Russia’s invasion of Ukraine – An Economic Update
Russia’s invasion of Ukraine has resulted in tragedy and a significant human toll. Global commodity prices have soared posing risks to the global economic recovery.
In this webinar, chief economist, Kevin Lings, and J.P. Morgan Asset Management economist, Mike Bell, provided an update on recent developments and the implications for local and global financial markets.
STANLIB hosted a special economic update, where Chief Economist Kevin Lings introduced the focus of the discussion as the Russia-Ukraine crisis and what this means for financial markets and the South African economy. How policy officials are responding and likely to respond going forward is also an important aspect that he highlighted.
Introduction: Russia’s economic influence
The economic link between SA and Russia is not as strong as one might envisage. SA-Russian imports and exports are less than 1% of our total trade, while our trade with Ukraine is less than 0.1%.
Russia itself is only 1.7% of the world economy – small as an economic system, but with the ability to cause significant disruption, mainly due to its role in the oil market and commodities and its strong trade and financial relationship with Europe. Russia is therefore having a much bigger effect on the world economy than the size of its economy would suggest.
The Russian economy is being decimated and sanctions are systematically hurting. At the start of the year, it was forecast to grow at almost 3% GDP, and now there is talk of a very severe recession. At the end of February, Russia had an investment grade credit rating, but in the first week of March, Russia had been downgraded 12 notches to a rating Fitch noted reflects risk of imminent default.
Impact on economies: a global perspective
Mike Bell, Global Market Strategist, J.P. Morgan Asset Management
The main economic impact of the conflict is on global commodity markets. Russia is a significant producer of commodities, with about 38% of all Europe’s natural gas coming from Russia and 23% of Europe’s oil. About 18% of all wheat that Europe consumes is from Russia and Ukraine combined.
Global markets are focusing on the impact of higher oil and gas prices. Gas prices have risen in the US, but nothing like the sharp rise in Europe, where gas was trading about 60% higher than over the last winter. Gas prices have been coming down in recent days however if they stay at elevated levels this would cause a severe squeeze on Europe and UK household incomes and subsequent consumption, and thus this risk of a recession in Europe and UK would be high. In the US, the risk is lower.
As conflict in Ukraine continues, the worst-case scenario is that the gas supply into Europe is shut off, either due to Europe choosing to stop importing from Russia or because Russia choose to cut supply. This would leave Europe having to shut down parts of the industrial complex to ration gas for households, which Bell thinks is unlikely. The problem, Bell said, is if things escalate, either through accident, or Europe deciding not to take energy or Russia deciding to retaliate to sanctions by limiting or cutting off supply.
Stopping the import of oil would really hurt Russia – which the US and UK have done, but not Europe, where about half of Russia’s oil exports go.
Uncertainty remains around the trajectory of gas and oil prices, and any fiscal stimulus to offset potentially higher prices for consumers in Europe and the UK. As it stands, the risk of recession in the UK and Europe is higher than a few months ago.
The market is already pricing in a relatively higher probability of a European recession. To date European equities have come down 17-18% from their peak.
In the US, there is a risk that oil prices will weigh on growth by squeezing consumer incomes. Wage growth is also negative in real terms. But there are some offsetting factors. Chase bank median deposits stats show that during the pandemic, US consumers saved and today, the average consumer in the US has about 80% more savings than at the beginning of the pandemic. If oil stays at $110 to $115 a barrel, it should therefore slow the pace of growth in the US, but not cause recession.
If, however, the oil price spikes materially higher, it could cause problems in the US. J.P. Morgan Asset Management’s view is that higher oil prices lead to higher headline inflation, and consumers spending less on “fun stuff” and more on filling up their car. Monetary policy to control inflation may lead to interest rate increases but the higher oil price is already doing some of the monetary tightening for the central bank so it’s unlikely interest rates will increase over the short term. If the unemployment does not increase and higher oil price does not cause a recession, then the central bank may increase interest rates more aggressively in 2023.
Sustained higher gas prices in Europe/UK lift the risk of recession in this region, but central banks may provide support. A higher oil price would lead to slower growth in the US with stronger savings balances protecting the US consumer from the impact.
Impact on economies: a local perspective
Kevin Lings, Chief economist, STANLIB
The impact on South Africa is both positive and negative. There are two key factors STANLIB is watching:
- Positive impact: The increase in commodity prices benefits SA exports and therefore the generation of more tax revenue, improving our fiscal position. There could also be a net benefit for SA in terms of stimulating mining and some other sectors and also providing a little growth initiative.
- Negative impact: The impact on inflation (through fuel and food prices) to consumer confidence, and investors’ appetite to invest money into emerging markets.
“My view is that the negatives outweigh the positives,” Lings said.
SA’s trade with Russia tends to be very seasonal and erratic as it is largely agricultural-based. Trade between the two countries is small accounting for less than 0.5% of SA’s exports, while our imports are less than 1%. Exports to Ukraine are less than 0.1%.
The direct economic impact of the crisis is therefore very small, but the indirect link a lot more impactful given as noted above what this means for commodity prices, the oil price, global inflation and interest rates.
The global commodity price index has escalated dramatically, and last week was the single biggest weekly increase (of 20%) ever recorded in commodity prices in US dollars.
Lings expected sanctions to be severe and protracted. “Over the coming months, our view is that commodity prices remain elevated across the basket”, he said.
Most currencies have come under pressure, but the rand is among about five currencies that have a done well due to the strong commodity element. “This is no doubt cushioning the impact of the oil price on our fuel price, and without this, there would be an even more severe impact”.
SA is expected to continue to enjoy the benefits of strong commodity prices. “We would expect that SA’s trade surplus will rocket again”, Lings said. “We know from tax revenue that government is into another bumper tax revenue phase,” putting us in a better fiscal position and giving treasury more options.
The Russia: Ukraine crisis has clearly reinvigorated the commodity cycle supporting SA’s fiscal position through mining company tax revenue collection. Many people could then draw the conclusion that this would also boost mining activity and production to meet a global supply shortage. However, there are limitations.
Unfortunately, mining production in SA is going sideways, and in fact weakened in the last year when commodity price have been at record highs. SA infrastructure is holding companies back from investing to grow production. SA rail and ports are at 100% capacity when not broken, meaning companies cannot export more. “We should step into the supply gap Russia is leaving, but we are unable to do so because we don’t have the infrastructure capacity to deliver. We are struggling to benefit from this multiplier effect.”
Increasing fuel prices are also clearly negative for the economy. A close on R3 a litre increase in the fuel price at the beginning of April will flow through to inflation which is heading towards 7%, above the target range, where it may stay for some time. This will significantly hurt low-income earners in South Africa, who spend 40% to 45% of their income on food and transport, and aggravate the social dynamic in this country. Unfortunately, the environment for unemployed and low-income earners is set to worsen with higher fuel prices.