people and livestock.

With trade restrictions targeting this supply, commodity prices are likely to remain elevated. At the same time, price volatility is causing large margin calls in commodity markets. As can be seen in the nickel market, this disrupts the flow of raw materials and leads to higher prices.

The war in Ukraine could increase inflation by up to 3% and severely dampen global growth. Europe will be hardest hit, while non-commodity-producing emerging markets, which have fueled global growth, are also at great risk.

Third, investors must expect losses. The West’s financial commitment to Russia is around $150 billion in debt and equity, of which around $71 billion is owned by US mutual funds. Western firms have leased around 500 planes (worth $10 billion) to Russia that may not be repayable. Since Russia is now unwilling or unable to make payments due to sanctions and suspension of payment systems, write-downs in the tens of billions have been announced.

Many foreign companies with Russian branches face high write-downs and there are few buyers for these assets. For example, BP sold +2.15% of its stake in Rosneft Oil RU:ROSN from BP
alone can result in losses of up to $25 billion. Losing access to Russian buyers will impact profits for Western auto, aerospace, technology and consumer companies.

Fourth, Ukraine distorts political options. Defense spending contributes to inflationary pressures. At the same time, the uncertain outlook and financial instability may limit the normalization of interest rates.

Fifth, the move away from globalization may accelerate. The ending of Cold War tensions has boosted world trade and capital flows over the past three decades, boosted global growth and kept consumer prices low. This tailwind turns around. Nations are increasingly emphasizing self-sufficiency to regain economic control.

“ Distortions in capital flows and higher interest rates are likely. ”

The confiscation of assets from the Central Bank of Russia and the exclusion of Russia from the global SWIFT payment system have undermined international financial agreements. China, India and other emerging markets may reduce holdings in US dollar-denominated DX00, +0.49% assets and trade in other currencies to avoid the risk of seizure. Because many of these countries are big savers and provide capital to the global economy, dislocations in capital flows and higher interest rates are likely.

Support for Ukraine came from the Anglosphere and a reserved Europe intent on managing energy security concerns. The rest of the world has remained largely neutral or has sided with Russia.

Brave new world of commerce

As many nations fail to comply with sanctions and restrictions, new trade relationships are forged. China and India continue to buy Russian commodities at significant discounts due to the lack of alternative markets for these commodities. Emerging market buyers are looking for cheap assets from western forced sellers. Attempts to sanction these countries, particularly China, India and Brazil, would disrupt the global trading system.

Russia’s war against Ukraine will fragment the world economy. Trade barriers and cross-border investment will lead to lower incomes, inflated prices for goods and services and reduced investment opportunities and returns worldwide. On top of that, the West could end up bearing most of the financial cost of this war.

Satyajit Das is a former banker and author of A Banquet of Consequences – Reloaded (Viking, 2021) and Fortune’s fool: Australia’s choices (Monash University Publishing, June 2022)

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