Macroeconomic Perils of the Russia-Ukraine War

Supply disruptions of oil from Russia had a large impact on world crude oil prices. Effects of such a sharp rise in crude oil prices reflected in the headline inflation level in many countries.

Macroeconomic Perils of the Russia-Ukraine War
A casualty of this war is evident in terms of rising inflationary pressures across the world economies.

By Dr. Preeta George & Chinmay Joshi

Amidst the pandemonium of several warnings of imposition of more and more sanctions by the Western nations as a retaliatory measure in the event of any transgressions by the Russian Federation in Ukraine, the Russian Federation, on February 24, 2022, invaded the sovereign territory of Ukraine with a full-fledged military might. War not only causes precious loss of human lives but it also inflicts economic pains. In its World Economic Outlook (WEO) January 2023 Update, the International Monetary Fund (IMF) painted a decelerating trend of global growth from 6.2 percent in 2021 to 3.4 percent in 2022 and 2.9 percent in 2023.

Apart from the dwindling growth prospects as predicted by the IMF, another casualty of this war is evident in terms of rising inflationary pressures across the world economies. Global inflation was predicted to rise from 4.7 percent in 2021 to 8.8 percent in 2022 before softening in subsequent years. A recessionary trend was already evident across world economies in the pre-war era, mainly due to the Covid-19 pandemic. However, this war has exacerbated the already grim economic situation by stoking rising inflationary pressures. The risk of ‘stagflation’ which is defined by World Economic Forum (WEF) as a period when slow economic growth and joblessness coincide with rising inflation has become a reality now. Ramifications of this war are visible through a bleak global economic outlook particularly in terms of ‘stagflation’. 

The persistent rise in the inflationary pressures is mainly because of the supply chain disruptions brought about by the war. Russia plays an important role in world energy production and export of energy products especially export of crude oil and natural gas. It is the world’s largest exporter of natural gas (241.3 billion cubic meters in 2021) and second largest exporter of crude oil (8.3% of overall crude oil exports in 2021) behind Saudi Arabia (16.5% of overall crude oil exports in 2021).

Naturally, any supply disruptions of oil and other energy products from Russia will have manifold impact on world crude oil and energy prices. Due to the sanctions on exports of Russian oil and other energy products, the world faced a sharp rise in the international crude oil prices. At the start of the year 2022, brent crude oil prices were trading nearly in the range of 78-80 USD per barrel. It started its northwards trend in February 2022 when the clouds of war started to hover over the world. Prices peaked in March 2022 and reached at the level of around 122 USD per barrel and remained elevated beyond the mark of 100 USD per barrel till August 2022 before softening marginally thereafter. 

Effect of such a sharp rise in crude oil prices reflected in the headline inflation level in many Advanced Economies (AEs) and Emerging Market and Developing Economies (EMDEs). Headline inflation remained at an elevated level due to the increase in brent crude oil prices as brent crude oil prices is a large component of headline inflation in these economies. As noted by US Fed Chairman Jarome Powell, every 10 USD increase in the price of a barrel of oil will lead to 0.2% increase in headline inflation in US. In India, fuel inflation rose by 10.97% as compared to headline inflation level of 5.72% in December 2022.

Besides, the inflation situation globally, has aggravated also on account of supply chain disruptions reflected in raw material prices of fertilizers, metals and minerals and food.  As per some estimates, Russia’s fertilizer supply is around 17% of global fertilizer supply. As per the UN World Food programme, Russia and Ukraine account for 18% and 10% respectively of global Wheat exports, 14% and 12% respectively of global Barley exports and 26% and 37% respectively of global Sunflower oil exports. 

Inflation is not always a growth deterrent. Some degree of inflation is required for achieving economic growth. This is the reason some of the countries in the world have adopted an inflation targeting mechanism. The process of inflation targeting is simple. As per the IMF, “The central bank forecasts the future path of inflation and compares it with the target inflation rate (the rate the government believes is appropriate for the economy)”. UK (1992), Brazil (1999), Japan (2013) and India (2015) were some of the countries which have adopted such a mechanism.  

Inflation has its negative effects when it rises above a threshold level. High inflationary pressures in the economy erodes the purchasing power or real income (income adjusted for inflation) with the people which is the single biggest cost of inflation. On the other hand, lower inflation and deflation or falling prices leads to lowering of economic activity and a reduction in income and output. It further leads to decline in the consumption level and a fall in the aggregate demand and a lower standard of living. In some economies an increasing level of poverty is also witnessed.

Charts 1 & 2 clearly depict the growth deceleration caused by high inflation. After the recovery from the Covid-19 pandemic, economic growth started to decline and exhibited a decelerating trend while prices remained elevated (Chart 2). Economic growth started its southwards journey especially from the early months of 2022 since the start of the war. 

Chart 1: Real GDP Growth (Annual percent change)

Source: WEO October 2022, IMF and Authors’ calculations

Chart 2: Inflation Rate, Average Consumer Prices (Annual percent change)

Source: WEO October 2022, IMF and Authors’ calculations

Such a double whammy of elevated inflation and dwindling growth requires coordinated monetary and fiscal policy responses. Stagflation, on one hand should be dealt with increasing interest rates by monetary authorities so that inflationary expectations can be anchored successfully and at the same time governments should also pump in more money into the economy through expansionary but well calibrated and targeted fiscal policy measures so that growth prospects can be revived. Policymakers should stick to disinflation glide path to control the rising price pressures even if it means going slow on achieving economic growth. It would not be unwise to remember the English proverb – slow and steady wins the race. 

(Dr. Preeta George, Professor, Economics, Bhavan’s SPJIMR & Chinmay Joshi, Academic Associate, Finance and Economics, Bhavan’s SPJIMR. Views are author’s own.)

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First published on: 19-02-2023 at 13:40 IST
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