Global Impact of Russian Invasion –Moody’s
Russia’s invasion of Ukraine is taking a massive human toll and has put global democracies on the defensive, but under most scenarios, it is likely that global economic fallout will be modest.
Europe will struggle more than the U.S., but Russia will take the biggest economic hit.
There are many scenarios on how the Russian invasion of Ukraine will unfold, each darker than the next, but the most likely scenario is that Russian troops will go no farther than Ukraine, and any disruptions to oil, natural gas and other commodity markets will be limited and temporary.
If so, the impact of the Russian invasion on the U.S. economy will be on the margins. While Europe’s economy will be hit harder, its economic recovery will continue. Russia, however, will suffer a debilitating recession, and for Ukraine’s economy, this is a catastrophe.
The principal link between the Russian invasion and the global economy is through oil, natural gas, and other commodity and industrial prices. Read: Sell Pressure Hits Nigerian Eurobond Amid Russia’s Invasion
This constitutes the bulk of what Russia and Ukraine export to the rest of the world, together accounting for 12% of global oil production, 13% of titanium production, 14% of wheat production, 17% of natural gas production, 30% of palladium and helium production, and 70% of neon production.
The oil exports are essential for meeting global oil demand; natural gas is especially important for Europe, which gets more than one-third of its natural gas from Russia; the wheat is vital for many emerging markets; and the neon is critical for the production of semiconductors, which is only now making its way back from being hammered during the Delta wave of COVID-19 last summer.
Since it became clear that Russia was amassing troops on its border with Ukraine earlier this year, West Texas Intermediate oil prices have risen about $15 per barrel to more than $90 per barrel.
Indeed, before Russia’s provocations, global oil prices appeared to be headed lower, as the gap between global supply and demand was closing.
Global energy producers were slowly but steadily increasing supplies and had nearly caught up to global demand, which has quickly rebounded with the fading pandemic.
The reason oil prices have risen is that even though global supplies have not been significantly disrupted by the Russian invasion, there is a considerable threat that they will be.
The $15-per-barrel increase in prices is a premium added to oil prices to compensate for this risk. If supplies are actually disrupted, even briefly, then $100-per-barrel oil seems like a real possibility.
If oil prices get this high and stay there, then American consumers will pay almost $4 for a gallon of regular unleaded by this spring, up about 60 cents. A useful rule of thumb is that for every $10-per-barrel increase in the price of oil, the cost of a gallon of regular unleaded gasoline increases by about 30 cents.
One-hundred-dollar oil, if sustained, would ultimately add as much as half a percentage point to year-over-year consumer price inflation, costing consumers approximately $80 billion more in gasoline bills and reducing U.S. real GDP growth by approximately 0.2 percentage points this year.
This is a modest impact, and even this is likely an outside estimate of the fallout of the Russian invasion on the U.S. economy. That’s because, at $100 per barrel, the economic incentive for other global producers to pump more oil, including North American frackers and OPEC countries such as Saudi Arabia will be overwhelmingly enticing.
The number of oil rigs in operation in the U.S. had already doubled since their pandemic low, and that was at $80 per barrel. With prices up a lot, rig counts should ramp up quickly.
Of course, Russia’s invasion of Ukraine, and the resulting higher oil prices, is especially bad timing. Inflation, which is already painfully high, will go higher in the coming months.
And oil and gasoline prices play an outsize role in shaping the inflation expectations of global investors, businesses and consumers. Most of us purchase gas regularly and see the price each day as we go to and from work.
Nothing influences people’s thinking about future inflation more than what they are paying at the pump today. If inflation expectations start to rise, then the Federal Reserve will have little choice but to raise interest rates more aggressively than it already is signaling that it will.
Even before the Russian invasion, global investors had been anticipating as many as seven 25-percentage point rate hikes this year.
This will be difficult for the economy to adjust to, but any more rate hikes would meaningfully increase the odds that the economy will stumble. So far, inflation expectations are holding firm, but they bear close watching.
The wobbly stock market is another potential economic vulnerability that could be exposed by the Russian invasion. Stock prices are down about 10% from their all-time high at the start of the year, equal to a loss of about $5 trillion in market capitalization.
This is largely due to investors adjusting to the prospects for the Fed tightening and higher interest rates, and is consistent with a garden-variety correction. While the Russian invasion has caused big intraday swings in stock prices, they are still about where they were when all this began.
However, stocks remain significantly overvalued, and if events don’t stick precisely to script, which isn’t too hard to imagine, they are at risk of selling off.
Another sustained 10% decline in stock prices would be consistent with a bear market in stocks, which would be the loss of real money for many households, causing them to turn more cautious in their spending.
It would also signal that global investors are discounting an economic downturn dead ahead. Russia’s and Ukraine’s outsize role in the global neon market could also turn out to be a big problem, as neon is critical to the semiconductor-making process.
If neon production and exports are disrupted, then chip production will be too, with big implications for production of everything from consumer electronics to vehicles.
This takes on added importance given the ongoing supply-chain disruptions to the chip and chip-dependent industries caused by the pandemic. When Russia annexed Crimea from Ukraine in 2014, neon prices spiked as much as 600%.
Fortunately, production processes have improved since then, and most chip producers have stockpiled materials and explored alternative sourcing.
But while the chip industry may not suffer an immediate disruption from the Russian invasion, if it drags on, we can expect chip prices to jump and lead times to remain extended, further exacerbating shortages and broader inflationary pressures.
Europe’s economy will struggle more with the Russian invasion than the U.S. economy, but it should be able to manage the fallout reasonably well.
Europe’s largest economic exposure is its dependence on Russian natural gas. Germany is the most vulnerable, with one-half of its natural gas coming from Russia, followed closely by the rest of Eastern Europe and Italy.
European natural gas prices reflect this dependence, hovering near $30 per million BTU, up from almost $5 a year ago. For context, U.S. natural gas prices have pushed up to just over $4 primarily due to colder winter weather, but there is also some diversion to Europe via liquefied natural gas.
Home heating and electricity prices have jumped throughout Europe as a result. Europe’s economic ties to Russia via international trade, foreign direct investment, capital flows, and banking relationships are also more substantial than between the U.S. and Russia, but even so, the relationships are modest in the grand economic scheme of things.
According to the Bank of International Settlements, as of the third quarter of 2021, U.S. banks had an insignificant $15 billion in exposure to Russian banks, while the European bank exposure was a small but more substantial greater than $80 billion.
For context, U.S. banks have $125 billion in exposure to China, while Europe’s exposure to China is closer to $350 billion.
Under the most likely scenario that the Russian invasion ends in Ukraine and there are no meaningful disruptions to energy and other commodity supplies, we expect Europe’s real GDP growth this year to be reduced by just over half a percentage point.
It will be a different story for the Russian economy, which is set to take a massive hit. Western governments are ratcheting up sanctions.
The most meaningful is the decision to throw most Russian banks out of the SWIFT international payment system and freeze the Russian central bank’s U.S. dollar-, pound- and euro-denominated foreign reserve holdings.
Russia has a substantial $650 billion in reserves, but the sanctions will cut them by significantly more than half, making it difficult for the Russian central bank to support the value of the ruble, which has already fallen as much as 15% to a record low since all of this began.
A weaker ruble will result in more inflation and higher interest rates, undermining Russian consumer spending and business investment, and thus, the economy. The central bank has more than doubled its benchmark interest rate to 20% in response to the crisis.
Russian businesses may also have difficulty paying for imported goods, further fanning inflation and interest rates, and the country could have difficulty making debt payments, resulting in defaults, and further cutting Russia off from access to global credit.
Global rating agencies have already downgraded Russian debt to junk status or have warned that they soon will.
Other important sanctions include mothballing the new Nord Stream 2 pipeline that was to take natural gas from Russia to Europe via Germany, placing controls on Western exports of technology and other sensitive goods to Russia, requiring Western firms to divest their investments in Russian companies, restricting Russian air traffic, and imposing sanctions on Russian officials including Putin.
The totality of the sanctions imposed will be a big hit to the Russian economy, and we expect Russia to suffer a serious recession this year, even more severe than that experienced during the pandemic.
Moreover, more sanctions may be coming, but even if not, Russia’s ostracized economy will be diminished for a long time to come.
There are many other possible darker scenarios on how Russia’s invasion of Ukraine will play out. For instance, Russia could curtail its exports of oil, natural gas, metals and industrial products. It is plausible under this scenario that oil prices will spike closer to $150 per barrel.
Putin could also extend his invasion beyond Ukraine, if not by design then by accident, given the considerable confusion that exists in the midst of a battle.
The damage to the global economy in these scenarios would be severe, and recession unavoidable, but it would push the reeling Russian economy even deeper into the abyss.
Given this, it is difficult to imagine Russia going this route, but it was difficult to imagine just a few weeks ago where things stand now, and thus it is prudent not to rule any scenario out. Russia’s invasion of Ukraine is wrenching to watch as it inflicts an enormous toll on the Ukrainian people.
Hopefully, there is a resolution soon. If there is any good that comes out of it, perhaps it will be a reaffirmation of democratic nations in their democracies and a newfound willingness to fight for them. #Global Impact of Russian Invasion –Moody’s
