The war in Ukraine could not have come at a worse time for the global economy – when the recovery from the pandemic-induced contraction had begun to falter, inflation was skyrocketing, central banks in the world’s largest economies world were preparing to raise interest rates, and financial markets were hovering above a formidable constellation of uncertainties.
The war has compounded these uncertainties in ways that will reverberate around the world, harming the most vulnerable people in the most fragile places. It is too early to tell how much the conflict will alter the global economic outlook. Like the novel coronavirus, the latest crisis has come in a form largely unexpected – in its scale and ferocity, in its location, and in the global response to it. Everything will depend on what happens next. But it is already clear that rising food and energy prices, along with supply shortages, will be the immediate source of suffering for low- and middle-income economies.
Many developing economies around the world remain weakened by the pandemic. The healthy recovery that advanced economies have experienced over the past year has largely ignored them: By 2023, levels of economic output in developing economies will still be 4% below their projected pre-pandemic levels. The total debt of these economies is now at its highest level in 50 years. Inflation is at its highest level in 11 years and 40% of central banks have started raising interest rates in response.
As devastating as it has been, the coronavirus pandemic has been an object lesson in the power of policymakers to respond effectively to disaster.
The Ukraine crisis could make it harder for many low- and middle-income economies to get back on their feet. In addition to rising commodity prices, spillovers are likely to occur through several other vectors: trade shocks, financial turmoil, remittances and refugee flight. The countries closest to the conflict, due to their close trade, financial and migration ties with Russia and Ukraine, are likely to suffer the greatest immediate harm. But the effects could spread far beyond that.
Food and fuel costs
Some developing economies are heavily dependent on Russia and Ukraine for food (Chart 1). These two countries supply more than 75% of the wheat imported by a handful of economies in Europe and Central Asia, the Middle East and Africa. These economies are particularly vulnerable to an interruption in the production or transport of grains and seeds from Russia and Ukraine. . For low-income countries, the disruption of supplies as well as rising prices could lead to increased hunger and food insecurity.
Russia is also a major force in the energy and metals market: it accounts for a quarter of the natural gas market, 18% of the coal market, 14% of the platinum market and 11% of crude oil. A sharp fall in the supply of these raw materials would paralyze construction, petrochemicals and transport. It would also reduce the growth of the whole economy: estimates from a forthcoming World Bank publication suggest that a 10% increase in oil prices that persists for several years can reduce the growth of economies in development importing raw materials by one-tenth of a percentage point. Oil prices have risen more than 100% in the past 6 months. If it lasts, oil could shave a percentage point off the growth of oil importers like China, Indonesia, South Africa and Turkey. Before the war started, South Africa was expected to grow by around 2% per year in 2022 and 2023, Turkey by 2 to 3% and China and Indonesia by 5%, therefore a slowdown of 1 growth point means that the growth be cut between one-fifth and one-half.
Financial turbulence
The conflict has already caused tremors in financial markets, prompting a sell-off in stocks and bonds in major global markets. An increase in investor risk aversion could lead to capital outflows from developing economies, leading to currency depreciations, falling stock prices and higher risk premia in bond markets. This would create acute stress for the dozens of highly indebted developing economies. Economies with high current account deficits or large shares of short-term debt denominated in foreign currencies would find it difficult to refinance debt. Alternatively, they would face higher debt service obligations.
Financial strains could be aggravated by central banks’ response to higher inflation. In many developing economies, inflation is already at its highest level in a decade. Further impetus from soaring energy prices could lead to an inflationary spiral as expectations of higher long-term inflation take hold. This, in turn, could prompt central banks to tighten monetary policy faster than expected so far.
Flight of refugees and remittances
Since the start of the conflict, more than 2 million people have fled Ukraine to neighboring countries, marking the largest mass migration to Europe since World War II. The United Nations High Commissioner for Refugees expects the number of refugees to climb to 4 million soon. Adjusting to the sudden arrival of large numbers of newcomers is difficult for host governments. It puts pressure on public finances and on the delivery of services, especially health care, which remain scarce as the pandemic enters its third year.
Moreover, the economic pain could radiate beyond Eastern Europe to countries that rely heavily on remittances to affected countries. Several Central Asian countries, for example, are heavily dependent on remittances from Russia – in some cases, these remittances represent up to 10% of the country’s GDP. Many Central Asian countries will likely see a drop in remittances due to the conflict.
Prevention pays
It’s time to act. The World Bank Group, together with the International Monetary Fund, is moving quickly to provide assistance to Ukraine and other affected countries. A $3 billion support package in the coming months will include $350 million for Ukraine by the end of this month. Governments in developing economies should also act quickly to contain economic risks. Building foreign exchange reserves, improving financial risk monitoring and strengthening macroprudential policies are essential first steps. Policymakers will need to be vigilant – and make careful course corrections – in their response to rising inflation. They should also begin to rebuild fiscal policy buffers depleted by COVID-19, eliminating inefficient spending and mobilizing domestic financial resources where possible. And they should strengthen the social safety nets needed to protect their most vulnerable citizens in times of crisis.
As devastating as it has been, the coronavirus pandemic has been an object lesson in the power of policymakers to respond effectively to disaster. However, prevention is better than cure. Governments in developing economies would do well to act now.
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