How is Russia's invasion of Ukraine affecting the global economy?

David Woods

As the global economy continues to rebound from the COVID pandemic, Russia's invasion of Ukraine will slow global growth, but not halt it. The Australian Treasury estimates that global growth in 2022 will be 3.75 per cent, with Russia's illegal invasion of Ukraine causing a 0.75 per cent drag, in addition to untold human suffering.

The effects will be felt chiefly through higher prices for commodities like oil, gas, coal, wheat, fertiliser and metals. These prices – already high - soared in early March due to supply interruptions, uncertainty in international markets, sanctions and 'self-sanctioning' by firms no longer willing to deal with Russia. Other factors affecting commodity prices include global demand, especially in China, where COVID-related lockdowns have reduced demand for commodities such as oil – for now.

High prices will also increase already-high global inflation this year (an extra 1.5 percentage points, according to Treasury), and many countries will see interest rates rise to combat this. Inflation has hit a 40-year high in the US; the US Federal Reserve responded by raising interest rates in March and will probably hike several more times over the coming year.

Australia, as a commodity exporter with limited direct exposure to the economies most affected by the conflict, is in a relatively good position to adapt. High prices for LNG, wheat, coal and barley will improve our terms of trade and national income if the rise in export prices outweighs increased input costs (like fuel, fertiliser and machinery). Australia should also become still more attractive for investors, particularly in the mining and agriculture sectors.

Finally, the Russian economy will contract sharply (the International Monetary Fund says 8.5 per cent in 2022), although the extent could vary depending upon the duration of the conflict, possible additional sanctions, and Russian policy responses. The Russian Central Bank initially hiked interest rates from 9 to 20 per cent in an effort to stabilise the currency and financial system; it has since reduced rates back to 17 per cent. Higher interest rates increase the cost of borrowing and debt repayments, reducing spending and investment. The cost of imports has also risen sharply for Russian people and businesses. In the longer term, the withdrawal of Western capital, skills and technology will erode Russian productivity and competitiveness and create an increasing drag on Russia's longer-term growth.