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The Ukraine crisis...and its economic impacts on Australia

Russia’s invasion of Ukraine is – most importantly – a humanitarian crisis.

However, as the invasion enters its fourth week, the global economy is increasingly feeling the effects of trade embargos, corporate boycotts and financial sanctions imposed on Russia by the West.

Principally, the conflict and ensuing sanctions have driven some global commodity prices to dizzying heights, led by oil, gas, minerals and cereals.

As Russia invaded Ukraine, global oil prices spiked, made worse by OPEC’s decision not to increase production. In turn, petrol and diesel prices have moved up sharply, driving inflation concerns across the world.

Conversely, gas markets are usually more localised, with the majority of the world’s gas travelling by pipeline. With limited capacity to receive LNG via shipping terminals, Europe is heavily reliant on Russia (responsible for 45% of Europe’s natural gas imports in 2021) which means that energy shortages in parts of Europe are a potential consequence, not just higher prices.

Even more significant, broader impacts of the conflict could come from rising food prices which may primarily hurt poorer countries like Egypt, the world’s top wheat importer, which depends on grains from nearby Russia and Ukraine. Prior to the conflict, Russia and Ukraine were expected to supply a quarter of global grain exports in 2021-22.

For the global economy this can be seen as a ‘stagflationary’ shock – higher prices and a disruptive hit to economic activity at the same time. Deloitte UK Chief Economist Ian Stewart has noted:

Higher inflation and a squeeze on spending power complicate the decision facing Western central banks that were poised to tighten monetary policy.

Still, stemming this burst of inflation will remain an important central bank priority – the pace and timing of interest rate rises will likely be the key question, rather than whether they will occur or not. Just today, the US Federal Reserve announced a quarter-point rate hike to combat a 40-year high in US inflation, the first rate increase since 2018.

Australia is geographically distant from the conflict zone, and direct economic impacts from trade are likely to be modest in the short term but we should beware the consequences of geopolitical tensions reshaping the world economic order. Neither exports nor imports to Russia and Ukraine (combined) exceeded 0.2% of Australia’s total exports or imports in each of the last three years.

But the global surge in energy prices is being seen here as well. In particular, the petrol price surge to over $2 a litre for unleaded fuel has excited attention, with significant discussion around the potential for fuel excise relief from the federal government.

As well as consumers directly feeling the pain of higher petrol prices, there will also be an indirect impact across many other goods and services from higher transport costs. Deloitte Access Economics now expects Australia’s CPI to escalate from its current rate of 3.5% to a peak of 4.8% that would be the highest rate of inflation seen since 2008.

Higher inflation will also affect the Reserve Bank’s deliberations this year. RBA Governor Philip Lowe noted that:

The war in Ukraine and the sanctions against Russia have created a new supply shock that is pushing prices up, especially for commodities. This new supply shock will extend the period of inflation being above central banks' targets… If so, the higher inflation would be more persistent and broad-based, and require a larger monetary policy response.

Complicating the decision for the Reserve Bank is a fortunate offset for Australia – we are a significant producer and exporter of energy (in coal and gas), as well as wheat. In 2019, Australia was the sixth largest wheat exporter in the world – behind Russia (the world’s largest exporter) and Ukraine (the fifth largest).

So, while higher energy prices are akin to a tax on consumers, there may be some significant benefits to Australian producers of many commodities via higher prices in the short term.

The chart below shows Deloitte Access Economics’ projections for Australia’s trade balance. This balance of Australia’s exports minus our imports has already leaped over the past two years, and is expected to jump up further from 4.3% of GDP in 2020-21 to more than 6% in 2021-22.

Chart 1: Balance of trade (% of GDP)

Source: Deloitte Access Economics Business Outlook, March 2022 (forthcoming)

That stunning lift in the trade balance spawns some indirect benefits via additional economic activity, a higher $A than we might otherwise have seen, and tax receipts to government. However, it will also be partly offset by a higher flow of income offshore (profits and dividend payments to foreign owners producing these commodities).

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