Home ›› 08 Mar 2022 ›› Editorial
From the end of World War II to the early 1990s, there was an upward trend of armed conflicts in the world. Many of these armed conflicts were wars of independence, some tinged with the struggle between communism and democracy that characterised the Cold War period.
The war against Russia is one Western countries want to fight with only economic sanctions, not guns. Despite its long gestation and planning by Vladimir Putin and his supporters in the Kremlin, was supposed to end quickly once financial retaliation began. Yes, there would be military skirmishes on the ground, but little more than a few casualties were expected once a range of penalties began to bite. The Western powers have quickly realised that unless they are willing to fire the financial equivalent of a nuclear arsenal, Putin has made sure Russia is largely immune, at least in the short term. Over a decade, Kremlin policy has carefully reduced domestic public and private sector debt and allowed the central bank time to build a war chest of foreign assets large enough to shore up the country’s finances for months, if not years. This means that the sanctions put in place over the past couple of days by the EU, US, UK, Japan and Canada are unlikely to have any significant effect on the Russian economy or its financial stability. Only the full package of measures used against Iran–shutting Russia out of international payment system SWIFT while also banning purchases of Russian oil and gas may do the trick. The SPFS is the Russian equivalent of SWIFT and was developed by the Central Bank of Russia in 2014, after the United States government threatened to disconnect Russia from the SWIFT system. The first transaction on the SPFS network involving a non-bank enterprise was executed in December 2017.
As of March 2018, over Russian 400 institutions (mostly banks) are part of the network. That means that the SPFS system supports intra-Russian transactions, however the problem with any SWIFT disconnection would be the absence of international connectivity. That then becomes a question as to how quickly Russia is able to integrate SPFS with other systems, and whether or not the United States would also place sanctions on countries connecting to SPFS. In fact, there are plans to integrate the Russian SPFS network with the China-based Cross Border Interbank Payment System (CBIBPS), while the Russian government is also in talks to expand SPFS to developing countries such as Turkey and Iran. Since 2019 many agreements have also been reached to link SPFS to other countries payment systems in China, India, Iran, as well as the countries within the Eurasian Economic Union (EAEU) which includes Armenia, Belarus, Kazakhstan and Kyrgyzstan. The EAEU also has Free Trade Agreements with Serbia, Singapore and Vietnam with multiple other deals pending.
At the end of 2020, 23 foreign banks were connected to the SPFS from Armenia, Belarus, Germany, Kazakhstan, Kyrgyzstan, and Switzerland. The stakes in disconnecting Russia are high. It would usher into place a new Cold War with mutually disconnected systems. EU trade and energy from Russia would need to be replaced by the United States instead, meaning EU consumer prices would significantly increase. SWIFT would be seen as untrustworthy by emerging nations and would cease to be global. The sensible thing to do would be for the West to agree not to place NATO troops and military hardware in Ukraine or Georgia. For the US to instigate a divided world spells the end for globalisation and the end of US influence over large areas of the planet that would feel abandoned – such as Asia. That would occur just at a time when the Asian economies now represent the larger share of global wealth development. Choosing which side to be on may not be such a black and white decision. It’s possible that the financial markets and political analysts could underestimate the implications of this geopolitical regime shift.
The possible impact on economies of the countries due to the present Ukraine crises or for that matter any war, may include:
War and inflation
In many circumstances, war can lead to inflation – which leads to loss of people’s savings, rise in uncertainty and loss of confidence in the financial system. For example, in the US civil war, the Confederacy struggled financially to meet the cost of the war. Therefore, they started printing money to pay soldiers salaries. But, as they printed money, the value of money soon declined. High inflation hits middle-income savers the most as they see the value of their savings wiped out.
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During the Second World War, the United States saw a rise in inflation because the economy was running close to full capacity, the high levels of government spending and shortage of workers saw inflationary pressures. During war, the economy can also experience cost-push inflation due to shortages of goods and services and rising price of raw materials like oil. If a country is devastated by war and the capacity to produce goods is sharply reduced, it can create the circumstances of hyperinflation as governments desperately print money to try and deal with lack of goods.
War and oil prices
War can often lead to higher prices of oil because major conflict can threaten supplies. For example, the Gulf war of 1990 led to rising oil prices.
The 2022 Russian invasion of Ukraine led to a rise in the price of oil and gas, and this will lead to higher global prices for fuel. As Russia is a major supplier of oil and gas, economic sanctions on Russia in response to the invasion will reduce supply and put upward pressure on gas prices.
War and national debt
During war, we often see a rapid rise in public sector debt. The government is willing to borrow a lot more than usual because – there is patriotic support for the war effort. Both the First and Second World Wars were very costly for the UK. In both cases, the national debt rose very sharply. In the post-war period, debt continued to rise due to reconstruction and the creation of the welfare state.
The financial cost of war
Although war can provide a temporary boost to domestic demand, it is important to bear in mind the cost of war. In particular the opportunity cost of military spending, the human cost of lost lives, the cost of rebuilding after the devastation of war. Also, it depends on the kind of war, how prolonged it is, where and how it is fought. For example, the US fought wars – WWII, Korean War, Vietnam War and it appeared that these wars led to a boost in domestic demand and some manufacturing companies did very well. However, we shouldn’t forget that these wars occurred on territories outside the US. The real devastation took place in Asia and Europe.
The Russia Ukraine crisis poses huge risks for a world economy that’s yet to fully recover from the pandemic shock. The conflict already looks like the most serious war in Europe since 1945. Russian forces carried out airstrikes, captured army bases and advanced toward Kyiv as civilians fled. Western officials said the capital may fall at any time, with its air defense eliminated. The assault followed weeks of tensions that already sent tremors through the world economy by ratcheting up energy prices.
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The pandemic has left the global economy with two key points of vulnerability — high inflation and jittery financial markets. Aftershocks from the invasion could easily worsen both. There’s a threat to growth too. Households spending an ever-larger chunk of their incomes on fuel and heating will have less cash for other goods and services. Plunging markets would add another drag, hitting wealth and confidence, and making it harder for firms to tap funds for investment. For central bankers, the twin challenge — of managing prices and keeping their economies growing — will get even harder. The Federal Reserve and European Central Bank have been gearing up to tighten monetary policy. The Russia crisis may force a rethink. Just how big a blow the conflict ends up delivering to the global economy will depend on its length and scope, the severity of Western sanctions, and the possibility that Russia might retaliate. There’s the potential for other twists too, from an exodus of Ukrainian refugees to a wave of Russian cyber-attacks.
In the first, a swift end to fighting prevents a further upward spiral in commodity markets, keeping US and European economic recoveries just about on track. Central bankers would have to tweak their plans, not scrap them.
In the second scenario, a prolonged conflict, tougher Western response and disruptions to Russia's oil and gas exports would deliver a bigger energy shock and a major blow to global markets. That would likely take ECB rate hikes off the table this year, while Fed tightening would slow down.
A worst-case outcome would see Europe’s gas supply cut off, triggering a recession, while the US would see significantly tighter financial conditions, a bigger hit to growth, and a markedly more dovish Fed.
The increase in prices of essential commodities including petroleum products, the increase in price of construction materials may create further pressure on our fight against inflation. The economic challenges faced by the countries who import from us specially the ready made garments may create pressure on our foreign exchange earnings and create a negative impact on the deficits in balance of trade. It may be mentioned here that The EU accounts for more than 60 per cent of country's total RMG exports while $650 million worth of RMG is directly exported to Russia and additional $300-350million exported to Russia through other countries. On the other hand, the inward remittances may start to go down as evident through the numbers recorded for February 2022.
We have gone through a period of more than 2 years facing off the pandemic, proves that we are quite resilient. However, this present context of war may put us through another set of stress testing situation.
In the meantime, let’s pray that this crisis settles down soon without being converted to a full scale war. The loss of lives, the increased pressure on livelihood and other distressed situation can immediately be dealt with the return to peace by the countries involved.
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The writer is MD and CEO of Community Bank. He can be masihul1811@gmail.com.
