What are the economic consequences for the conflict between Russia and Ukraine? Stagflation in sight, according to the Coface

The conflict between Russia and Ukraine has caused turmoil in the financial markets and significantly increased uncertainty about the recovery of the global economy. In summary, since the last publication of Coface, an expert in international credit insurance, the world has changed and so have the risks.

Here is his latest press release.

– The rise in commodity prices intensifies the threat of high and sustainable inflation, which increases the risks of stagflation and social unrest.

– Certain sectors such as automotive, transport, or chemistry should be more impacted

– Coface predicts a deep recession of the order of -7.5% for Russia in 2022 and has downgraded its risk assessment for Russia to D (very high).

– The European economies are the most threatened. At this stage, Coface anticipates at least 1.5 percentage points of additional inflation in 2022, while GDP growth could be reduced by one point. If we add to this a total interruption of Russian natural gas flows, the impact on GDP would be at least 4 points, which would lead to EU growth close to zero – or even in negative territory – in 2022.

The conflict is further increasing the pressure on the energy and raw materials markets 1

Russia is the 3rd largest oil producer in the world, the 2nd largest natural gas producer, and is among the top 5 producers of steel, nickel, and aluminum. It is also the 1st exporter of wheat in the world (almost 20% of world trade). For its part, Ukraine is an important producer of corn (6th), wheat (7th), and sunflower (1st), and is among the top ten producers of sugar beets, barley, soybeans, and rapeseed.

When the invasion was announced, the world’s financial markets fell sharply, and the prices of oil, natural gas, metals, and foodstuffs jumped. Recently, Brent oil prices have crossed the $100 per barrel mark for the 1st time since 2014 ($115/b at the time of writing), while TTF gas prices in Europe jumped to a record high of 192 euros on the morning of March 4th. While high commodity prices were one of the risks already identified as potentially disrupting the recovery, the escalation of the conflict increases the likelihood that prices will remain high for much longer. This in turn intensifies the threat of high and sustainable inflation, thus increasing the risks of stagflation and social unrest in advanced and emerging countries.

The automotive, transport, and chemical industries are the most vulnerable sectors

The crisis obviously affects the automotive sector, which is already being put to the test by shortages and high prices for components and raw materials: metals, semiconductors, cobalt, lithium, and magnesium… Ukrainian car factories supply the leading Western European car manufacturers. Some have announced the shutdown of their factories in Europe while other factories around the world are already planning production shutdowns due to chip shortages.

Airlines and sea freight companies will also suffer from rising fuel prices, with airlines being the most impacted. It is estimated that fuel represents about a third of their total costs. In addition, European countries, the United States and Canada have banned Russian airlines from accessing their territories and, in return, Russia has banned access from its airspace to European and Canadian aircraft. This will lead to higher costs because the planes will have to take longer routes. Finally, the airlines have reduced room for maneuver to cope with the increase in expenses, as they continue to suffer a decrease in their revenues due to the pandemic. Rail freight will also be affected: European companies do not have the right to call on Russian railway companies, which should disrupt freight activity between Asia and Europe, which passes through Russia.

We also expect that raw materials for the petrochemical industry will be more expensive and that the surge in natural gas prices will have an impact on the price of fertilizers, and therefore on the entire agri-food industry.

A deep recession in perspective for the Russian economy

The Russian economy will be in great difficulty in 2022 and will experience a deep recession. Coface now predicts that GDP will decrease by -7.5% in 2022 after the economic recovery of 2021. This led us to downgrade the country risk assessment from B (fairly high) to D (very high).

The sanctions concern, in particular, large Russian banks, the Russian central bank, Russian sovereign debt, certain Russian public officials and oligarchs, as well as the control of exports of high-tech components to Russia. These measures put considerable downward pressure on the Russian ruble, which has already collapsed and will lead to an increase in consumer price inflation.

Russia has a relatively solid financial situation: low level of external public debt, recurring current account surplus, as well as large foreign exchange reserves (about $640 billion). However, the freeze imposed by the Western depositary countries on these reserves prevents the Russian central bank from deploying them and reduces the effectiveness of Russian actions. The Russian economy could benefit from the rise in the prices of raw materials, in particular for its energy exports. However, the EU countries have announced that they intend to limit their imports from Russia. In the industrial sector, the restriction of access to semiconductors, computers, telecommunications, automation, and information security equipment produced in the West will be detrimental, given the importance of these elements in the Russian mining and manufacturing sectors.

The European economies are the most threatened

Due to its dependence on Russian oil and natural gas, Europe appears to be the region most exposed to the consequences of this conflict. The replacement of all European supplies of Russian natural gas is impossible in the short or medium term and current price levels will have a significant effect on inflation. At the time of writing, and while Brent crude is trading above $125 a barrel and natural gas futures suggest prices permanently above €150/Mwh, Coface anticipates at least 1.5 percentage points of additional inflation in 2022. This would erode household consumption and, combined with the expected decline in business investment and exports, it would reduce GDP growth by about half a point.

If Germany, Italy, or some Central and Eastern European countries are more dependent on Russian natural gas, the commercial interdependence of the eurozone countries portends a general slowdown.

In addition, we estimate that a total interruption of Russian natural gas flows to Europe would bring the impact on GDP growth in 2022 to 4 percentage points. This would bring GDP growth close to zero, or even into negative territory – depending on how the destruction of demand would be managed.

No region will be spared from imported inflation and global trade disruptions

In the rest of the world, the economic consequences will be felt above all through the rise in raw material prices, which will fuel the already existing inflationary pressures. As always when commodity prices soar, net importers of energy and food products will be particularly affected, with the specter of major supply disruptions in the event of an even greater escalation of the conflict. The decline in European demand will also hamper global trade.

In Asia-Pacific, the impact will be felt almost immediately via the rise in import prices, especially for energy. Many economies in the region are indeed net importers of energy, with China, Japan, India, South Korea, Taiwan, and Thailand leading the way.

As the commercial and financial links between North America, Russia, and Ukraine are quite limited, the impact of the conflict will mainly be through the price channel and the slowdown in European growth. Despite the prospect of lower economic growth and higher inflation, recent geopolitical events should not derail monetary policy in North America at this stage.