War in Ukraine:Economic & Military Consequences

David Kipre

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Since February 24, more than 95% of the world’s magazines have highlighted the invasion of Ukraine by the Russian army. The consequences are all the more serious as this could be the most important conflict to take place on European soil since the Balkan wars in the 1990s. From the increase in the cost of raw materials to the closure of certain large companies, here are some of the negative economic repercussions of the war in Ukraine.

I-Falling stock markets and soaring commodity costs

The Russian economy depends on raw materials export. The sector accounts for 60% of Russian exports. Russia is the world’s largest producer of wheat (Ukraine is fifth), one of the largest exporters of oil, supplies about 40% of European gas and produces large quantities of metals. The country is the world’s largest producer of palladium, which is used in the construction of catalytic converters for cars, the second largest producer of aluminum and nickel, and the seventh largest producer of copper. Ukraine is the world’s largest producer of corn.

In fact, on February 24 alone, the price of natural gas rose by more than 25% on the TTF market; a platform located in the Netherlands and considered a reference in Europe.

The oil barrel exceeded 100 dollars per barrel, the ton of wheat reached a record level at 344 euros per ton and the price of natural gas jumped by 40% in one day. “Paradoxically, this is an advantage for Russia, because we have not stopped importing Russian raw materials for the time being,” says French economist Alsif. That said, the economist points out that this is true in the short term. Germany, for example, relies heavily on Russian liquefied natural gas. Once an alternative to Russian raw materials is found, this excessive economic dependence will inevitably turn against the country.

However, for the time being, it is difficult to do without Russian raw materials, especially gas. According to the president of the oil group Total Energies, Patrick Pouyanné, speaking in Paris at the forum of the National Federation of Public Works, “if Russian gas does not come to Europe, we have a real issue of gas prices in Europe. In other words, Europe has no immediate solution to replace gas imports from Russia. On the Paris stock exchange, the CAC 40 index fell by almost 3.8% during the session of Thursday 24 February.

II-A demand and supply shock

The demand shock comes mainly from the reaction of consumers and investors to the strong rise in uncertainty.  Household consumption is declining in favor of savings. Investment is also declining, with companies adopting a cautious, wait-and-see attitude, except in defense-related sectors. The evolution of European stock markets since the beginning of the conflict reflects this climate. Net demand from abroad is also likely to deteriorate. On the export side, the deterioration is driven by the same logic as the decline in domestic demand. On the import side, rising prices for energy, minerals, and some agricultural products will greatly increase the bill.

The supply shock comes essentially from the rise in energy costs, with oil having already risen by 20% compared to 80% for the price of gas in the last week. Brent crude has risen from 91 dollars to 111 dollars and the spot price of gas in Germany has risen from 95 euros/MWh to 175 euros/MWh. The same is true for a number of metals for which Russia is a major producer, such as palladium, vanadium and titanium, which are essential for the automotive and aerospace industries. Ukraine is a major wheat exporter and 36% of world trade in wheat (and 80% of sunflower oil) passes through the Black Sea. The supply chains will undergo new disorganizations that will generate higher production costs.

III-Tax increase

If this conflict with Russia is destined to continue, European governments will not be able to avoid thinking about increasing taxation. War means war effort and war contributions. Such a measure, which will divert resources from private consumption to public consumption and investment, will also have a rather deflationary effect.

For us, it is preferable to increase taxes and to distribute the burden of the war equitably on all French people rather than to put the burden on the poorest categories through inflation or possible shortages linked to administered prices.

IV-The effects of sanctions on the global economy

The sanctions announced so far against Russia are not likely to paralyze its economy. They do not, for example, at least at this stage, include excluding Russia from the SWIFT system for bank transfers, or stopping imports of oil, gas, grain and aluminum from Russia, simply because such sanctions would be more likely to hurt Western consumers, especially Europeans, than Russia, which has low debt and large foreign exchange reserves. Russia may also redirect much of its exports to China, with which it has increasingly close ties. The suspension of certification of Russia’s completed but not yet operational NordStream2 pipeline to Germany and the announcement of sanctions against its shareholders by the United States could reduce Europe’s expected gas supplies by 10-15%. In other words, there could be a shortage of gas supplies in Europe in the coming years, which would mean looking for alternative sources of gas and energy and driving up prices.

While the conflict is a blow to the Russian economy, particularly because of the sanctions imposed on some of its banks and citizens, and the sharp devaluation of the ruble, which will affect the purchasing power of Russians, and the war devastates the Ukrainian economy, the direct effects on global GDP will be small because of the modest share of these economies in global output. This is especially true if the conflict is short-lived, as many expect, given Russia’s overwhelming military advantage.

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