Russia’s military aggression against Ukraine, which has become Europe’s largest ground war in generations, has impacted millions of people and triggered a large-scale humanitarian crisis as vulnerable Ukrainians take shelter or flee their homes. The intensification and spread of the conflict is deeply troubling and is having a devastating impact on those people caught in the crisis.
This article focuses on potential market and economic implications of the conflict.
In this Q&A, John Emerson and Robert Lind share their views on the related impact of the conflict on markets and the global economy.
In your view, what is President Vladimir Putin’s ultimate objective?
John: President Putin has been very clear about his objectives. First, he believes Ukraine is part of Russia and he would like to reintegrate Ukraine one way or another with Russia. Second, Putin is deeply concerned about the idea that the Russian people would perhaps rise up and demand a different leader and a different kind of government. This is one of the reasons why he maintains such control over the media and the press that is reported to the Russian people.
Putin also wants to make sure that Ukraine does not become a thriving democracy with deep ties to the West. Therefore, his third objective is to remove President Volodymyr Zelensky’s government and to exercise sufficient control over Ukraine, its economy and its people to bring them closer to Russia.
Do you think the current sanctions on Russia are effective or can we expect more?
John: The sanctions that are currently in place haven't been effective in deterring President Putin from continuing his war and attacking civilian populations. As a consequence of that, I believe stronger sanctions will be necessary.
Putin’s actions towards Ukraine, which he took to try to strengthen Russia, have had precisely the opposite effect. The conflict has – in my view - been a disaster for Russia both from an economic and geopolitical standpoint. For example, it has been a geopolitical objective of Putin's to try to divide the West, Europe, EU (European Union) member states, and NATO (North Atlantic Treaty Organization) member states from one another and certainly divide Europe from the US. The immediate snapback consequence of his decision to invade has been that these relations have never been closer since the immediate aftermath of 9/11.
It remains to be seen whether, over the longer term, the economic pain that will be experienced in Europe or in the US will lead to a fraying of that unity. The objective in terms of designing the Russian sanctions is to impose maximum punishment on Russia, with minimal pain on the sanctioning nations. However, there may be points where countries diverge in terms of their approach.
The conflict could also prove to be a disaster for Putin from a political standpoint. If the Russian people grow tired of the economic consequences and the leaders of Russia, other key players there may begin to question Putin's judgement. Because of his invasion and the sanctions that were immediately implemented, he has hurt Russia substantially, not just for the short-term, but for the medium- and maybe even the long-term.
What are the potential implications of the sanctions on Western economies?
Robert: There are two main areas of concern. First is the transmission mechanism through the financial system. We have seen significant distress in the Russian financial system and that will inevitably bleed into banks and other financial institutions. The impact will principally be in Europe, though we may see that spill over into the US as well.
The most crucial negative impact of the sanctions over the course of the next few months is likely to be from energy prices. Over the last few weeks, we have seen a sharp spike in the price of oil and gas, which is going to impose a significant cost on Western economies, again, particularly in Europe. The costs will significantly impact both consumers and companies as well as force governments to consider ways to protect their economies from this energy price shock.
How will the war impact the global economy and the recovery from the COVID pandemic?
Robert: The conflict has been a profound shock. It will have a significant impact on European economies and to a lesser extent the US as well as the rest of the world. At the start of the year, we were looking at an economy that was recovering from the Omicron COVID variant. Activity was picking up; we were seeing a recovery in consumer spending and business investment. This all now looks in doubt.
We are now facing an environment of significantly higher commodity prices, which could persist for longer than many would anticipate. This represents a significant negative supply shock for the world economy. It will raise inflation and reduce economic growth, posing an extremely challenging problem for policymakers.
If we see an escalation of sanctions, particularly when it comes to energy, that will deliver a much bigger price shock to both oil and gas. It is also conceivable that the Russian administration might decide to cut off the supply of oil and/or gas to the West. Even speculation around the possibility of this could generate materially higher prices for the energy commodities. The related implications of this could turn out to be the biggest risk facing the European economy and the broader global economy.
How has the road map for central banks been impacted by the conflict?
Robert: This current situation is incredibly challenging for central banks such as the Federal Reserve and the European Central Bank: they are dealing with a shock that can create higher inflation and weaker growth. As a result, they can't rely on the policy models that they have used over the last 20 years.
I believe central banks are worried about the potential lessons of the 1970s when we last saw significant energy price shocks created by geopolitical turbulence.
Theoretically most central banks would advise against doing too much in the face of shocks like these, and instead look through a temporary increase in inflation caused by energy prices. I think there are two problems with that in the current environment. The first is we're starting from a period of very low interest rates. Monetary policy has been extraordinarily loose over the last couple of years. Therefore, there is a risk that this inflationary impetus from high commodity prices could prove longer lasting.
The second issue is we don't know how long energy prices are likely to stay at these elevated levels. I'd like to believe that energy prices will start to fall back if we see a cessation of tensions in Ukraine. But this could be a long, slow conflict in the region. Even if we see a temporary ceasefire, that doesn't mean the pressure in energy markets is going to go away.
In addition, it is highly likely that governments, particularly in the EU, are going to accelerate their plans to reduce their dependence on Russian energy, which also means there is going to be continued upward pressure on energy prices. It is hard to see the inflationary pressure from commodity and energy prices going away soon.
How could Europe potentially fix or rectify the dependency on Russian energy?
Robert: In the short term, very little can be done to change Europe’s demand for Russian gas. While countries have been gradually shifting away to other sources such as Norway (which supplies 20%-25% of the EU gas demand1) and increasing the use of LNG (liquefied natural gas), there are capacity constraints in both. That said, it is entirely possible that over the next few months, Europe could still cope if there was a blockage in the gas supply from Russia.
The much bigger question would come as we look out to the winter this year and into 2023. The situation will become far more challenging by then if we are still looking at significant gas supply disruption from Russia. For example, I think the introduction of energy rationing in the EU is a very real possibility.
There is clearly going to be an acceleration of the plans that were already in place to shift the energy transition in Europe onto a faster pathway. However, this requires large scale investment and significant changes in infrastructure, which can optimistically only be delivered over the course of the next three to five years.
How well equipped is the EU to deal with a migration crisis?
Robert: We have seen a step change from the EU compared to the refugee crisis associated with the Syrian conflict in the Middle East in 2015. We have seen a clear recognition that there needs to be a very quick response to what is a very sizeable humanitarian tragedy. Over two million Ukrainians have already left the country, most fled to Poland. While this obviously means providing additional support to Poland, at some point there will be a discussion about settlement of those refugees around the rest of the EU.
The potential scale of the migration crisis could pose a big challenge. The longer the war goes on, the greater the financial pressure will be on the countries that are first in line to receive those refugees (Poland, Hungary and Slovakia2). The EU will need to consider how it can help those countries. I believe we will see further debates about burden-sharing and solidarity. We may also see the introduction of a specific recovery fund to help these countries come to terms with large inflows of migrants.
1. Data as at 10 March 2022. Source: Norwegian Ministry of Petroleum and Energy
2. Data as at 8 March 2022. Source: The United Nations Refugee Agency (UNHCR)