THE UKRAINE TRAP

Sanctions are not hurting Russia, but the war is taking a toll on US and EU economies.
February 24 marks the one-year anniversary of the Russia-Ukraine war.
Although it was believed this was going to be a one-sided battle, the US and its allies stepped in with weapons for Ukraine and sanctions against Russia.
Around $300 billion of Russia’s gold and foreign exchange reserves are frozen by sanctions.
The embargo on Russian oil by the US and its allies is still in place.
Russian access to the SWIFT financial transaction processing system has been stopped.
Multinationals such as McDonald’s, KFC, Adidas, British American Tobacco etc have closed down their operations in Russia.
People thought Russia would crumble economically.
After all, the $2 trillion Russian economy is minuscule in comparison to the US and its allies with a combined market size in excess of $30 trillion.
But the Russians are showing no signs of economically caving in.

Russian economy holding strong

In fact, there are signs of the Russian economy performing better.
As per estimates by the IMF, Russia is expected to grow by 2. 1% in 2024, in comparison to 1% for the US, 1. 6% for the Euro area (27 countries), and 0. 9% for Japan.
The other big economies such as China and India, which have not imposed any sanctions and continue to buy oil from Russia, are expected to grow at 4. 5% and 6. 8%, respectively.
In fact, companies of Chinese and Indian origins such as ANT group, China Communications Construction Company, JSW Steel, State Bank of India etc, continue to do and expand business in Russia.
Besides China and India, Russia continues to trade aggressively with countries in Africa and Latin America.
The sanctions by the West seem to have little impact on Russia.
It was therefore no surprise to see the Russian ruble appreciate the most during the month of June last year, hitting 52. 3 to the dollar, strongest since May 2015.
The annual inflation rate in Russia fell to 11. 9% in December 2022 from 12% in the previous month.
Inflation is slowing for the eighth consecutive month and reached its lowest since February 2022 when the war started.

Woes for Europe

Meanwhile, in the Euro region the growth rate is plummeting, jobs are hard to come by, and inflation rates are going through the roof.
As of December 2022, inflation rate in the EU region was 10. 4%, with some countries such as Latvia, Lithuania, Hungary, Estonia and Poland witnessing inflation rates in excess of 15%.
Before the war started, almost 40% of the total energy demand in Europe (especially natural gas) was met by Russia.
But sanctions have affected the supply of Russian energy.
And a substitute for this is costlier US energy (both natural gas and gasoline), which means Europe has to shell out more.
This means an aggravating budget deficit for European governments.
A higher budget deficit can be sustained only if the economy is growing.
However, economic growth is continuously falling in the Eurozone.
Government debt as a percentage of GDP rose from 83. 8% in 2019 to 96. 4% in 2022.
Higher energy and food prices engendered by the war are likely to push the deficit higher by another 2%.
Moreover, slower GDP growth, an aging population, war and higher energy prices are making it difficult to increase tax realisation in the Eurozone.

US burning its fingers

In the US, inflation is showing no signs of retreat. It hit a historic high of 9. 1% in June 2022, the highest recorded during last 40 years.
It is presently around 6. 5%, this is much higher than the Fed target of 2%.
And this is in spite of repeated rate hikes.
The higher allocation of money to the defence sector and expenditure on the Ukraine war mean the US government is spending too fast without any commensurate increase in economic output.
For fiscal 2023, the defence budget has been increased to $857 billion, which constitutes more than a third of the total budget.
Meanwhile, rate hikes and inflation in the US and Europe have led to a fall in real wages.
This has led to an increase in labour agitations – train workers in France and the UK, energy sector workers in Norway, and aviation workers in various budget airlines in the US.
Tightening monetary policy and continuation of the war are going to see many more such labour agitations.
Russia can survive this war economically thanks to China and India.
What seems to be a zero-sum game for Europe is proving to be a positive-sum game for Russia, China and India.
What seems to be a war of ideology – democracy versus autocracy – is proving to be an expensive proposition for Western allies.