The Economic Fallout Of Putin’s Misadventure In Ukraine

At 5 am on February 24, an air raid siren in the Ukrainian capital of Kyiv marked the beginning of probably the biggest conflict in Europe since the Second World War. By 6 am, Russian President Vladimir Putin, in a surprise televised address, made the war official by declaring a military operation in Ukraine. He said that Russia was left with no choice but to defend the people of Ukraine from a “genocidal government”.

As expected, the round of sanctions from the western world continued with the United States (US) announcing the freezing of assets of four Russian banks and limiting high-tech exports. Similarly, the European Union (EU) also targeted Russia’s banking market. European Commission President Ursula von der Leyen said the package includes targeting 70 per cent of the Russian banking market, key state-owned companies and its energy sector.

The first round of sanctions

The first round of economic sanctions by the Western world was triggered after Putin’s February 21 speech in which he recognised the two pro-Russian republics of Donetsk and Luhansk in Ukraine. The US, in the first round, had imposed full blocking sanctions against VEB, an economic-development bank and Promsvyazbank, which finances Russia’s defence sector and also froze its assets in America. It further prohibited American individuals and companies from making deals with them and blocked their access to dollars.

These sanctions, which would result in the global isolation of the world’s 11th largest economy, will have immediate and long-term global implications due to the dominance of a globalised and connected world economy since the collapse of the Soviet Union in 1991.

“The interconnected world we’re living in since the fall of the Soviet Union has made aspects like our economies, polity, culture and technology interdependent. Russia’s actions in Ukraine and the immediate sanctions will not just have a ripple effect over Russia but the world at large,” says Subodh Kumar Sajjan, Assistant Professor with Department of Political Science, University of Delhi.

Surge in Brent Crude

Immediately after the invasion on February 24, the Brent Crude benchmark surged over $100 per barrel for the first time since 2014. This adds to the misery of the consumers as major economies around the world are already reeling with high inflation figures. In India, there is no direct bearing yet as state owned-fuel retailers continue to hold petrol, diesel and LPG rates. However, if the volatility persists in the global benchmark, Indian consumers may soon bear the brunt of high fuel prices once the elections get over on March 7.

Credit rating agency ICRA in a report suggested a roll back in excise duties to pre-pandemic levels to soften the impact on Consumer Price Index (CPI) inflation trajectory. “The rollback however will come at a fiscal cost of nearly Rs. 0.9 trillion to the Government of India,” ICRA noted.

Rise in food prices

A surge in crude oil prices will have a significant impact on the food industry as well leading to a price rise of many FMCG products. “Vegetable oil, which is used in several other FMCG products will also experience inflation. Rise in input costs, directly or indirectly will cause brands to hike prices, stressing the bottom line,” says Krishnarao Budda, Senior Category Head at Parle Products.

Russia and Ukraine together account for more than a quarter of global wheat exports, while Ukraine alone makes up almost half of exports of sunflower oil. Both are key commodities used in many food products.

Volatility in equity benchmarks

Indian equity indices witnessed their sharpest fall on the day of the invasion since March 2020 with the Sensex falling by 2700 points and Nifty by 815 points. However, the benchmarks rebounded the following day because of NATO’s clarification over its intention of not being engaged in an armed conflict. 

This may change in the coming days as NATO’s Response Force was activated for the first time since its establishment in 1949 on February 25. NATO’s Supreme Allied Commander, General Tod Wolters said, “The force is ‘flexible’ and ‘combat credible’.”

Larger global implications

Given the sanctions that Russia faces, it may turn towards China for its financial needs. The trade between the two countries is quite insulated from Western sanctions as only 33 per cent of payments from China to Russia are being made in dollars which was somewhere around 97 per cent in 2014.

Russia’s financial system may get insulated with its tilt towards China but for the global economy the rise in oil and gas prices with high inflation figures will increase the pressure on central banks to hike interest rates. Added to that, the volatility in markets will dampen investors’ confidence.

How can Russia retaliate?

Liana Fix, Resident Fellow at the German Marshall Fund and Michael Kimmage, Professor of History at the Catholic University of America mentions in a note that the sanctions on banking and technology transfer could see Russia retaliating in the cyber-domain as well as in the energy sector. 

“Moscow will limit access to critical goods such as titanium, of which Russia has been the world’s second-largest exporter. This war of attrition will test both sides. Russia will be ruthless in trying to get one or several European states to back away from economic conflict by linking a relaxation in tension to these countries’ self-interest, thus undermining consensus in the EU and NATO,” they mention.

Another area where the Western world is contemplating cutting Russia is SWIFT, a messaging network used by 11,000 banks in 200 countries to make cross-border payments. While announcing the sanctions after the invasion, US President Joe Biden said that cutting Russia from SWIFT “always remains an option".

The West is not showing any haste here as cutting Russia off from SWIFT would make it harder for international buyers to pay for energy supplies to Europe. Secondly, China would seek this opportunity to put forward CIPS, its rival to SWIFT, for cross-border payments in yuan.

In the long term, Russia’s tilt towards China for its financial needs would challenge the tenets of globalisation of the world economy prevailing since 1991. It will further accelerate the division of the world into two economic blocs and, in many ways, will shape how the global economic order operates for years to come.