International financial impacts of Russia's war in Ukraine
What will be the impact on the dollar versus the ruble?
The invasion of Ukraine continues, and several questions regarding the Russian and global economy remain unanswered:
- Will the sanctions be successful?
- What does successful mean?
- What will be the impact on the Russian economy in the short/medium/long term?
- What will be the impact on the United States, its allies, and the rest of the world?
- What is the potential impact on the dollar?
Though it is difficult to address each question in its entirety, I will offer some answers with the hope of generating further discussion.
Western sanctions are unprecedented in their scale and scope
The Western sanctions are unprecedented in their scale and scope. Furthermore, they are being imposed on Russia, which is more integrated into the world economy than other countries that face similar sanctions (e.g., Cuba, Iran).
In a sense, this time is different with respect to sanctions. Russia’s largest banks, including SberBank and VTB, operated in several western countries (including the UK) and are listed on the London Stock Exchange. Removing these banks from the SWIFT payment system prevents them from intermediating between clients, making them effectively insolvent. A bank that cannot facilitate export/import transactions has few options:
- Concentrate on facilitating domestic transactions in rubles
- Conduct business with countries willing to disregard Western sanctions, or
- Trade in currencies other than those of the United States and its allies.
The fact that SberBank’s stock lost more than 99 percent of its market value and remains effectively frozen suggests that life for such institutions outside SWIFT won’t be easy.
While unprecedented, Western sanctions are not absolute. Numerous Russian banks have escaped sanctions, in part to facilitate Western purchases of Russian oil and gas. Countries such as Germany and Italy remain heavily reliant on Russian energy, despite proclamations that they will wean themselves off of it in the medium term.
Yet as reliant as German industry is on imports of Russian gas, energy exports matter even more to Russia. A European embargo on Russian oil and gas (which the United States has already done) would likely devastate the Russian economy. Russia earns approximately $1 billion a day from oil and gas exports to Europe, and it is unclear how quickly it would be able to reroute energy shipments should Europe stop buying.
This income is critical for Russia, since it allows funding of the war and props up the ruble. The invasion and all that it implies has shocked global oil markets resulting in higher gas prices—fueling inflationary pressures in the United States, United Kingdom, and European Union—while increasing Russia’s export receipts.
More than 500 multinational companies from McDonalds to BP have decided to cease operations in Russia
There are also more than 500 multinational companies from McDonalds to BP that have decided to cease operations in Russia. Many are currently trying to write-down their Russian operations or sell them to a domestic buyer. With a few exceptions, profits from Russian operations will not proportionally impact these firms. However, the question remains whether the Russian economy can survive without major retail, oil and gas, and technology companies from the West.
Another element involves the global nature of funding for Russian firms and its government. Russian government debt is proportionally small—USD $40 billion, or less than 3 percent of GDP. However, exclusion from the SWIFT system may prevent the Russian government from making coupon payments in U.S. dollars for dollar-denominated bonds. Failing to make these payments would put the Russian government in default on foreign debts, something that has not occurred since 1917.
The situation is worse for Russian firms. BlackRock, the largest asset manager in the world, among others, has ceased investment and divested Russian equities.
The selling of Russian equities at the onset of the war caused a large drop in the Russian stock exchange, which only stopped when Russia halted trading and closed the exchange. Strict controls on the trading of Russian equities makes estimation of valuations difficult, but it is likely that most Russian stocks would see substantial declines in open trading.
On the other hand, the ruble seems to have reverted to its value against the USD of just prior to the war, after a 25 percent drop in the interim.
How can one interpret this? Perhaps the market feels that Russia will bypass the USD by engaging partners such as India or China in ruble or local currency transactions. Perhaps the Russian central bank raising domestic interest rates to 20 percent had an effect. The picture remains unclear.
The sanctions will likely have a significant medium-term impact on Russia, but they are unlikely to end the war
Though the sanctions will likely have a significant medium-term impact on Russia (possibly even causing a financial crisis similar to that of 1998), they are unlikely to end the war.
There are a number of reasons why this would be so: Putin’s grip on power, Russia potentially finding alternative ways to trade in rubles, and the possibility that sanctions can raise nationalism, making the war in Ukraine easier to justify in Russia.
Sanctions can weaken and isolate Russia, cause a reversal to globalization and its resultant benefits, highlight the importance of energy independence (or dependence on friendly nations only), and perhaps even impact the dollar as a reserve currency (though it is unclear whether the world would move toward other currencies, such as RMB, for fear of being sanctioned).
If, and as, the war continues, it will likely unleash considerable economic and social instability across the globe. Besides oil and gas, Russia and Ukraine are major exporters of fertilizer, wheat, and barley.
Fertilizer is critical in the production of basic foodstuffs, and any disruption in this market can have devastating effects on food security, particularly in the developing world. Similarly, disruptions in wheat and barley markets can cause widespread social unrest. As an example, in Sri Lanka, skyrocketing bread prices have produced violent protests and clashes between citizens and government forces.
In this global world, there is potential for severe economic consequences of a war that involves a major producer of oil and gas, fertilizer, wheat, and barley, not to mention a nuclear power. The full extent of the war’s economic impact might not be known for some time. However, even though Western sanctions will undoubtedly weaken the Russian economy and unleash global volatility, they will likely not change the outcome.