Tensions between Russia and Ukraine are at their highest since 2014 with as many as 190,000 Russian troops currently deployed at the border, intensifying fears that a full-scale invasion of Ukraine could be imminent. NATO members – particularly the US and UK – have openly come out in support of Ukraine, indicating that they will not hesitate to impose severe sanctions on Russia if they choose to escalate the situation further. Should an invasion begin, the economic consequences will be grand, with NATO members being forced to make tough decisions on sanctions that could potentially also be detrimental to themselves.
The real risk for the global economy is that, for the sanctions to be as severe as NATO has suggested, they would have major implications outside of the Russian economy and state. Although the sanctions are mostly so far indeterminate, the most severe penalties are likely to come in two forms. The first would be via a boycott of Russian natural gas, with an indefinite postponement of the Nord Stream 2 pipeline that would have one day supplied gas to Europe. The second would be through the removal of Russia from the SWIFT messaging network that is used by over 11,000 banks across the world.
For the Russian economy, these sanctions could be significant. Oil and gas comprise over 60% of the country’s exports and 30% of its gross domestic product (GDP), and preventing the use of its pipeline would make this project obsolete, leaving Russia with nothing to show for its major investment gamble. UK Defence secretary Ben Wallace described this move as “one of the few chips that can make a difference”. The consequences of the pipelines postponement would not be confined to Russia, as this comes at a time when Europe is already experiencing an acute energy crisis. The EU relies on Russia for 40% of its natural gas imports, something that was likely to increase if Nord Stream 2 went ahead. As well as this, Russia is currently the second-largest exporter of oil to the US.
Boycotting Russian energy would therefore mean NATO – and especially Europe – may struggle to meet energy demands that would have been fulfilled by the pipeline. Russia may also impose countersanctions that reduce gas flows to Europe through the original Nord Stream pipeline. Both consequences could result in an energy shortage; higher gas prices could be here to stay.
The second option is the exclusion of Russia from the SWIFT system and is often referred to as the ‘nuclear option’, and would have by far the biggest economic consequence for the Russian economy, at least in the short term. The SWIFT system allows money to be wired across countries and is a cornerstone in the international payment system. Should Russia be cut off from this platform, it would be cut off from the global economy. This would have devastating short-term impacts until they were able to find a viable alternative. Although painful, the impact of this may not be quite as significant as the West envisions. Amid threats of being cut off from SWIFT in 2014 after the annexation of Crimea, Russia began developing its own financial messaging system that, according to the Security Council of Russia, will prevent ‘a catastrophe’ should the sanction be imposed. However, the true use of this service will be unknown unless the sanction is imposed.
Exiling Russia from the SWIFT system would certainly have consequences for the West too. Europe and the US are amongst Russia’s biggest trading partners (1st and 5th respectively), so there is no doubt that European and US trade with Russia would suffer significantly until Russia found a suitable alternative. Furthermore, it reflects poorly on Europe to make the Belgian-based SWIFT a politicised, and indeed weaponised, institution rather than a financial tool. This may encourage other countries in tension with the West, such as China, to also explore new financial mechanisms. This leads us to question whether many European countries would be readily willing to impose a sanction with such unintended and rolling consequences.
Alongside the aforementioned sanctions, the UK and US have also suggested levying sanctions on banks and individuals associated with the Kremlin in the form of either asset freezing or travel bans. Although possible, there is wide speculation that there would be significant bureaucratic opposition from the UK Treasury and the business department which have blocked similar attempts in the past. If this was imposed it would of course make life difficult for said individuals, but it is unfortunately the ordinary Russians who will suffer most. Their already lowered standard of living is expected to fall, while the growth rate (that shrunk from 2.3% to 0.3% in the years following the annexation of Crimea) is also predicted to decline further.
Although significant attention is given to the impacts of an invasion and its subsequent sanctions on Russia and the West, the consequences for Ukraine must also be highlighted. The economy has been in limbo since the annexation of Crimea in 2014 – tourist visits are half of what they used to be in years preceding 2014 and foreign investment has still not recovered either. No matter the scale of conflict, any significant military action by Russia is likely to further damage these sectors or delay their recovery process, putting Ukraine in a much more uncomfortable position than Russia or any Western country. Since the beginning of the year, the value of the Ukrainian Hryvnia has declined 4% against the dollar, making it one of the worst performing currencies in the world, and investors have already begun to freeze funding and suspend expansion plans until they better understand how this crisis will play out. As Ukraine alone does not hold the power to effectively combat a Russian invasion or impose any sanctions, retaliation is very much out of their hands.
Despite the huge economic consequences that an invasion of Ukraine would have, the question remains: will the sanctions be enough to deter Russia from escalating the situation and invading? For now, it seems far from certain that they will be. Most experts suggest that Russia is willing to take extreme risks in order to reach its political goals and, with it unclear what sanctions the US and Europe would be comfortable imposing (given the impacts on themselves), it does not appear that the suggested sanctions would materialise as enough to deter an invasion. However, as the US and Europe solidify their response to the invasion and as sanctions become clearer, the situation is subject to significant change.