Europeans and Americans are complacent about the bill that will come due for Russia’s war on Ukraine. Yet the financial costs of the war will upset both business and personal finances, savings and investment returns around the world for some time.
First, there is the direct cost. The U.S. government’s proposed $33 billion aid package for Ukraine is the latest instalment of generous Western aid. With Ukraine needing around $5 billion a month, more will be necessary. The 5 million war refugees now scattered across Europe will require assistance until their return or resettlement. Rebuilding Ukraine’s infrastructure and industry demands an estimated $600 billion so far, and Western supporters, primarily the U.S. and Germany, will have to provide this money. Many Western countries are also increasing defense budgets, reacting to the deteriorating geopolitical outlook.
This spending reduces funds otherwise available for countries’ health, education, social services, and infrastructure. It must be financed through taxes or government borrowing. Given the already fragile state of public finances still recovering from the coronavirus pandemic, this will strain debt levels and pressure interest rates.
Second, Russia and Ukraine are major raw materials suppliers. Russia is the second-largest natural gas
producer (17% of global output) and the third-largest oil
producer (12%) as well as a key supplier of aluminium (6%), copper
(3.5%), nickel (7%), platinum
(40%) and titanium (50%). Russia is a major fertilizer producer, generating around 18% of potash and 20% of ammonia output. Russia and Ukraine both supply 90% of neon gas used in lasers to make semiconductors. The two countries produce more than a quarter of the world’s wheat as well as large quantities of cereals and oilseeds for both humans 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 seen in the nickel market, this disturbs the flow of raw materials and results in higher prices.
The Ukraine war may add as much as 3% to inflation and reduce global growth sharply. Europe will be the worst affected, while non-commodity producing emerging markets, which have powered global growth, are also heavily exposed.
Third, investors face losses. The West’s financial exposure to Russia totals around $150 billion in debt and equity securities, of which around $71 billion is owned by U.S. investment funds. Western firms have leased around 500 aircraft (valued at $10 billion) to Russia, which may not recoverable. With Russia now unwilling or unable to make payments due to sanctions and exclusion from payment systems, tens of billions of dollars in write-downs have been announced.
Many foreign businesses with Russian operations face large write-downs, with few buyers for these assets. For example, BP’s
disposal of its stake in Rosneft Oil
may result in losses of up to $25 billion alone. Lost access to Russian buyers will affect earnings of Western automobile, aerospace, technology and consumer businesses.
Fourth, Ukraine is distorting policy options. Defense spending adds to inflationary pressures. At the same time, normalization of interest rates may be restricted by the uncertain outlook and financial instability.
Fifth, the shift away from globalization may accelerate. The end of Cold War-era tensions boosted global trade and capital flows over the past three decades, raising global growth and keeping consumer prices low. That tailwind is reversing. Nations increasingly emphasize self-sufficiency to regain economic control.
“ Dislocations of capital flows and higher interest rates are likely. ”
The seizure of Russian central bank assets and the exclusion of Russia from the SWIFT global payment system have undermined international financial arrangements. China, India, and other emerging nations may reduce holdings of U.S. dollar-denominated
assets and trade in other currencies to avoid the risk of seizure. With many of these countries being large savers, supplying capital to the global economy, dislocations of capital flows and higher interest rates are likely.
Support for Ukraine has come large from the Anglosphere and a reluctant Europe, intent on managing energy security concerns. The rest of the world has remained largely neutral or sided with Russia.
Brave new trading world
With many nations not complying with sanctions and restrictions, new trading relationships are being forged. China and India both continue to purchase Russian commodities at substantial discounts, due to the lack of alternative markets for these raw materials. Emerging-market buyers are looking to purchase cheap assets from forced Western sellers. Attempts to sanction these countries, especially China, India and Brazil, would fracture the global trading system.
Russia’s war on Ukraine will fragment the global economy. Barriers to trade and cross-border investment will result in lower incomes, inflated prices for goods and services and reduced investment opportunities and returns across the world. On top of all this, the West may wind up bearing most of the financial cost of this war.