Russia’s attack on Ukraine has shaken the world. How do the sanctions affect the markets, how are Nordic assets faring and what are the long-term financial impacts of the crisis? Our chief strategist Valtteri Ahti explains.
What will be the short-, medium- and long-term impacts of the Russia-Ukraine war on GDP growth, inflation, and interest rates in Europe, as well as in the US or other major regions?
The primary way the war affects economic growth and inflation is through rising commodity prices. The effect of the war is hence dependent on how much it raises commodity prices. Commodity prices are rising as companies are reluctant to purchase Russian supplies despite the fact that Western sanctions do not apply to energy transactions.
The effect of the war on commodities depends on the duration of the war. However, even if the war ends the sanctions may stay in place. This will happen if Russia establishes a puppet regime over the conquered Ukrainian territories. The West has not recognized Crimea as part of Russia, which Russia annexed in 2014, nor the separatist republics of Donetsk and Luhansk. The West will not recognize a puppet regime in Ukraine and will maintain pressure using sanctions.
Rising commodity prices raise inflation and lower economic growth for the global economy. The problem is particularly severe for Europe where already more than half of inflation comes from energy prices and because there is relatively little domestic energy production. Europe imports 40 percent of its natural gas from Russia and is dependent on Russian oil. The worst-case scenario for Europe is one of very high inflation and economic recession.
The United States will face a smaller inflationary shock as energy inflation is a smaller component of overall inflation. The rise also does little damage to economic growth as the US is the world’s largest oil producer. In 2020 the US produced 18.6 million barrels of oil or 20 percent of global oil production. Russia produced 10.5 million barrels or 11 percent of global oil production.
China is the world’s largest producer of manufactured products and faces a demand shock as global demand fall. The country also faces aa as cost inflation as it is the world’s largest consumer and importer of commodities.
What should an investor do in this situation?
Historically, most geopolitical shocks end up being buying opportunities. However, as the situation is in a state of flux and rapidly changing and given some of the major risks, we think it is still too early to buy risk. Major risks include an escalation of the conflict that would entail either the West imposing energy sanctions or a frustrated Russia shutting off gas from Europe. Both outcomes would result in a commodities price spike and a major fall in risk assets.
We expect commodity prices to remain elevated and think that there is a significant risk of commodity price spiking if the conflict escalates.
Do you think the economic and financial sanctions on Russia will be enough to end the war?
We do not think they will end the war, but they may hasten an end to the war as the sanctions may moderate Russia’s war goals. There has been some moderation to Russia’s demands. Putin holds the keys to ending the conflict. The economic and financial sanctions apply pressure on both Russian citizens and the oligarchs, which in turn apply pressure on Putin. It appears that Putin’s power relative to these key groups is very strong. In fact, it appears that few Russian or Soviet premiers were as powerful as Putin.
Putin has threatened Finland and Sweden if both they participate in the conflict. To what extent are they really threatened, and do these threats affect Nordic assets?
All four Nordic countries (Sweden, Finland, Norway, Denmark) are model societies by any western liberal transparent measure. The Nordics are known for high quality of life, innovativeness, democracy, and stability. They constantly top all competitiveness and business condition rankings in the world.
All Nordic countries have a unique combination of open dynamic economies and a strong social welfare system. Add strong political institutions and high predictability within the economy and top up with a century of experience in equality issues and decades of experience in sustainability issues, and you get countries that are not just committed to be strong defenders of western democratic values, but also define the meaning of a successful western democracy for the future.
Ukraine was not a member of NATO or the European Union. The United States has explicitly stated prior to the conflict that it would not be willing to fight a war with Ukraine. The resistance against Russia would be much fiercer if Russia attacked a European Union member such as Sweden or Finland.
Sweden and Finland are both in NATO's Partnership for Peace since 1994. A central aim of the partnership cooperation is developing military capabilities and ability to act jointly to meet the needs of national defense and international crisis management. Sweden and Finland have modern armed forces and Norway and Denmark are founding members of NATO. Sweden and Finland may apply for NATO membership after Ukraine conflict subsides. In this instance we expect Russia to both threaten the Nordic countries and impose economic sanctions, but do not expect military confrontation.
What awaits Russia in the political context and international markets after the war is over?
In a political context, if Russia wins and annexes or establishes a puppet regime in Ukraine, it will continue to be isolated from the global economy via sanctions. It will be closed out of political and cultural institutions and become a pariah state such as Iran or North Korea. Russia will increasingly align itself with China. The world’s largest commodity producer and industrial power are an ideal match and both opposed US hegemony. Europe will seek to end energy dependence, which will open the door to energy sanctions.
Does the Bank of Russia have enough tools to prevent a collapse of its economy?
It does not. The Bank of Russia doubled its policy rate to 20 percent in defense of the collapsing ruble. The economic sanctions both lower economic growth and raise inflation in Russia. The central bank can fight inflation and soften the blow to the ruble, but the cost is an even greater shock to economic growth through high interest rates. The key pillars of the Russian economy are its commodity exports that are fetching record prices. However, at the moment it appears that Russia is having difficulties selling its stocks as western companies are avoiding any interaction with Russia.