The Cost Of Conflict – how will the war in Ukraine impact global markets?

The war in Ukraine poses an unimaginable human cost. It is also sending shock waves through the world economy. With hundreds dead and more than half a million fleeing the country, this tragedy will have significant, long-term human and economic consequences.

Market volatility has substantially increased since Russia’s invasion, alongside rising costs of raw materials and increasing manufacturing prices, further denting an already weak demand in certain sectors. This latest humanitarian crisis could knock more than a percentage point off global growth this year and add two and a half percentage points to inflation, according to the OECD, calling for targeted government spending hikes in response. Concerns abound over the two fundamental “Fs” of commodity markets: food and fuels.

Impact on global markets

Russia and Ukraine are some of the largest producers of wheat globally. Together, they account for 29% of all wheat exports. But with a war raging on, those exports are in danger.

Adam Slater, Lead Economist, Oxford Economics, recognises the impact of the war on global commodity prices. He tells Business Leader readers: “Prices for energy products such as oil and gas have risen sharply and there have also been significant rises in the prices of other commodities whose supply might be disrupted, including wheat and corn.”

Thomas Pugh, economist, RSM UK, agrees: “From a global point of view, the most obvious impact is in commodity markets. For example, the prices of oil and wheat are up by 66% and 78% y/y respectively, but almost all major commodity prices are significantly up. Global equity markets have been relatively resilient and have recovered some of their losses recently,” he tells Business Leader.

The war introduced new uncertainty to a stock market that already had a shaky start to the year. Slater reveals the knock-on effects: “Other financial market effects include a decline in global stock markets, especially in Europe, which is seen as most exposed to the negative impacts of the war due to its geographical proximity and reliance on Russian oil and gas. There has also been some widening of high yield credit spreads, reflecting reduced risk aversion and an increase in long-term government bond yields, especially in Europe. On currencies, the dollar has gained modestly while the Russian rouble has weakened sharply and some emerging market currencies have weakened modestly,” he says.

The war will give a powerful push towards global inflation and will dampen the already limp recovery from the pandemic. David Belle, Founder and Director, Macrodesiac, thinks the war catalysed an already strenuous situation: “We are seeing real problems stemming from our commodity staples and their prices. Grain, wheat, natural gas and oil have all seen rapid price increases over the last month or so, putting more strain on consumers. One of the leading causes for the Arab Spring were high food prices, specifically wheat, and we’re starting to see some mentioning of countries like Egypt being dissatisfied with the cost of the commodity.”

Belle is also foreseeing changes in the buoyant housing market: “We are very much an ‘aspire to own your own home’ culture, and many who have bought over the last year or two are likely going to find that they have bought the top of the market, since higher rates coupled with already stretched pockets from price inflation are almost a double whammy in the short to mid-term. But arguably, this is a good thing, since current average prices to salaries for London are at about 8-10x. A cooling off is definitely needed,” he adds.

The Tech Challenge

The Russian invasion has already had an impact on the energy and commodities market. However, there’s another major industry that will take a hit: tech. Tech accounts for over 4% of Ukraine’s GDP, and is growing fast. For firms with Russian investments and operations, the invasion of Ukraine is devastating but not totally unexpected.

MobiDev, a software engineering company incorporated in the US, has 400 engineers in Ukraine. Most of their clients are US, EU and UK-based businesses. After 2014, when Russia annexed Crimea and occupied the near-border Donetsk and Lugansk regions, MobiDev implemented a business contingency plan. They moved all the data and infrastructure to the cloud outside Ukraine, set up secure remote access for employees, launched a fully operational office in Chernivtsi and a front office in Poland.

Regarding the challenges associated with the current displacement, Oleksii Tsymbal, Chief Innovation Officer, MobiDev, says: “Alongside securing people’s safety, we had to bring confidence to our clients and fulfil our obligation to deliver software products. MobiDev implemented daily updates for our clients with transparent information.” Tech talent is the Ukraine was initially compromised, according to Tsymbal. “Today, all project teams are fully operational as people have reached secure locations. But during the first week, the company could bring no more than 65% of our functional capacity.”

Client trust is paramount and even though MobiDev will not be run out of the Ukraine, there have been some changes. “Although western Ukraine is a relatively safe place, we have to assure stability for our clients by moving some operations to Poland. But we’re not planning to leave Ukraine. We are keeping our office in Chernivtsi. And will reopen offices in Kharkiv and Mykolaiv as soon as it is safe. On behalf of businesses in Ukraine, I’d like to urge working with Ukrainians, as it is the best support for the people and the country,” Tsymbal says.

A spokesperson for N-iX, one of the largest Ukrainian technology companies with over 1,700 specialists, highlights the negative impact of the war on many industries across the globe.

“N-iX works with many enterprises and Fortune 500 companies delivering software development services. In recent years, we’ve seen an acute shortage of IT professionals, not only in the US and the UK, but even in popular software outsourcing destinations like Eastern Europe. Ukraine alone is home to over 250,000 IT specialists, many of whom have been forced to relocate to safer regions of Western Ukraine to continue their work. This is a very important talent market for many UK companies, and it keeps operating even during the war,” she says.

“Even during the first few weeks of the war, N-iX kept service delivery level above 90%. Our clients are stunned by this level of service at such a harsh time for us, but our people really came together trying to do what they can do best. The Ukrainian tech industry is one of the main contributors to the country’s GDP, so the sector is banding together, not only to help the victims of Russia’s invasion but also to support the Ukrainian IT industry and the country’s economy,” she adds.

There are few conflicts since WWII that have had the potential to directly impact the cost of living in the UK. Slater points out that although the UK is less directly reliant on Russian energy supplies than many other European economies, its markets are affected because of exposure to rises in European gas prices and to potentially weaker growth in mainland Europe.

“The London All Share index is down around 4% since the conflict began. UK 10-year gilt yields have risen slightly after an initial decline. The pound has lost around 1% against a broad basket of currencies, mostly due to a decline of around 3.5% against the US dollar,” he says.

Economists see euro area inflation running 1.8% higher, at 5.7%, because of the war, while UK inflation is expected to come in 1.3% higher, at 6.7%, according to Deloitte’s Chief Economist, Ian Stewart. The surge in commodity prices that followed Russia’s invasion of Ukraine may worsen the squeeze on UK living costs and reduce growth.

Central banks are now put into a precarious situation, according to Belle: “Hike aggressively to contain inflation while being cognisant of the possibility they’re hiking into peak growth & demand, or remain softer on tightening monetary policy in the hope that inflation resolves itself?” Belle concludes: “In a US midterm year, I am unsure the latter is a viable possibility specifically for the Federal Reserve.”

Pugh recognises the impact of rising energy prices. “The biggest impact in the UK is on the price of natural gas and electricity, which are up by over 400% and 300% y/y respectively. The FTSE 100 has proved relatively resilient, but the more domestically focused FTSE 250 has fallen by more, reflecting the fact that the UK economy will be hit hard by soaring energy prices,” he says.

However, Belle offers some optimism for UK markets: “I think the UK has better potential to fight inflation than the US, or even the ECB. We aren’t used to ballooning stock markets, so there is not necessarily a fear that increasing rates will deleverage the FTSE wiping off a tonne of wealth.”

Sanctions so far

The Western response to Russia’s invasion will initially focus on sanctions. The measures against both the banks and individuals include UK asset freezes, a travel ban and prohibition on British individuals and businesses dealing with them.

The N-iX spokesperson says: “Termination of business operations and exerting pressure on Russia, calling and lobbying for wider and more comprehensive economic sanctions is imperative for restoring peace in Ukraine and saving European democracy, which must be our top priority.”

Dealings with the Russian Central Bank and Russian travel to and through 33 countries’ airspace has been banned, billion-dollar projects have been halted, many Russian banks were blocked from using SWIFT, and powerful members of Vladimir Putin’s inner circle were individually sanctioned.

MobiDev strongly support sanctions: “They are a powerful tool to stop the Russian war machine. Here in Ukraine, we understand that sanctions are an expensive weapon for our allies. But it saves the lives of Ukrainian people and will save even more as they progress.”

Economic forecasts shift and the course of the conflict is unpredictable. It is not hard to imagine circumstances, such as an acceleration of the conflict or a cutting off of Russian gas supplies to Europe, that would increase the scale of the shock to growth and inflation. Equally, communication between the sides may take precedence, paving the way to end this devastation.

With a war, increasing inflation, rising interest rates, and COVID making a comeback in China, volatility is the bottom line.