Russia-Ukraine Conflict: Economic Implications for Sri Lanka
By Asanka Wijesinghe:
The Russian invasion of Ukraine deepens the existing
global economic woes – persistent supply chain bottlenecks and associated rising inflation – clouding the prospects of a smooth global
economic recovery from the pandemic. The West, led by the US and the EU,
swiftly imposed strict economic sanctions, targetting Russian
banks, oligarchs, political leaders, and state-owned and private entities,
generating additional uncertainty over the global economic outlook. The initial
disunity in the West on cutting off Russia from SWIFT-a global financial telecommunication
system that allows the smooth and rapid cross-border transaction of money- was
resolved over the weekend. Such a move will inevitably make payments for
Russian exports and imports hard. The ongoing military conflict in Europe could not have come
at a worse time for Sri Lanka given its own prevailing high inflation, rising
energy costs, and scarcity of foreign exchange. Against this backdrop, this article discusses the
economic impact of the European conflict on Sri Lanka, the sectors that will be
hit hard, and ways to mitigate the negative impact.
Global Economic
Impact
Immediately
after the Russian invasion on 24 February, commodity markets rallied up. The Brent spot price of a crude oil barrel
reached USD 105 for the first time after 2014. Similarly, the cost of wheat
futures for March 2022 in the Chicago Board of Trade (CBOT) exchange peaked, at
its highest since mid-2008 (Figure 1). The Russian
Federation and Ukraine-known as Europe’s
breadbasket- are major cereal, fertiliser, critical minerals, and iron and
steel exporters. Meanwhile, the Western powers were busy over the weekend in
negotiations to tighten sanctions on Russia.
While the
fate of Ukraine hangs in the
balance, the consensus among analysts is that the Ukrainians were mounting a fierce and unexpected resistance, effectively increasing the costs for Russia. The US, EU
and their allies are contributing to the military conflict by providing financial and military assistance to Ukraine
while imposing sanctions on Russia
to make dollar transactions difficult. Thus, the severity of the global
economic impact will be determined by the scope and duration of the conflict
and the effectiveness of Western sanctions.
Western
countries will be keen to minimise the spillover effects of sanctions on their
economies. Like Germany,
the major European economies heavily depend on Russian energy, making it
necessary to exempt the energy sector from sanctions. Indeed, the sanctions
package unveiled by the Biden administration did not target the energy sector. As long as payments for energy-related
transactions go through non-sanctioned and non-US financial institutions, an
unconstrained flow of money is guaranteed. Thus, oil prices dropped with
futures closing below USD 93 a barrel in New
York. However, that optimism was largely fading in
early trade on 28February. The Brent price rallied over 100 dollars again while wheat, soybean, and
corn futures were up. Cutting off Russia from SWIFT and imposing
sanctions on the Russian Central Bank can deal a severe blow to the Russian economy in the long run. The collapsing ruble can be a harbinger of Russia’s
economic collapse. A possible economic fallout will reduce Russian demand for
foreign products, and if Russia
cuts off natural gas to the European market, a likely outcome will be a recession.
Figure 1: The Brent Crude Oil Price and
CBOT Wheat Futures Price Movements
Source: Author’s
illustration using NASDAQ data
Implications
for Sri Lanka
Overall,
Russia and Ukraine account for 2% of Sri Lanka’s
imports and 2.2% of exports in 2020. However, both countries are vital import
sources for wheat and export destinations for Sri Lanka’s black tea (Figure 2 and
3). Russia and Ukraine purchase about 18% of fermented black
tea (>3kg) exported by Sri
Lanka. Similarly, 45% of Sri Lanka’s wheat imports are sourced from Russia and Ukraine. In addition, more than
half of Sri Lanka’s imported
soybeans, sunflower oil and seeds, and peas are from Ukraine. Moreover, Russia and Ukraine are significant import sources
for asbestos, semi-finished products of iron and steel, copper (cathodes), and
potassium chloride for fertiliser.
Unless
the Ukraine
crisis is not solved immediately, the fuel and commodity prices can rally further. The inflationary pressure in the Western markets,
especially in Europe due to high energy prices and supply chain bottlenecks,
may reduce consumers purchasing power, lowering the demand for goods exported
by Sri Lanka. Europe is
a significant export destination for readymade garments, tea and spices, and
seafood. There is also a growing
tendency for increased military expenditure in the long run, which might reduce
the “peace dividends” for European households. For example, the German Chancellor
committed 2%
of GDP for defence expenditure, addressing an
extraordinary session of Bundestag. Replacing consumerism with militarism will
adversely affect countries like Sri
Lanka that depend on the European export
market. In addition, a prolonged crisis may impede Sri Lanka’s ability to purchase
necessary raw materials like fertiliser. Importantly, Sri Lanka’s
exposure to the situation is mainly through linkages to the commodity and
European export markets rather than direct exposure to the two countries
involved in the conflict.
Figure 2: Sri
Lanka’s Imports from Russia
and Ukraine
Source: Author’s
illustration using Trademap data
Figure 3: Sri
Lanka’s Exports to Russia
and Ukraine
Source: Author’s
illustration using Trademap data
Mitigation
Sri Lanka should focus on safeguarding access to vital raw materials and food commodities. Globally, responding to the crisis, countries are stockpiling grain and exploring alternative ways to do business with Russia in purchasing raw materials. Sri Lanka has limited options to mitigate the impact on already deteriorating food security conditions and access to raw materials. As wheat and rice are substitutes, high wheat prices may increase the demand for rice. Thus, it is necessary to remove input shortages like fertiliser to ensure domestic production is adequate. Due to the current foreign exchange crisis, Sri Lanka’s ability to effectively face such shocks is constrained. Thus, the urgent priority is to resolve the current foreign exchange crisis to regain the ability to trade swiftly. Achieving debt sustainability and securing dollar inflows from multilateral institutes might be the options at Sri Lanka’s disposal. Then, entering forward contracts for raw materials and fuel and negotiations with friendly countries for food on predetermined prices are possibilities.
Asanka Wijesinghe is a Research Fellow at IPS with research interests in macroeconomic policy, international trade, labour and health economics. He holds a BSc in Agricultural Technology and Management from the University of Peradeniya, an MS in Agribusiness and Applied Economics from North Dakota State University, and an MS and PhD in Agricultural, Environmental and Development Economics from The Ohio State University. (Talk with Asanka – asanka@ips.lk)
