Ukraine crisis may prompt global economic woes

A. R. Chowdhury
Published : 12 March 2014, 11:12 AM
Updated : 12 March 2014, 11:12 AM

While the world watches the escalating crisis in Ukraine, investors, policymakers and world leaders must consider how the instability could rattle the global economy. The country itself is cash-strapped – Finance Minister Oleksandr Shlapak says Ukraine needs $15 billion in the next 2 1/2 years to stay afloat. And now the global financial markets are in a state of volatility, with the Ukrainian hryvnia plunging to an all-time low versus the U.S. dollar and the Russian rubble following suit. Oil prices have risen and stock markets in most countries have sold off.

How will this affect the U.S. economy? Two specific considerations: trade and energy prices. Fortunately, the direct exposure of the U.S. economy to Ukraine is minimal. American exports to Ukraine total about $2 billion, while imports comprise less than $2 billion. So any trade disruption likely would have limited effect. The same is true for the European Union whose total trade with Ukraine totals about $50 billion, miniscule when measured against the $18 trillion EU economy.

So, where's the rub? Russia.

American trade ties with Russia are more extensive, but the overall numbers ($41 billion) are still rather small when viewed in the context of the overall U.S. economy. However, the trade exposure of the EU to Russia is far more extensive: Russia is the single most important source of petroleum products for Europe.

Further, Russia is one of the world's largest producers of natural gas, and its pipeline to Western Europe makes them the world's largest exporter of natural gas. Because Europe imports roughly one-half of its natural gas consumption, the region is vulnerable to any fluctuations in that market.

If Russia wants to punish the West for its support of Ukraine, it could embargo energy exports that would cripple most EU economies. Although the direct exposure of the United States to the Russian economy may be rather small, the indirect effects are not insignificant. Higher petroleum prices would have a pernicious effect on U.S. consumer spending, and a recession in Europe would weaken U.S. exports.

To be clear, the Russian economy is not immune to the effects of such an embargo. In fact, the Russian economy is currently growing at a meagre 1.2 percent – any energy embargo on Europe would plunge Russia into recession as well.

Ukraine's immediate economic concern is its weakened economy. The country owes $13 billion in debt this year and with the nearly $16 billion due before the end of 2015, the country appears to be headed for default.

It's not clear who might bail them out. Russia has frozen a $15 billion relief plan, and there is no comparable alternative in sight. The most likely source of support would be the U.S. and the EU through the International Monetary Fund. According to Bloomberg, the U.S. is currently readying $1 billion in loan guarantees.

Ukraine is one of the world's top exporters of corn and wheat, and prices could rise even on concern those exports could halt. Ukraine's instability comes at a difficult time for emerging markets worldwide, which are seeing growth slow as the Federal Reserve eases its economic stimulus. The situation in Ukraine could lead investors to reassess the risks of other emerging markets' slowing economic growth.

In the meantime, the escalating tensions and risk of a wider military conflict, however small, could continue to boost demand for safe havens, including U.S. government bonds, gold and the Japanese yen and Swiss franc, while undermining equity prices.

Put simply, the situation demonstrates the need for better dialogue between the warring parties. For Ukraine, it is not merely about choosing between Russia and the West – it's about changing the whole post-Soviet political system.

The global financial markets crave stability. Right now in capitals worldwide, a flurry of diplomatic activities aim to diffuse the situation in Ukraine. For the sake of economic stability, we can only hope that the rhetoric dies down and rational minds prevail.

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A. R. Chowdhury is a professor of economics at Marquette University, Chief Economist at Capital Market Consultants and an Advisor to the Federal Reserve System.