The war in Ukraine has heightened the tensions in the global economy: lower growth and higher inflation are now a given. Ideas that the possibility of a swift diplomatic or domestic solution to the conflict exists are nothing but wishful thinking. The early phase of Putin’s assault on Ukraine has not gone to plan and as a result it risks being much longer and bloodier. The commodities canary is already indicating how global the economic fallout from the war will be.  Great power rivalry is back (if it ever went away) centre stage.

  • A protracted conflagration has begun and there is no silver lining in sight. Putin miscalculated twice. (1) About the fierceness of Ukraine’s resistance: the Russian army could prevail with overwhelming force, but having ignited anti-Russian fervour and an insurgency, it won’t be able to hold Ukraine, let alone pacify it by installing a puppet regime. (2) About the West’s resolve: rather than dividing it, he’s done the opposite – creating a broad coalition against him, affording NATO a renewed sense of purpose. Now Putin is in a bind: unable to retreat, his rhetoric and response is increasingly threatening (the oblique references to Russia’s nuclear arsenal earlier in the week have now become open threats). As a Latvian psychiatrist turned diplomat put it to us: “he’s like a lion having pursued his prey to the top of the tree and then finds himself unable to climb down – anything is possible”. The risks posed by Putin failing are as high as those of him prevailing. Short-term, the range of possible miscalculations and wild cards are head-spinning.
  • Even before the Russian invasion of Ukraine, the global economy was at a critical juncture, with central banks having to suppress inflation without provoking a recession (a tall order in itself). Now, the task is made considerably more difficult by the war in Europe. For multiple reasons on which we expand below, global lower growth and higher inflation are a quasi-certainty, coupled with a significant risk of stagflation.
  • Many Western commentators are guilty of a lot of wishful thinking when they say that the pain inflicted on Russia’s economy will force Putin to negotiate, that he might be deposed, that the oligarchs will plot his demise, that a diplomatic solution remains possible, and so on. None of these will happen in the coming weeks. Three key considerations inform and shape Putin’s thinking: (1) The West cannot be trusted; (2) it is in terminal decline (a view shared by most autocrats); but (3) intent on toppling his regime. This ‘state of siege’ mentality combined with the fact that to date his assault on Ukraine is not going to plan means (counter-intuitively) that the current crisis will endure, with far-reaching consequences unfolding over many years.
  • Western sanctions now amount to full-scale financial war and are inflicting much pain on the Russian economy. Those imposed on Russia’s central bank and the decision to remove some Russian lenders from SWIFT have led to a collapse in the rouble (-28% against the $ on 28 Feb.). For the moment, Russian exports of energy to the West continue (generating a bit less than UDSD1bn a day), but as Europe imports 40% of its gas and 25% of its oil from Russia, energy supply may well become one of Putin’s next battlegrounds.
  • To fathom what might be coming next, it’s essential to realise that Russia is not governed by consultative processes between ministries and agencies, but by a closely-knit quintet of similarly aged individuals who share the same background (namely Putin, Bortnikov, Naryshkin, Patrushev and Shoigu). These five operate in a cognitive silo, impervious to any consideration that is not defence or security related. Seen in this light, the risk of a protracted mess or escalation currently dominates all plausible scenarios.
  • Russia only represents 3% of the world economy, but the economic knock-on effect of the war is global, with commodities as a conduit. Take agriculture. Russia and Ukraine are among the world’s major players, together accounting for 76% of global sunflower oil exports, 29% of wheat, 20% of corn, 33% of barley. Furthermore, Russia is among the largest exporters of the three major groups of fertilizers (nitrogen, phosphorus, and potassium). A telling example: last week, wheat prices went up 16%+, with the contingent pain hitting hardest the import-dependent countries in the Middle East and North Africa, already victims of their worst droughts in over two decades. As food and energy prices are inextricably intertwined, expect similar examples to multiply all over the world.
  • For Western investors and businesses, the war amounts to a regime-change. Most of those present in Russia must prepare to draw a line under their activities (and vice versa). More broadly, the war is a reminder (and could be an incentive to them) that other countries are also keen to challenge the Western-led international order established after WWII. Hence, moving forward, energy and food security will become key considerations. Commodity hoarding and rising economic nationalism will further contribute to a de-globalizing world centred around nations and regions.
  • With the war, the world has entered a new universe. Gone are the illusions (held particularly in the West) that great power rivalry was no longer the normal course of history. The conflagration in Ukraine will be the pivotal event that triggers radical changes in global geopolitics(China/US), economics (resilience vs efficiency), finance (yuan vs dollar), trade (more security-focused) and even values (clarity vs delusions). Regarding the defence pivot, Germany’s decision to create a special fund of €100m to re-equip its military and to boost its defence budget to a level of 2% of GDP is already proof of that.
  • In conjunction with Carl Icahn’s campaign against McDonald (to stop it imprisoning pregnant pigs in tiny crates) and Norway’s sovereign wealth fund public disclosure that it would vote against Apple’s pay policies, public exhortations that Western companies leave Russia are a harbinger of things to come for companies that take ESG lightly or misunderstand what stakeholder capitalism really entails. Activism will eventually submerge them. Whether it’s investor activism, social or political activism, all three are fast gaining ground and often working in unison and with the support of the media. In 2022 and beyond, expect lawsuits, proxy fights and shareholder resolutions with an ESG ‘angle’ to grow at a very fast, if not exponential, rate. The S in ESG is fiendishly difficult to measure, but this is no deterrent to it attracting more and more attention.
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