Into the third week of the war between Russia and Ukraine the world is at another major tipping point on the road to recovery from the last global crisis. This intersection requires the right geopolitical decisions to be made for the right economic steps to be taken. Unfortunately, it does not look like we’re going to take that path, and this may have painful economic consequences ahead.
Let’s look at the possible things that can go wrong:
Russian default on global debt. This is first up. Russia has not defaulted on overseas loans since the Imperial Tsarist government and 24 years since they defaulted on Rouble denominated loans (which led to a financial crisis in 1998 and the rescue of Long-Term Capital Management). Russia has coupon payments denominated in USD coming up on 16th March. They have the foreign exchange reserves to easily pay off all their overseas obligations but not the access to those reserves. Putin has passed a law saying that overseas debt can only be paid in Roubles but the debts themselves don’t have that built-in feature. This seems like an avoidable crisis and they have one month’s grace before it gets classified as a default; western governments can agree to release their debt obligation payments since it is owed to banks and institutions in the west. But political measures often trump common sense. This could be bad for global financial markets unless common sense prevails.
Russia has effectively confiscated 500 aircraft on lease to Russian airlines through a nationalisation order. This has been stated by Putin to be a counter measure to global sanctions. This will be a long-term disaster for Russia. The leasing companies will go to debt tribunals who will rule in their favour and take the money (and penalties) from Russian reserves held overseas. In six months, the Russians will not have the spare parts to service these jets which will fall into disuse. Technology blockades will prevent them from onshoring the servicing capabilities and have wider effects on the economy. This is just bad for the Russian economy which is on a downward trajectory at any rate.
Oil, gas and wheat disruptions are affecting the globe. Although the US is the world’s largest producer of oil Russia accounts for 40% of global exports.
Source: Worldometer.com
Because countries now are not allowed to deal with Russia this is going to keep oil prices elevated until a solution acceptable to the west is found to this crisis- which may take longer than the war will last. Reparations will likely be demanded by Ukraine which will mean that sanctions will remain in place as a bargaining tool. There have been talks ongoing between Russia and Ukraine but is prone to uncertainty at this point. As we know- high oil prices are going to feed into high inflationary pressures already well entrenched globally.
Furthermore, Ukraine is a major exporter of wheat and disruptions in exports will mean high food prices which- apart from inflation, is also likely to mean hunger in Africa, according to the IMF’s Managing Director Kristalina Georgeiva. Given the millions of Ukrainians fleeing the battle zone (the biggest European refugee crisis since WW 2) it’s not improbable to see that there may be hunger related deaths in Europe as well. We are already seeing governments start to place export restrictions on agricultural produce to ensure food security at home. Another key fact to note is that global grain stockpiles have been on the decline for the last 5 years- a worrying sign given the likely disruptions to this year’s harvest.
Separately, Chinese covid cases are up at 1,500 a day- extreme measures at containment are likely to create supply jams. This is not getting as much airplay nowadays because of it being overshadowed by the war but China- which had managed to keep Covid-19 case numbers at single- and double-digit numbers for the last two years is now seeing an explosion. Given how successful they were in containing it the last time they will probably do it again but, the disruptions to production and transportation will again add to the supply chain bottlenecks that created inflationary pressures globally in the first place. Over 30 million Chinese are now subject to Covid lockdowns. And it isn’t as if China is isolated: Europe is also reporting rising cases – Germany, Netherlands, UK; In Asia S. Korea, Vietnam and Japan reported over half a million cases between them in one day alone (14th March).
Given that Russia is also a major global producer of Nickel the prices of steel products and nickel for car batteries will climb in consumer markets quickly. A feed through of high commodity and food prices together with a new round of covid-led supply chain disruptions is going to deal a mighty blow to global growth this year.
We should also see some of the things that could go or are going well- just to balance things out:
There are always workarounds that markets may come to: bringing back Venezuelan and Iranian oil to the world markets will bring down oil prices quickly. Meanwhile, economic interest is ensuring that the Russians are pumping in record amounts of gas into European countries (which are being paid for and not subject to sanction on payments) so that is keeping energy prices (and Europe) insulated. India is currently exploring a Rouble-Rupee market (as they did when the Soviet Union broke up) which would bypass the sanctions faced by Russia.
And over in Africa, some countries are seeing the benefit of the turmoil in Europe. Being isolated from the conflict whilst exporting some of the same commodities that are climbing in price has been a boon for not just their exports but also their hard currency debt. All African debt has junk bond status but they are now being seen as a safe haven EM alternative and are finding buyers for their paper. Their gains this month alone in Dollar terms have more than offset the losses being faced because of the rising overall yields in dollar denominated bonds; that is to say, the yield fall in these bonds have been greater than the yield rise in dollar bonds overall.
There are things which now seem inevitable: higher inflation and lower growth. What is critical now is to get back on a path to maximum growth given these (hopefully short-term) constraints. Unfortunately, was and disease seem to have other plans for us in mind.