Russia-Ukraine crisis: Economic consequences on South Asia

While commodity producers and exporters will benefit from an economic shock sparked by the intensifying Russia-Ukraine conflict, South Asia’s growth in 2022 is likely to be hit as the region is a net importer of commodities

In late February 2022, the crisis between Russia and Ukraine escalated as the global economy1 was beginning to recover from the COVID-19 pandemic after recording the worst economic performance since the great recession. The recovery in the real economy has been outpaced by rising inflation. Accordingly, advanced economies have started to withdraw huge monetary stimulus provided during the pandemic and signalled monetary policy tightening by commencing to taper off quantitative easing and raising interest rates by major central banks. 

Disruptions in supply chains and rising petroleum prices before the invasion of Ukraine caused challenges in managing global inflation and growth. The invasion has increased commodity prices further as Russia and Ukraine combined have significant shares of world supplies of oil, gas and other commodities. For instance, Brent Crude oil prices breached the $ 100 a barrel barrier, the highest level since 2011.2 Heightened uncertainties have increased volatility in global financial markets due to concerns on timing and extent of monetary policy tightening by major central banks. The 2022 outlook for the global economy now seems bleak. 

While commodity producers and exporters will benefit from an economic shock sparked by the intensifying Russia-Ukraine conflict, South Asia’s growth in 2022 is likely to be hit as the region is a net importer of commodities. The extent of the economic hit would depend on the duration of the conflict, the severity of Western sanctions on Russia and Russia’s policy response. The economic impact on South Asian countries would also vary depending on their economic linkages with Russia and Ukraine. The transmission of the conflict shock will occur through commodity trade linkages to larger economies like India, Pakistan and Bangladesh. 

Tourism and trade linkages are involved in smaller countries like Sri Lanka and the Maldives; Russia and Ukraine are important tourism markets for these countries and additionally Russia imports about 20% of Sri Lankan tea.3 As financial flows are low with Russia and Ukraine, South Asia’s financial markets are likely to be insulated from the conflict. However, global financial flows to South Asia could be indirectly affected linked to volatility in global financial markets following the invasion. 

The best-case scenario of a partial invasion of Ukraine and negotiations for a ceasefire could minimise the impact of the conflict shock on South Asia as the effects on commodity prices and supply chains are likely to be temporary. However, this scenario appears unlikely as Russian forces are continuing to advance on major cities and military establishments of Ukraine. 

Presently, Russia seems intent on a full invasion of Ukraine aimed at establishing a Russian friendly administration in Ukraine. This second scenario could trigger stronger Western sanctions against Russia for a longer period causing a persistent rise in commodity prices. Sanctions on some Russian banks from using the Swift messaging system for international payments and settlements through corresponding global banks has caused difficulties for Russia to make payments for trade through foreign banks. Sanctions against all Russian banks from the Swift system will have long lasting negative impact on global trade and financial flows leading to spiralling commodity prices, thereby worsening the outlook for global and regional growth and inflation. 

Inflation in South Asia4 rose in the aftermath of the pandemic, increased income inequalities and pushed more people into poverty. A full invasion scenario is likely to further increase the region’s inflation which will retard growth and widen income inequalities. If Ukraine resists achieving Russia’s objectives for a longer period with Western military assistance and more sanctions on Russia, the negative effect will be more lasting on South Asia.

Higher sanctions on Russia can create opportunities for some countries to benefit as Russia is likely to look for more trade with other friendly/neutral countries like China and India to circumvent sanctions by the West. Similar trade diversion was observed when the US imposed sanctions against Iran.5 Using the Euro, Iran shifted to trading with some European and Middle Eastern countries. 

Furthermore, India and China conducted barter trade with Iran, exchanging crude oil for food to circumvent sanctions on payments through corresponding banks. However, such benefits may not be sufficient to offset the cost of higher commodity prices for South Asian countries given that the region is a net importer of petroleum products.  

The worst-case scenario is a full-scale war in Europe, the sending troops to Ukraine by the Western allies and prohibitive sanctions on Russia (e.g. cutting off Russian gas and oil supplies to the rest of the world). The situation may deteriorate further with the use of nuclear weapons as Russia is playing a ‘chess game’ with the West6 including upping its preparedness to use nuclear weapons. The West may also stop buying Russian oil and gas. 

The economic fallout for South Asia from the worst-case scenario will be more adverse than the combined economic impact of the pandemic. It could tip the global economy into its second recession in three years with possible differential effects across South Asia. Larger South Asian economies with bigger domestic markets and some fiscal space (e.g. India and Bangladesh) may be able sustain lower but positive growth for some months. Smaller and economically vulnerable economies (e.g. Bhutan, Nepal, Maldives, and Sri Lanka) could see significant growth contractions. Pakistan, suffering from multiple vulnerabilities, is also likely to contract. 

Economic management in South Asia during heightened global uncertainties from the Russia-Ukraine conflict will be difficult. To help to engineer a soft-landing, South Asian countries should rapidly implement monetary and fiscal policies to stabilise their economies, improve external debt management and aid reducing the hardships on the poor. Once some economic stabilisation is visible, they should embark on economic reforms to unleash the private sector and markets as well as transit towards low carbon green growth. 

Footnotes:

1 https://www.imf.org/en/Publications/WEO/Issues/2022/01/25/world-economic-outlook-update-january-2022

2 https://www.ft.com/content/cde1a3c5-9143-457c-9e9f-a09edfec8148

3 https://island.lk/russia-ukraine-conflict-economic-implications-for-sri-lanka/

4 https://www.imf.org/en/Publications/WEO/Issues/2022/01/25/world-economic-outlook-update-january-2022

5 https://voxeu.org/article/iran-sanctions-and-diverted-trade-exporter-level-evidence

6 https://rakeshsood.in/2022/02/26/putins-moves-are-hardly-chess-thumping/

(Dr. Nandalal Weerasinghe is a former Senior Deputy Governor of the Central Bank of Sri Lanka and Dr. Ganeshan Wignaraja is a Non-Resident Senior Fellow at the Institute of South Asian Studies of the National University of Singapore.)