The course of wars cannot be predicted. The Ukraine war may end in a few weeks with Russia and Ukraine signing a face-saving deal. Or it may drag on for months before ending in a muddled stalemate. Or it could carry on a full year with Russian military occupation foiled by guerrilla resistance.
Many predict stagflation: slowing growth plus inflation. But what are the chances of an outright recession? A quick end to the war will pre-empt a recession. But if the war continues for six months and sanctions beyond that, a recession is likely. At this point, it is not probable, but entirely possible.
The resurgence of Covid in China has led to lockdowns in major ports and industrial centres, exacerbating supply disruptions from the war and sanctions. But the world economy is resilient. Covid slashed consumer spending and left consumers, especially in the US, with comfortable bank balances, which will assuage the coming reduction in purchasing power. All countries were poised for a sharp economic rebound as Covid petered out. The US had exceptionally low unemployment when the war started, a rare starting point for a recession. Nevertheless, a long war will be devastating.
Most recessions, representing deficient demand, can be tackled by high fiscal deficits and loose monetary policy to increase demand. But this will fail if the problem is not deficient demand but a war-induced supply shock. Printing more central bank money in such circumstances will simply send prices even higher.
Will western sanctions induce Vladimir Putin to taper his demands and come to a quick compromise? Not likely. These will seriously hit the Russian economy and oligarchs. Financial sanctions, especially denial of Russian participation in the SWIFT (Society for Worldwide Interbank Financial Telecommunication) payments system, will take a heavy toll. But countries that go to war expect to pay a price and will not easily give up even if they suffer serious setbacks. I doubt if economic sanctions will bring Putin to his knees quickly.
The US ban on imports of Russian oil and gas means almost nothing since the US is a net exporter of both. The impact may be no more than of a Saudi Arabia ban on imports of Russian oil. Europe continues to import Russian oil and gas. So does India, especially gas.
A fall in export volume of 30% of Russian oil and gas may seem a terrible blow. But this can be more than offset by the rise in prices of export commodities. The price of oil is volatile, but touched $139 a barrel shortly after the war began, an indication of where prices will go if the war lasts months. If Russian oil export volume is down 30% but price is up 50%, the country will earn far more, not far less. The same is true of Russian exports of wheat, maize, nickel and palladium.
Russia will face problems in getting hard currency for such exports. Much may have to be sold at a discount through indirect channels or cryptocurrencies. India is openly buying at a steep discount. But high prices could more than compensate Russia for discounts.
Coming Up: Puppet Show
Nobody doubts Russia’s ability to militarily occupy Ukraine. But Ukrainian leaders will get unlimited financial and arms support for a guerrilla war that bleeds Putin. Russia may instal a puppet regime in Kyiv backed by Russian arms and money. But the puppet government will be under constant pressure from its own people. Putin’s claim that there is no such thing as a Ukrainian people is as hollow as Israeli prime minister Golda Meir’s claim that there is no such thing as the Palestinian people.
Some recessions are preceded by a slump in commodity prices. That is not the case today. A second cause of recessions is excessive monetary tightening by central banks to check inflation. That, too, is not the case today. The problem today is a supply shock.
The classic example of a supply-induced recession was in 1973-74, caused by the Arab oil embargo in the Egypt-Israel war. This quadrupled oil prices, which were then kept high by supply manipulation by the Opec.
We face something similar today, with sanctions exacerbating the war-induced supply shock. The war has crippled shipping in the Black Sea, a major export outlet for Ukraine and Russia, since no marine insurance is available to cover war risks. This has worsened congestion at other ports and sent freight rates spiralling. The sowing season in the steppes of Russia and Ukraine is approaching. Even a modest delay in ending the war may badly hit sown acreage, causing the loss of a whole year’s production of wheat and maize.
Longer-term trends have exacerbated the supply shock. A rising green attack on oil and coal companies has led to under-investment in energy for years. Green concerns have slowed applications for new mines for all minerals. Greens have often stopped the spread of genetically modified (GM) crops that could raise yields. This makes the world greener, but more vulnerable to supply shocks.
We must hope for a quick end to the war. We must also prepare for a long war and recession.
This article was originally published in The Economic Times on March 23, 2022.