Ukraine crisis: Economy stable for now, but risks mount
The volatility surrounding Russia’s military assault on Ukraine continues to evolve. The conflict is a humanitarian tragedy that has already affected the lives of millions of people The volatility surrounding the Ukraine crisis continues to evolve. The conflict is a humanitarian tragedy that has already affected the lives of millions of people. Markets have responded sharply. While the U.S. market (as represented by theS&P500) has largely recovered, European markets have been hit harder – as it relates to the policy developments over the weekend – with the German DAX index leading the way down. The situation is likely to remain fluid in the coming days and weeks. Here are some of the risks and likely outcomes that we have identified... The situation is likely to remain fluid in the coming days and weeks. Here are some of the risks and likely outcomes that we have identified.
Spread of conflict outside of Ukraine is unlikely
The absolute worst-case scenario – from both a human and economic cost perspective – would be that the fighting extends past the Ukrainian border. Neighbouring countries like Poland are members of the North Atlantic Treaty Organisation (NATO). Under article 5 of that agreement, attacking one member is considered a provocation of the entire alliance. This would drag NATO into the war and potentially trigger a global conflict, with all the appalling consequences that would entail. If we consider the nuclear deterrent and assume that the Russian President Vladimir Putin is a rational actor, this outcome seems very improbable.
Energy price spikes - a risk to consider
A more likely worst-case situation would be the disruption of energy supplies from Russia to Europe. Many European countries are dependent on Russian oil and gas. Germany relies on Russia for about 60% of its natural gas imports. The challenge for Russia, on the other hand, would be the loss of revenue this strategy would entail, especially considering the huge costs of its war effort.
Europe’s vulnerability has been reflected in its sanctions thus far, with ‘carve-outs’ or exemptions for energy purchases from Russia. Even the restrictions related to the SWIFT payment system has not yet been applied to Russian energy companies or energy-related financial firms like Gazprombank. If the West were to take a harder stance on the Russian oil and gas sector, we’d expect a significant spike in prices which in turn could trigger a recession in Europe. For now, this risk still seems unlikely, but is not out of the question.
Cyber-attacks could be imminent
Of all the potential risks still to come from the conflict, we believe cyber-attacks are the most likely. It has been rumoured that there are more people working in cyber in Russia than there are people working in Microsoft. This could be an indication of how much the country has invested in its cyber-attacking capabilities. If Western sanctions tighten, this would be a way for Russia to respond in a way that would also be deniable by the Russian government.
Putin’s priorities unambiguous, but ongoing stability uncertain
Putin has made a choice to prioritise national security over the economy. Sanctions could knock the Russian economy by up to 5% of GDP. This could have ramifications for the political stability of the country. In his last two military campaigns (in Georgia in 2008 and in Crimea in 2014), Putin enjoyed a significant ‘nationalism bounce’ and a boost to his approval ratings. It remains to be seen if the Russian public will react that way this time, especially if things go badly and Russia suffers heavy losses. Ukraine represents a greater challenge to Russia than Iraq did for the US: it land-mass is greater, its population is larger. Social media has been decidedly anti-Putin.
Any decline in Putin’s popularity at home could take years to manifest itself given the nature of the political system there. Social unrest in Russia will not be good for global stability or the world economy.
The bottom line
There will be continued economic and political uncertainty in the coming days and weeks as the war unfolds. In the near-term it seems highly unlikely that the violence will spill over Ukraine’s borders into NATO countries. As it stands now, the crisis does not appear likely to derail the global economic cycle and bring forward a recession. This could change however, especially if Europe’s Russian energy supply is cut-off, and this leads to a sustained price spike. In the near term, this risk could make central banks a little more cautious on rate hikes.
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