Economic consequences of the Ukraine crisis

“The direct impact on the global economy of the now-inevitable Russian recession will be limited.”

Even though events are extremely fluid and one of the maxims of economics is that persistence matters, significant near- and longer-term consequences of Russia’s invasion of Ukraine are already becoming apparent.

The near-term consequence of the war will be higher inflation and lower growth in advanced economies. This will exacerbate the policy dilemmas faced by major central banks (as described in the MAP March Global Macro Outlook Note) and will widen the divergences between them. Against the grain of the previous crises of this century, the net result will likely be higher short and longer-term interest rates driven by greater volatility of both growth and inflation, as well as emerging fiscal and geopolitical risk premia.

The direct impact on the global economy of a Russian recession will be limited, given that Russia accounts for less than 2% of global GDP. But Russia is a major commodity supplier, accounting for 12% of world oil output, 17% of natural gas, and both Ukraine and Russia are important wheat exporters (9% and 20% of the world total, respectively). Higher energy prices will drag on growth and exacerbate already significant inflationary pressures across all major economies.

In terms of the longer-term impact of the crisis, it has accelerated the forces of de-globalisation. Continuing a trend, Western sanctions have targeted technology and financial payments. The latter were significant and undercut basic assumptions of international finance. The geo-strategic risks that have been laid bare will rupture European energy markets. All these fragmentations will raise costs and increase economic volatility over the medium term.

Governments are also increasingly compelled to devote more resources to re-building domestic resilience (eg Germany’s commitment to raise defence spending to 2% of GDP). When coupled with additional health spending triggered by the widespread shortcomings exposed by the pandemic and the need for ongoing support for people displaced by the various economic transitions, the strains on fiscal resources will deepen.

The energy transition, already a priority central to tackling climate change before the conflict, will become a strategic imperative. The confirmation biases in many immediate reactions — ranging from ‘massively accelerate renewables’ or ‘let’s go back to the fossil fuel age’ — will not withstand the scrutiny of geo-strategic considerations, cost constraints, and the time scales required to make meaningful changes.

On balance, the combination of high short-term energy prices (and outright scarcity), the risks of stranded carbon and long-term climate competitiveness will lead to more rapid industrial restructuring, also highlighted in our MAP March Macro Global Outlook Note.