How the situation in Ukraine affected the economy of Russia - Essay Example

HOW THE SITUATION IN UKRAINE HAS AFFECTED THE ECONOMY OF RUSSIA By and How the Situation in Ukraine Has Affected the Economy of Russia Introduction The conflict in Ukraine has caused serious economic consequences in not only Ukraine and Russia but it has impacted the frail recovery of the European economy. Therefore, even though the main victim of the war has been Ukraine where an estimated six billion euros or 6% of GDP has been affected from Donbass alone due to disruptions in industrial production, power cuts and the railway transport system, the effects of the conflict have caused dire consequences on the Russian economy, further making the economy that was stuck in stagnation and transition before the conflict worse (Havlik & Astrov, 2014). Thus due to heightened political risks investments has been hampered due to the falling ruble as investors move out to seek new investment destinations. On the other hand, the frozen conflict is also hampering economic recovery in Europe as was evidenced by the slump of the Eurozone, especially in Germany due to loss of investor confidence as a result of the threat of war in central Europe (Kaletsky, 2014). The essay explores the economic consequences of the Ukraine and Russia conflict to the economy of Russia. The Russia-Ukraine crisis has caused grievous economic consequences on the Russian economy, especially due to economic sanctions imposed on Russia by the Western countries. Economic Impacts on Russian Economy The Russia-Ukraine crisis has caused serious economic consequences to the Russian economy. Some of the effects of the crisis include the following; imposition of financial sanctions by the Western nations such as the U.S., lower GDP growth rates, deteriorating exchange rates, raising interest rates and inflation that led to commodity price increases such as buckwheat by over 70%, falling oil prices and exports in general among many other economic impacts that are hailing the country as it undergoes the economic transition that began before the conflict (Boghani, 2015). Exchange Rates Since the beginning of the Ukraine and Russia conflict the Ruble has been on a downward trend making it the worst performing currency globally after the annexation of Crimea. This has been caused by caused by decrease in foreign reserves accounts as evidenced by the increasing demand for foreign currency by e.g. the Khanty-Mansiysk Otkritie Bank that is the second largest bank in Russia (Spence, 2014). According to Ross (2015), the yield for Ruble bonds of 5 years rose to 16.26% because of the declining exchange rate for the Ruble against the dollar. Moreover, analysts argue that the woes of the hailing exchange rates of the Ruble have been worsened by the falling prices of oil, which is a major factor for the financial markets of Russia and major export earner for foreign currency since Russia was thrown into economic recession due to the Ukraine conflict the (Ross, 2015). For instance, the Ruble declined by almost 11% against the dollar in December 2014, making it a historical drop of the ruble in a single day since the 1998 Russian financial crisis, which led to the collapse of the ruble and caused wages to decline to their lowest level after the collapse of the Soviet Union (Ross, 2015). Spence (2014) argues also that the ruble started losing its value against the major world currencies after the signs of the Ukrainian conflict emerged, the imposition of sanctions against Russia by the western nations and the plunging of oil prices after the conflict started as shown in fig. 1 below that shows the ruble has been weakening after the Ukraine Crisis began. Fig. 1 Source Spence (2015) Interest Rates Kuznetsov (2015) states that the Bank of Russia increased it lending rate from 10.5 to 17% in attempt to stabilise its currency that reached a low mark of 47.17 in December 2014. This move helped change the exchange rate to 56.46 against the U.S. dollar after a falling by about 1.1%. Kuznetsov (2015) goes to state that the “current level of policy rates is overly high for the economy, which creates excesses of liquidity in the banking system” and this has led to a low demand for loans as borrowers and investors have resorted into saving due to high interest rates after the conflict of Russia and Ukraine began. The fig. 2 below demonstrates how interest rates have been increasing in the Russian economy after the country’s currency exchange rate started declining and inflation increased forcing the Bank of Russia to increase interest rates a move that drew similar reaction from lenders in the banking system resulting in high interest rates in the domestic market. This explains the high savings witnessed in the country as investors opted to saving lieu of investing. Fig. 2 Source Spence (2015) Inflation Risks and GDP Since the start of the Ukraine-Russia conflict in March, inflation rates in Russia have been accelerating in because of a weak currency that has made imports expensive hence raising the rates of inflation in the economy. Moreover, the imposition of sanction by the Western nation on Russia is denying many Russian companies access to Western financial sources necessitating them to downgrade and reduce their investments as they service their debts. Therefore, it is anticipated that Russia will register zero growth rates compared to previous years such in 2013 when the economy grew by 1.3%. For this reason, as the central bank moves to tame the weakening rubble resulting in high interest rates and low exchange rates, inflation rates are expected to increase to over 8.0% by the end of 2015 from last year’s % end year average rate of CPI 7.80 (6.7%) (The Moscow Times, 2015). Moreover, the inflation rates are expected to continue increasing because the prices have imports have been increasing due to the weakening ruble exchange rate resulting from the imposition of sanctions on Russia, which led to the decline of international reserves by $124.135 billion an equivalent of 24.4% in 2014 to $385.46 billion by the start of 2015 (Geodakyan, 2015). Chart - CPI inflation Russia 2014 (Jan-Nov) The average inflation of Russia in 2014: 7.80 % Fig. 3 Source “Inflation Russia 2014” (2015) Fig. 4 Source Statista (2015) From the graph above the inflation rates in Russia continued to increase after the start of the conflict hitting a high rate of 16.9% by March 2015. According to Smityuk (2015) the Russia’s GDP is likely to drop by 5% this year because of plummeting oil prices and sanction imposed on the country by the Western nations. This assertions are echoed also by Havlik & Astrov (2014) who states that “A crude estimate of economic effects – lower GDP growth by about 1 percentage point compared to the pre-conflict scenario – yields a loss of Russian GDP close to EUR 20 billion in 2014, and more than EUR 30 billion in 2015 and EUR 50 billion in 2016.” These assertions by Havlik & Astrov (2014) and Smityuk (2015) are also illustrated by Trading Economics (n.d.) that demonstrates that Russian GDP declined from $ 2079.02 in 2013 to 1860.6 in 2014 because of the financial sanctions imposed on Russia after the Ukraine conflict as shown in fig. 5 below. Fig. 5 Source Trading Economics (n.d.) Economic Sanctions Russia was slapped with economic sanctions due to its entry into the Ukraine conflict by several Western nations such the U.S. and EU in regard to trade. These sanctions are financial in nature and have limited Russia’s ability to source funds from abroad; a source that has been significant to the Russian economy funding its small domestic aggregates of money. For instance, foreign debt for Russian banks and companies was about $646.9 billion when the sanctions were imposed on the country of which $134.2 billion was due by the end of 2015 (Inozemtsev, 2014). This implies that sanctions are likely to squeeze money out of the domestic interbank market as was evidenced by the high interest rates for banks refinancing that soared from 5.5% to 8.0% during the months February-July 2014 (Inozemtsev, 2014). This change in interest rates led to an increase in inflation during the year that hit 6.5% by the end of the year and are expected to increase to over 7.5% by the end of 2015 as forecasted by analysts (The Moscow Times, 2015). Moreover, the sanction have been the reason for the decline of Russia’s international reserves by $124.135 billion an equivalent of 24.4% in 2014 to $385.46 billion by the start of 2015 (Geodakyan, 2015). This decline has resulted in the collapse of the ruble’s exchange rate against the dollar due to increased demand for foreign currency. Conclusion It is evident from the analysis above the Ukraine-Russia conflict had many economic implication on the Russian economy that has left the economy hailing to date. Some of the implication, for instance, arising from economic sanctions include the collapse of the ruble, decline in GDP, increase in interest rates and inflation. References Boghani, P. (2015) ‘What’s Been the Effect of Western Sanctions on Russia?’, Available at: http://www.pbs.org/wgbh/pages/frontline/foreign-affairs-defense/putins-way/whats-been-the-effect-of-western-sanctions-on-russia/[Accessed 11 Oct. 2015]. Geodakyan, A. (2015) ‘Russia’s International Reserves fell by $5.4 Bln over One Week’, Available at: http://tass.ru/en/economy/834145 [Accessed 11 Oct. 2015]. Havlik, P., & Astrov, V. (2014) ‘Economic consequences of the Ukraine conflict’, Available at: http://wiiw.ac.at/economic-consequences-of-the-ukraine-conflict-n-60.html [Accessed 11 Oct. 2015]. Inflation Russia 2014. (2015). Available at: http://www.inflation.eu/inflation-rates/russia/historic-inflation/cpi-inflation-russia-2014.aspx [Accessed 11 Oct. 2015]. Inozemtsev, V. (2014) ‘Russia’s Economy After the War with Ukraine: Where Is It Heading?’, Available at: http://www.aspeninstitute.cz/en/article/3-2014-russia-s-economy-after-the-war-with-ukraine-where-is-it-heading/ [Accessed 11 Oct. 2015]. Kaletsky, A. (2014) ‘Ukraine’s Frozen War Brings Dramatic Changes to World Economy’, Available at: http://blogs.reuters.com/anatole-kaletsky/2014/12/12/ukraines-frozen-war-brings-dramatic-changes-to-world-economy/ [Accessed 11 Oct. 2015]. Ross P. (2015) ‘Russia Ruble Crisis: Currency Continues to fall, Ukraine Conflict and Falling Oil Prices To Blame’, Available at: www.ibtimes.com/russia-ruble-crisis-currency-continues-fall-ukraine-conflict-falling-oil-prices-blame-1780538 [Accessed 11 Oct. 2015]. Smityuk, Y. (2015) ‘Economic Recession in Russia May Reach 5% in 2015 — Deputy PM’, Available at: http://tass.ru/en/economy/835546[Accessed 11 Oct. 2015]. Statista. (2015) ‘Russia: Inflation Rate from July 2014 to July 2015’, Available at:http://www.statista.com/statistics/276323/monthly-inflation-rate-in-russia/ [Accessed 11 Oct. 2015]. The Moscow Times, (2015) ‘Russia to See Zero Growth and Soaring Inflation as Sanctions Strangle Economy’, Available at: http://www.themoscowtimes.com/business/article/economists-predict-zero-growth-and-four-year-high-inflation-for-russia/508120.html[Accessed 11 Oct. 2015]. Trading Economics (n.d.) ‘Russia GDP’, Available at: http://www.tradingeconomics.com/russia/gdp[Accessed 11 Oct. 2015]. Read More