Clients of the Russian bank VTB gather at its head office to meet with the bank’s representatives and seeking reimbursement of their investments, lost due to the recent western sanctions imposed on Russia, in Moscow, Russia on Friday.

The world was emerging out of the Covid pandemic-induced economic shock. Now the shock of the Ukraine war is pushing the US and global economy into a stark recession.

The United States has weaponised economic sanctions in a very major way in the post-cold war period. Heavy handed economic sanctions have been applied against several countries to include Iraq, Iran, Syria, Libya, North Korea and now Russia. Economic sanctions were imposed on Russia in 2014 itself post its takeover of Crimea. In the build-up to the current war in Ukraine, the primary dissuasion and deterrence strategy of the US and the West was the threat of imposition of very serious economic sanctions. Hence their primary means to dissuade or deter Russia was via stringent economic sanctions and supply of defensive weapons to Ukraine. Sanctions usually take the form of:

* Trade sanctions.
* Energy sanctions.
* Financial sanctions.
* Sanctions on individual companies.
* Travel sanctions.

The sanctions enforced in 2014 had caused a 5% drop in Russian GDP. What were the specific economic sanctions threats that were held out to deter a Russian invasion of Ukraine? These were:

Close Nord Stream 2 gas pipeline. This new gas pipeline has been constructed from Russia to North Europe (primarily to supply Germany). It was designed to bypass Ukrainian territory (where existing gas and oil pipelines were routinely being pilfered). America has been very clear to block this pipeline so that it could sell its own gas to Europe. The economics were stark. Nord Stream 2 gas would cost the Germans $270 per 1,000 cubic feet. Gas from the US would cost them almost five times at $1,000 per cubic feet. Stopping Nord Stream 2 would hurt Europe badly, especially Germany and France. Germany had invested heavily in the construction of this pipeline and stood to benefit the most, as in spatial terms Russian gas is closest to Germany and Western Europe. Though this pipeline was complete, it had yet to be certified. The threat was that certification would be withheld.

Impose full blocking sanctions on large Russian banks, energy companies, defence companies and oil projects.

Freeze Russian foreign exchange reserves in American and European banks (some $300 billion worth of Russia’s total forex reserves of $630 billion was parked in US and European banks). In a blatant breach of global trust, US and West would simply seize these Russian forex reserves.

Sanction key Russian leaders. Key Russian leaders, oligarchs and their families would be targeted individually for sanctions. This was supposed to hurt key decision makers in a pointed manner and ostensibly spare the ordinary Russian citizens.

Exclude Russia from SWIFT. SWIFT stands for Society for Worldwide Interbank Telecommunications. Headquartered in Brussels, it has 11,000 banks as members globally. Swift is the global electronic payment system based in Belgium. This step was deemed the equivalent of an economic nuclear strike and was deemed a last resort option. But China has developed its own equivalent for SWIFT. It may not want to opt out of SWIFT. But if forced out or thrown out, it would not mind as it has its own viable options to supplant SWIFT. So has India developed the Rupay as an option.

China As Ally For Economic War

In anticipation of these sanctions, Russia had built up huge foreign exchange reserves ($630 billion) based upon the export of natural gas and oil at elevated prices and its very favourable balance of trade position. Russia had been under sanctions since 2014 and had worked out its slew of countermeasures. Putin had visited Beijing for the Winter Olympics in February 2022. The two leaders had detailed discussions and worked out a formula of “friendship without limits”. Russia would rely heavily on China for bailing it out from the application of harsher financial sanctions. This could entail Chinese purchase of Russian oil and gas and a concerted attempt to replace the dollar as the international currency of oil trade. China had a platform similar to SWIFT and accepted in 180 countries. India has Upland and Rupay. The threat of Western sanctions however, completely failed to deter Russia from its projected invasion of Ukraine.

The West was taken by surprise. The German intelligence chief had to hastily flee Kiev and the French chief of intelligence lost his job. Surprisingly, the very first sanctions came from Germany when it refused to certify the Nord Stream 2 Pipeline. The UK put some Russian individuals and entities under sanctions. Most people felt that it was too little too late and the economic sanctions had failed in the primary task of deterring Russia from invading Ukraine.

Initially the economic sanctions did seem to be making a huge impact. The Russian stock market tumbled dangerously and Russia had to stop the trading on the stock markets and there was flight of capital from the country. The rouble plummeted dangerously against the dollar. It fell from 80 roubles to a dollar to over 160 roubles to a dollar. A number of Western multinational firms moved out, causing large scale dislocation and loss of jobs. The US claimed that a large number of highly qualified Russians also began to flee the country.

The West had weaponised its banks and financial systems to hit hard at Russia. It was a virtual act of war. It also seized over $300bn of Russian Forex reserves in American and European banks. Inflation rose sharply in Russia.

Russian Response To Economic Sanctions

Russia today is the most sanctioned country in the world. It is very certain that before the launch of the Ukraine offensive, Russia must have war-gamed the economic war scenarios and come up with some response options.

Defensive Measures. Normal defensive measures against economic sanctions include:
Building up a large war chest of forex reserves: Russia had built up a huge forex reserve of $630bn.
Capital controls: Prevent flight of capital from the country.
Increase interest rates: Russia increased these up to 20%.

Forced capital conversion: Force gas payments in roubles. This was a master stroke that stopped the steep fall of the rouble and in fact it came back to 80 roubles to a dollar. Russia well understood that Europe was badly dependent as Russian natural gas and oil not just for heating homes but also for running its metallurgical industries and for power generation.

Russia was supplying almost 13% of the global crude oil exports. Taking it out of the global markets suddenly was bound to have huge implications in terms of oil availability and rise of prices. This could easily have been foreseen but strangely was not. For a time oil prices shot up to $130 a barrel before sliding back to $100 a barrel. In fact, the steep rise in oil and gas prices themselves helped to pay Russian costs of the war. It was Europe that kept buying Russian oil and gas on the sly and contributed the most to Russia’s war chest during this conflict.

DOUBLE WHAMMY. The world was emerging out of the Covid pandemic-induced economic shock. Now the shock of the Ukraine war is pushing the US and global economy into a stark recession. Inflation in US is at a 40-year high. $7 trillion have been lost on the US stock markets which are bleeding badly. The technical companies in the US have taken a big hit and lost $3 trillion. As a result of the ill thought through economic sanctions, the US economy has taken a major hit, but inflation is up to 10% and GDP is down 1.4% in the first two quarters of 2022.

Impact of Biden's Switch To Renewable Energy

It is noteworthy that Biden had stopped oil and gas extraction/production in the US to switch to renewable energy in a bid to check global warming. Thus oil and gas supplies were already going down and prices were rising in US even before the war in Ukraine started. Europe today stands to lose the most in this economic war. Structurally, it is very heavily dependent on Russian oil and gas. As stated, 50% of Russian crude, 65% of petrol products and 90% of its piped gas go to Europe to keep it warm in winter and run its power plants and factories. To delink from Russian oil and gas, Europe will need to create infrastructure that could take a number of years to come up.

The global economy was too deeply integrated and the disruption caused by sanctions on Russia has equally disrupted the western economies also. It is virtually a butterfly effect. A sudden attempt to put some 3 billion barrels per day (bpd) of Russian oil out of circulation has sent oil prices skyrocketing.

Food Grains

Russia and Ukraine are both major producers of food grains (wheat, barley and maize) as also of fertilisers. Ukraine also used to export major quantities of sunflower oil.

Ukraine is the fifth largest exporter of wheat. However, today, all its sea coasts are blockaded. It has lost the key ports of Sevastopol, Mariupol and Kherson, and the port of Odessa, from where the bulk of food grains are exported, is under Russian naval blockade.

Ukraine also used to export phosphate and nitrogen-based fertilisers. This fertiliser supply has also been disrupted. Fertiliser prices are now above $60 per 1,000 cubic feet. Reduced supply of food and fertilisers could affect some 6 billion people globally. It could create severe malnutrition in the Middle East, Africa and South America. Some 2 billion humans could face malnutrition as a result of this war.

Summary of Economic Impacts

A major long-term economic impact of the Ukraine war will emerge from the complete erosion of trust in global financial institutions and global economic governance.

By grabbing some of Russia’s $300 bn which were parked in American and European banks, the US has severely eroded trust at the global level. This will lead to a sharp polarisation. China, India, Russia and other major economies will now think twice before putting forex reserves in American or European banks. This could spell the end of globalisation as we know it.

IMPACT ON RUSSIA: The cost of the Ukraine war has been almost $1 billion per day. Paradoxically, this has been offset by European purchase of Russian oil and gas at virtually $1 billion a day. Russia has put in place strict currency control, heightened interest rates and stopped flight of capital. Due to elevated energy prices, and continual exports of oil and gas, Russia today has a current account surplus of $95.8 billion in the past four months of 2022. The sanctions have dismally failed to deter the Russian invasion or even slow down its war. The sanctions on Russia will bite only in the long term. In the long term, Russia may face a GDP drop of 15% if the sanctions continue unabated.

IMPACT ON UKRAINE: The toll in terms of human lives and civilian and military infrastructure has been horrific indeed. No amount of western propaganda can paper over this painful reality. Ukraine’s basic infrastructure has been destroyed. Some 40 of its cities and towns have been razed to the ground. The war has diverted human resources from labour to the military. 6-7 million Ukrainians have been displaced internally and some 5 million have gone out as refugees to the rest of Europe. The most severe consequence has been the loss of 80% of Ukraine’s coastline and its major ports. This has led to a severe choking of 90% of its wheat and food grains exports and 50% of its energy supplies. Ukraine has become a landlocked country and the total loss of its seaports will lead to a collapse of 40-50% of its GDP.

IMPACT ON EUROPE: The sanctions seem to have backfired rather badly on Europe. These severe consequences are inflation, which is at 8%, which had briefly touched 10%; rise in price of food; rise in price of energy; asylum cost, which is a direct cost to ensure the housing, feeding and welfare of some 5-6 million refugees from Ukraine; defence cost of supplying weapons, equipment and ammunition; reconstruction costs once the war is over.

GLOBAL IMPACT: Erosion of trust in global financial governance; possibility of de-dollarisation of global oil trade; elevated energy prices leading to high inflation and possible recession; possible food crisis and famines; Covid induced financial stimulus packages have severely curtailed the fiscal space to deal with any global recession.