Ukraine war: Rising crude oil prices may spell doom for world economy

Ukraine war and global economy
The world is still in the shadow of a global recession with total economic losses due to the Russia-Ukraine conflict touching $1 trillion.

The world economy was struggling to recover from the impact of the Covid-19 pandemic when Russia invaded Ukraine. The Ukraine war dealt a body blow to recovery efforts and led to volatility in the global financial markets. The biggest impact was felt in the soaring commodity prices and massive disruption in global supply chains. It seems that the world is in for a supply shock soon in the foreseeable future.

Since the outbreak of the pandemic, many large companies have been evaluating their production and supply. The Ukraine war has given them a reason to do it in haste. Soon, companies that have bases in the war zone will relocate their production closer to home. This is another factor that can affect global supply chains.

Since the Russian invasion began, the G7 and NATO have imposed strict sanctions on Russia. These will affect exchange rates. No trade with Russia means supply chain disruption, which will lead to inflationary pressure in several economies. In addition to this, the removal of Russia from the Society for Worldwide Interbank Financial Telecommunications (SWIFT) facility will hamper global economies that have strong bonds with Russia.

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The sanctions have triggered a collapse of the Russian currency which has fallen to new lows. This has resulted in a rise in borrowing by the Russian government and businesses. Isolating a large economy like Russia from international trade and the destruction of Ukraine will have repercussions that could lead to a global economic crisis.

The war has led to an inflation crisis in many countries. Central banks are monitoring the impact of rising international prices on domestic inflation. The situation may warrant fiscal policy support the most vulnerable sections of the population to cope with rising cost of living. Countries that have close economic ties with Russia and Ukraine may face scarcity and supply disruptions.

Will the Ukraine war lead to an energy crisis?

Russia is among the top three suppliers of oil and gas. Following the invasion, the US, UK, France, Germany, and other European countries have put sanctions on Russia. The ensuing disruption in supply saw global crude prices touching $139.13 a barrel, the highest level since May 2008. If OPEC does not cater to the increasing demand for oil and gas, there is a risk of high inflation. Russia supplies around 50 lakh barrels of crude per day. During the financial year 2020-2021, Russia supplied 11-12% of the world’s oil and around 17% of the world’s natural gas. So, pulling Russia out of the picture could escalate oil and natural gas prices to even higher levels.

Crude oil prices have slipped below $110 a barrel since then due to a cut in imports by China, the world’s largest oil importer. The Chinese government has locked down Shenzhen due to a rise in Covid numbers. However, a surge in oil demand is expected once the lockdown is lifted, which could lead to a rise in oil prices. A prolonged war accompanied by global sanctions on Russia could lead to massive spikes in global crude prices in the future.

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Even though Russia is not among the top exporters to India, India buys about $1 billion worth of oil from Russia, and its oil import bill is around $82 billion (2021). A prolonged war would mean a greater worry for India in terms of oil and natural gas prices. Analysts at Goldman Sachs expect oil prices to rise to $150 per barrel, an eventuality that may be disastrous for the Indian economy. We can foresee some kind of supply shock shortly if the crisis prolongs.

Supply chain disruption

Both Ukraine and Russia are among the top exporters of edible oils and food grain. Russia and Ukraine together are the bread baskets of Europe. International trade accounts for 50-60% of Ukraine’s GDP. Around 15-20% of the total grains export in the world market is from Ukraine. Jointly the two countries export around 30% of the wheat and 20% of the maize traded in the world market. The current geopolitical tension has put a question mark on the supply of these exports.

Ukraine is the largest producer and Russia is the second-largest producer of sunflower oil. Together they account for around 60% of the global supply of the commodity. The ongoing war and sanctions may lead to a global supply shock. Hence, the price of sunflower oil has reached a 14-year high in the commodity futures market.

In the context of precious metals like gold, prices have risen to an 18-month high. Russia is among the top 3 suppliers of gold after Australia and China. Harsh restrictions on Russia have hindered supply leading to an increase in gold prices.

Russia is also among the top exporters of industrial metals like aluminum, nickel, copper, platinum, and steel. Restrictions have led to disruption in the supply of these metals. Nickel prices have risen by 75%, and the prices of copper and aluminum have soared by 30%.

China is one of the leading trading partners of both Russia and Ukraine. The trading takes place through the Silk Route corridor via Poland, Belarus, Ukraine, Russia and Finland. There are over 75 rail freight routes from China connecting 170+ cities that may be disrupted sooner rather than later. The ongoing war could cause a supply shortage across the world.

What can be done to limit post-war repercussions?

Firstly, supply chain resilience should be prioritised. Countries must diversify import sources. Companies should reconfigure and relocate their units closer to home or at home to avoid another supply disruption. Economies across the world should have safety stocks and buffer inventory (in case of emergency). Nations including LDCs should find indigenous alternatives to the imports in various sectors like technology, infrastructure, and the medical sector.

The global financial institutions like the IMF are closely monitoring the economic impact of the war on other countries. The ongoing war and the sanctions may impact the global economy in several ways. World leaders should come together to ensure a diplomatic solution to the Ukraine war. Fighting, territorial expansion, harsh restrictions, and sanctions will lead to nowhere. Perhaps these can offer short-term solutions, but everyone will suffer in the long-run.

The conflict watchers are unsure of the real impact that the Ukraine war may have on the global economy, but all of them agree on the twin impacts of the invasion — rising prices and slowing economic activity. In US Fed has already raised its benchmark interest rate to counter the runaway inflation that recorded a 40-year high of 7.9% in February and the Europe is worried about a wage-price spiral.

It may be too early to understand the impact of the Ukraine war. The effects on the economy will manifest when the crisis unfolds over a period of time. Western Europe’s dependence on Russian gas will be an important factor in the coming days.

(Chandrabhanu Rohankumar is an economist based in Cuttack. Akshita Patnaik is a student and researcher.)