By Dr. Nilanjan Banik
February 24, 2023 marks the one-year anniversary of the Russia-Ukraine war. What seems to be a fight between David and Goliath is still continuing. The Russian armed force has the world’s largest stockpile of nuclear weapons, the second largest fleet of ballistic missiles, and almost five times more military personnel in comparison to Ukraine. By any estimation the battle was never going to be a fair fight, but with ‘foreign’ support. the US and its allies Ukraine continued fighting.
The military might of the Russians was challenged by the economic might of the US, the EU, Japan, and Australia; with strings of economic sanctions directed toward the Russian economy. Around $300 billion of Russia’s gold and foreign exchange reserves are frozen by sanctions. The embargo on Russian oil by the US and its allies is still continuing. Russian access to the SWIFT financial transaction processing system is stopped. Multinationals such as McDonald’s, KFC, Adidas, British American Tobacco, etc., have closed down their operation in Russia. The US and its allies thought Russia would crumble economically. The Russian economy with a market size (read, GDP) of around $2 trillion is minuscule in comparison to the US and its allies, with a combined market size in excess of $30 trillion. Much like what one would have thought the Ukrainian army caving in militarily, Russians are showing no sign either, economically.
In fact, there are signs of the Russian economy performing better. As per estimates by the International Monetary Fund, Russia is expected to grow by 2.1% in 2024, in comparison to 1% for the US, 1.6% for the Euro Area (27 countries), and 0.9% for Japan. The other big economies such as China and India, which have not imposed any sanctions and continue to buy oil from Russia, are expected to grow at 4.5% and 6.8%, respectively. In fact, companies of Chinese and Indian origins, such as ANT group, China Communications Construction Company, JSW Steel, State Bank of India, etc., continue to do and expand business in Russia. Besides China and India, the Russian continues to trade aggressively with countries in Africa and Latin America.
The sanctions by the West seem to have a little impact on Russia. It is therefore no surprise to see that the Russian rouble appreciated the most during the month of June last year, hitting 52.3 to the dollar, strongest since May 2015. Inflation is also moderated. The annual inflation rate in Russia fell to 11.9% in December 2022 from 12% in the previous month. Inflation is slowing for the eighth consecutive month and reached its lowest since February 2022, when the war started.
Meanwhile, in the Euro region the growth rate is plummeting, jobs are hard to come by, and inflation rates are going through the roof. As of December 2022, inflation rate in the EU region is 10.4%; with some countries such as Latvia, Lithuania, Hungary, Estonia, Czechoslovakia, Estonia, and Poland, witnessing inflation rates in excess of 15%. Before start of the war, almost 40% of the total energy demand in Europe (especially natural gas) was met by the Russians. Sanctions on Russia have affected the supply of natural gas and oil. And a substitute for it is the pricier US energy (both natural gas and gasoline), which means Europe has to shell out more. This means an aggravating budget deficit for the European governments.
A higher budget deficit can be sustained only if the economy is growing. However, economic growth is continuously falling in the eurozone. Government debt as a percentage of GDP rose from 83.8% in 2019 to 96.4% in 2022. Higher energy and food prices because of the war are likely to push the deficit higher by another 2%.
Two other factors are going against Europe. First is the climate change. Extreme heatwave, drought and flooding in part of Europe last year has seen lower crop harvests and higher prices. As per report of the UK Environmental agency, harvests of onion, sugar beet, apple, and hops, are expected to fall by between 10% and 50%. Second is the lack of demographic dividend. To maintain a stable population mix, on an average every woman should give birth to 2.1 children, assuming the average death rate applicable to the world population. In contrast, the same is much lower for some economies in the eurozone — 1.38 children per woman in Greece, 1.39 in Spain, 1.41 in Italy, and 1.94 in the UK. This has shifted the demographic balance towards elderly population. An elderly population usually depends upon social security and pension benefits, and do not contribute productively to the economy.
With a lesser number of younger skilled populations available to contribute productively, the government is going to realize fewer amounts through tax. Moreover slower GDP growth, war, and higher energy prices, are making it difficult to increase tax realization in the Euro zone region. The government has less money to spend on doles and pensions, and therefore need to borrow increasing the budget deficit.
Elsewhere, in the US, inflation is showing no sign of retreat. The inflation number hit a historic high of 9.1% in June 2022, the highest recorded during last 40 years. It is presently around 6.5% which is much higher than the FED target of 2%. And this is in spite of repeated rate hikes by the Federal Reserve. The higher allocation of money in the defence sector, and spending money in the war in Ukraine meant the US government is spending money too fast without any commensurate increase in economic output. For the fiscal 2023, the defence budget is increased to $857 billion that constituted more than a third of the total budget allotted for the economy. Moreover defence manufacturers are known for lobbying and funding political parties, most part of which is inflationary.
On the other hand, rate hike and inflation in the US and Europe has led to a fall in the real wage rates. This has led to an increase in labor agitations – train workers in France and the UK, energy sector workers in Norway, and aviation workers in various budget airlines in the US. A tightening monetary policy and continuation of war is going to see many more such labor agitations.
Russia can survive this war economically thanks to China and India. What seems to be a zero-sum game for Europe is proving to be a positive-sum game for Russia, China, and India. What seems to be a war of ideology – democracy versus autonomy – is proving to be a pricy matter for the Western allies. (IPA Service)
(The author is Professor, Mahindra University).