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The Financial Express

The economic costs and benefits of Ukraine war

| Updated: March 12, 2022 20:20:39


The economic costs and benefits of Ukraine war

Every war, big or small, short or protracted, has its costs and the war in Ukraine is no exception. Ironically, there will be benefits also. But while the costs will be borne by many countries, the benefits will accrue to few countries and individuals. The overview below of costs and benefits, though in economic terms, cannot be quantified at this point of time and will therefore be descriptive and qualitative in nature, though some data of micro and macro level expenditures and micro-level expenditures will be cited.

The first item of costs, is obviously, the price of military hardware that will be lost or damaged for both the belligerent countries now locked in mortal combat. The value of these weapons of death and destruction will add up to a humongous amount which can be translated only when all fronts in this high tech war are quiet. But one thing is clear, cost of replenishment or enlargement of the stock of hardware will ultimately devolve on taxpayers impinging on their standard of living. This will be further exacerbated if concerned governments adopt austerity measures reducing social expenditures.

The cost that will be borne by all countries irrespective of their involvement in the war is for sharp rise in the price for energy. The Russian offensive aggravated the upward trend in the price of oil and gas following the pandemic related stimulus by governments that put a huge tailwind behind an oil and gas demand recovery. Consumption in the US was running at record highs, almost a quarter of the global total. Given the overall rise in global demand for oil in post-Covid recovery, the price of crude oil rose above US$100, the highest since 2014 and it is likely to go higher as the war drags on. In tandem with oil, gas price has risen 60 per cent, though imports of oil and gas from Russia have not been banned, keeping their own interest in view (the West depends on Russia for 40 per cent of their oil and gas requirements). But the energy sector sanctions that include a ban on export of equipment and technology for refinery in Russia will add further price on energy price. The pressure on Western oil companies like BP and Shell to offload their shares in Russian oil giants will further exacerbate the price situation in oil market. Rise in oil price as the cumulative result of all these factors will be the single most egregious consequence for the global economy. Russia will be further handicapped in exporting oil and gas (though these are not banned items) because of the decision to cut off the country' s more than 100 banks from the inter-bank cross border payments from the international payment system. It is quite anomalous that when the advanced countries (in fact all countries) need oil from Russia, they have taken these punitive measures that impedes Russia's capacity to export. The 'hot' market of oil and gas will not only slow down recovery after pandemic, it has the potential of causing a recession in the global economy just when there has been an uptick in growth in global Gross Domestic Product (GDP).

Following the Russian invasion, America and European countries slapped a raft of severe sanctions targeting its financial, energy and transport sectors. The packet of sanctions announced by the Western alliance targeted 70 per cent or above 100 Russian banks cutting off Russia from the international financial markets. Their assets have been frozen as are the money deposited by Russian oligarchs. Russia cannot now raise money from international markets nor buy stocks and shares. After mulling over the matter for some time, even the SWIFT, the international payment system has been closed to Russia, cutting it off practically from the international trading regime. As the coup the grace, America froze the assets of the Russian central bank. Such a wide ranging and drastic array of sanctions targeting financial markets had never been adopted hitherto in respect of a country. The immediate impact of these measures has been a fall of Russian Ruble against dollar to the tune of 50 per cent on day three of the war and wiping out 70 per cent of value of shares in Russian bourse. Because of the bearish mood the Russian stock market was closed on February 28, the fifth day of the war. Meanwhile panicky citizens are queuing up before banks, almost resembling a run on banks. The central bank is assuring repeatedly that that there is enough money in tilt but the news of widespread and blanket sanctions have not been able to assuage the insecure feelings among public.

The Russian government factored in the incidents of sanctions as these were being threatened by America and Europe in the run up to the invasion. The country has a hefty reserve of $650 billion in gold with which it expects to cope with the various sanctions. But being cut off from SWIFT it will be difficult to carry on with international trade with other countries. For similar reason the country will not be able to use its sovereign fund that stood at about $175 billion at the start of February. For Russia money will not be a problem to pay for its imports but the problem will be in regard to payment. Here the country has a way out by aligning its financial system with that of China which has developed an international payment system of its own. Thus the Ukraine war is going to divide the global economy in two, harking back to the cold war of yesteryears.

On energy front, the sanctions announced includes an export ban on equipment, spares and technology that will hobble Russia's efforts to upgrade its oil refineries.

The most dramatic sanction on energy front is the postponement of certification of Nord Stream 2, the pipeline that is being taken from Russia to Germany under sea. Because of its importance Germany dithered for a while but had to relent under pressure from America and other EU countries. The costs of the Ukraine war, in terms of shortages for oil and gas, and higher prices will haunt America and Europe no less than emerging and developing countries. For now, Russian export of oil and gas to other countries will not be impeded, though payment may be delayed. Nor will Russians have to pay higher prices for oil and gas. But the overall impact of the war and the cumulative impact of sanctions will slow down the growth of Russian economy and through it impinge on the cost of living. The oligarchs and the ruling elite will not suffer in terms of their life style and creature comforts. So it will be the ordinary Russians who will bear the brunt of the punishing sanctions.

For the people everywhere, the item after oil and gas for which higher prices will have to be paid is food. Global food prices are set to soar as the war in Ukraine has threatened supply chains, pushing up commodities markets that had already hit multi-year highs. Russia and Ukraine together account for a third of world's wheat exports, a fifth of its corn trade and almost 80 per cent of sunflower oil production. The war has led to a closure of sea lanes and ports in Ukraine. Since 90 per cent of Ukrainian grain exports are transported by sea, the disruption in supply chain may play havoc with the food supply flows.

Wheat prices have risen by more than a fifth since the start of the year to near 10-year highs, while corn prices have risen 15 per cent. The disruption to supplies will hit supply chains already struggling with high demand and rising prices due to poor harvest in exporting countries like Canada. If a substantial part of Russian and Ukrainian grain fails to be shipped, wheat could rise to levels not seen since the crisis in 2007-08.

Russia produces 17 per cent of total fertiliser in the world. It exports fertiliser to many countries in Asia and Latin America. The war will disrupt this export in the near term and make it more expensive in the near future. The further rise in natural gas prices, the main ingredient of fertiliser, will increase the cost of production for other countries and consequently its price, making food prices rise. The impact will be felt by all countries.

The initial effect of the war in stock market was a fall in prices. Now most of the shares have bounced back. US stocks are drawing buyers after the recent tumble but some investors believe buying now is risky as the geo- political strife is not over yet. Longer is the war, prolonged will be the sense of uncertainty.

Russian bonds tumbled on Monday, the fourth day of the war, as investors braced themselves for the possibility that the latest round of sanctions could push Moscow to default on its debt for the first time since 1998. The action taken to cut Russia from SWIFT has fanned concern that foreign holders of Russian debt will not be able to receive interest or payment for principal amounts. Sanctions against the Russian central bank may seriously hamper its efforts to fall back on US$650 billion in foreign reserves, leaving markets to speculate that a country with only 20 per cent of GDP could be a defaulter. In the stock exchange, Russia's dollar-denominated bonds plummeted on Monday with its largest bond maturing in 2047, halving in price to 33 cents to one dollar, a level associated with high level of financial distress. The market moves came after S&P downgraded Russia's credit rating to 'junk' status, causing price of derivatives to soar.

Investors have not factored in all of the possible outcomes that could result from Ukraine war, including a prolonged conflict that weighs on global growth and sends inflation higher by pushing up commodity prices.

As pointed out earlier, there will be many types of economic costs borne by countries in varying degrees as a result of the war in Ukraine. Bangladesh will be no exception. First and foremost will be rise in prices of gas (LNG) and crude oil. As all its energy requirements are met through imports, the impact will be felt immediately even when the war is unfolding. After the price hike in diesel and kerosene by Bangladesh Petroleum Corporation (BPC) two months back  the price of oil and gas fell in international market until December 2021 and BPC earned profit. The corporation now is counting cost around Tk 150 million per day after the war broke out and Brent crude price shot up to beyond 100 US dollar per barrel. BPC is also counting cost for import of LNG after its price rose in international market in the wake of the war. As a result, there will be increase in domestic prices of petroleum products very soon that will percolate through all sectors of the economy adversely affecting costs of production from agriculture to industries which will push inflation higher than the present level of 6 per cent. The cost of living will rise for all classes but lower and middle income will be the worst sufferer. The cost of all other import items will also rise as a result of the war adding to the inflationary pressure.

On the export side, garment industry will find the promising Russian market shrinking in the near term. According to BGMEA Bangladesh exported garments to Russia worth US$482.4 million in 2019, $473.m in 2020 and $687.8m in 2021. This destination and volume of export has now become highly uncertain. Apart from garments, Bangladesh exports leather goods, plastic ware, ceramic products, jute, frozen food to Russia all of which are now hit by the war. Similar adverse effect will be on exports to Ukraine which was growing in recent years.

Another fallout of the war in Ukraine will be on subsidy payment. Just when the government was mulling over reduction of subsidy, it will be under pressure to increase subsidy from existing levels. For instance, the subsidy in agriculture sector recently rose from Tk. 7 billion to Tk. 30 billion. Now, after the war, there will be demand for additional subsidy. For Bangladesh the war in Ukraine is bad news in the context of one of its mega project-- the Rooppur Nuclear Power Plant (RNPP). Implementation of the of the 13.48 billion US dollar  RNPP project might become a victim of the sanctions slapped on Russia as most of the credit  is sourced from Russia.

Ironically, some countries and individuals will benefit from the war in Ukraine. First will be the countries that export military hardware to other countries Top on this list is America. According to Sweden-based think tank SIPRI the market share of America was 37 per cent of the total (2016-2020) while France had 8 per cent and Germany 5.5 per cent during the same period. Russia is also an arms exporter but being a belligerent in the current war where its loss of arms will be considerable, it will not be a major player in the export market of arms in the near future.

So the Western countries led by America is going to have a bonanza in arms sales to many countries in the wake of the Ukraine war, capitalising on the alarm bell rung by the war to arm themselves to the teeth, if possible, to deter potential enemies. To highlight the role Of America in arms export, it may be pointed out that 12 American arms manufacturers are among the top 20, accounting for 61 per cent of global sales (2020). Lockheed is on top of this list.

Even before the war started America and other arms exporting countries (excepting Russia) sold arms  to Ukraine to face off Russia, to avert another Crimea. Before and after the war broke out, arms and state of the art lethal weapons poured in Ukraine which made it emboldened not to come to an agreement expressing neutrality.

Just after the war broke out Biden Administration gave US$350 million aid to Ukraine all of which came in the form of lethal weapons. European Union, which gave aid to countries under the condition 'everything but arms' is now financing arms exports by member countries to Ukraine. Even Germany that has not sold any arms has given 1000 anti-tank missiles and 500 Stinger missile for air defence. It is now clear that the Western alliance, led by America, did not advise Ukraine to remain neutral by not joining NATO and confront Russia to settle her old scores with the neighbour. In fact the West is having a proxy war in Ukraine and relishing the ghost of cold war morphed into a shooting war. This is a dangerous gamble as no one knows what an impetuous man like Putin is going to do if pushed to the wall. Ominously, he has already placed the nuclear option at alert mode.

As can be guessed, the other beneficiaries of the war in Ukraine are the producers of oil, mainly in the Middle East, and also Indonesia, Nigeria and Venezuela. Russia and Iran will also benefit from rise in oil and gas prices if they are able to sale given the many sanctions.

For these few countries the war in Ukraine will be a boon. As the mother in Bertolt Brecht's, 'Mother Courage' told her sons, war is not a bad thing, not for everyone.''

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