The escalation of tension in Ukraine has reminded us of something many investors seemed to have forgotten: Geopolitical risk. Sanctions and the inevitable drop in trade have proven to generate a significant negative impact on the different economies involved. We know from the 2014 Ukraine crisis that the economic hit is severe and persistent.
The economic hit of sanctions is undoubtedly highest for Russia. The International Monetary Fund (IMF) estimated in 2015 that “Western sanctions and Russian countersanctions reduced Russian real gross domestic product (GDP) initially by 1–1.5% and that prolonged sanctions would lead to an even larger cumulative output loss. In 2019, the IMF estimated that sanctions reduced Russia’s growth rate by 0.2 percentage points every year in 2014-2018”, as reported in The New Atlanticist.
The impact on Russian citizens is wide even when these sanctions are targeted at individuals and state banks. The most obvious impact is the loss of purchasing power of the local currency, which has plummeted against the US dollar, which reduces salaries and savings in real terms.
The United States does not suffer a relevant impact from sanctions to Russia. It imported around $30 billion from Russia in the first eleven months of 2021 and exported $13.2 billion, according to Bloomberg. However, it does suffer indirect implications as consumer prices soar due to rising energy and food prices. Russia is a relevant global player in the export of metals, agricultural and energy goods and sanctions affect the marginal pricing in global markets.
The European Union (EU) has far more to lose than the U.S. from a conflict with Russia. According to Eurostat, Russia is the fifth largest trade partner of the European Union, with imports of $177.9 billion and exports of $104.1 billion. Additionally, reliance on Russian natural gas is very high, particularly in countries like Germany and the Czech Republic. Eleven EU countries import more than 50% of their natural gas requirements from Russia. For many it would be impossible to offset the flow of Russian gas with liquefied natural gas even using trucks if they were willing to accept prohibitive prices.
The impact on Ukraine is enormous. In “The Economic Effect of Hybrid Wars”, a study by professors Julia Bluszcz and Marica Valente, they show that “causal effects are estimated by computing the yearly difference in GDP per capita between Ukraine and its synthetic counterpart after the eruption of the war. Results indicate that Ukraine’s foregone GDP per capita due to the Donbass war amounts to 15.1% on average in years 2013-2017 and, respectively, 5.23% ($460.26), 9.18% ($832.96), 19.63% ($1,823.78), 19.80% ($1,893.38), 21.67% ($2,184.13) in 2013, 2014, 2015, 2016, and 2017”.
There is also an indirect impact on the global economy. Rising tensions in Ukraine are showing the widening differences between the Western countries and the Russia-China influenced nations. This is more than just about Ukraine or natural gas flows. The West is losing influence in Africa and Latin America in favour of China and, to a lesser extent, Russia. Latin America is slowly shifting toward China and Russia, as evidenced by the messages of the president of Argentina and the newly appointed Chile prime minister.
The impact of geopolitical risk has made energy and food prices soar higher all over the world. The increase in essential goods prices comes after a terrible year for global real wages, eroded by central bank-fuelled inflation.
The Ukraine crisis arrives as well in the middle of an evident slowdown of the largest economies after the placebo effect of massive stimulus plans. These risks add to a scenario where many economies are moving even closer to stagflation, and the ramifications will likely last longer than the conflict itself.
I beg to differ with Mr. Lacalle’s analysis. He uses data from 2014-2015 to determine the impact on the Russian economy to sanctions. For anyone who has been following the evolution of the Russian economy they would know very clearly that Russia has basically bulletproofed its economy and its citizens from any western sanctions.
What that means is that for about 90% of its needs, Russia is able to produce and manufacture those goods internally. Russia has its own payment messaging system comparable to SWIFT and is about 2 months into a 6 month project to integrate their system with China’s payment messaging system. As well, if you follow news reports in the US, it was made clear to the Biden Administration by the Federal Reserve that cutting Russia off from SWIFT will lead to the death of SWIFT. Why?
And here is the thing that you miss in your analysis. Europe cannot manage without Russian energy. The question is not about how to replace them but about how to pay for Russian goods (energy, materials, etc) if one cannot use SWIFT. Well the simple answer is that you use the Chinese payment messaging system. The impact on dollar denominated trade would be huge since most of the rest of the world led by China would ignore US/EU sanctions and continue trading with Russia.
As for Nord Stream 2, the impact in terms of cost and lost on the project being stopped is primarily bore by Germany and to a lesser extent Austria. Germany and to a lesser extent Austria paid for the pipeline. Next without that cheap and abundant source of energy, German industrial production would be severely impacted and worse for Germany, their desired pivot towards Asia which would give them a larger degree of independence and possibility to grow their economy would be thwarted.
As for Russia, based upon an interview with Tom Luongo my understanding that Russia’s lost on Nord Stream 2 is the equivalent of 1 months energy revenues. Also I would add that the explosion in energy prices caused by sanctions as well as the ramp up in volumes of energy products going east to China primarily easily make up for this impact. There would be some minor pain as they permanently shift to SIPS for large banks to handle international payments for those presently made using SWIFT. Russia would definitively turn away from Europe, a minor power in ever deepening decline along with its master the US. Except for a small smattering of colonies in maybe Africa and Americas many of the countries in the rest of the world will continue trading with Russia especially as many of them have joined the BRI.
So the one who has the most to lose by far for implementing sanctions is Europe and the one who has the most to gain, by severely damaging the economies of its so called allies is the US. Russia has been prepared for this for a number of years and is for the most part protected. One has to wonder just how brain dead is most of European leadership is to follow in this folly.
Sorry, I meant to add one point in relation to purchasing power parity. If you look at PPP, you will discover that Russia and Russians in general are in a very good position. Your comparison about the dollar is flawed since so little of what Russia produces or trades is done in dollars. As well, the Russian Central Bank hardly holds any dollars. Most of its energy trades are immediately converted into gold and also to a certain extent euros and yuan. The dollar hardly impacts on Russians. If you go to Russia, as I was last summer to see Spain play Switzerland in the European Championships, you will see people living very well on what in the US would be considered a modest salary.