Western sanctions against Russia could cause collateral damage, curb growth for major economies

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The push by Western governments to punish Russia for its invasion of Ukraine with crippling sanctions is likely to spill across borders and curb economic growth this year, while an onslaught of companies are abandoning Moscow as it descends into a pariah state.

Western countries – led by the United States, European Union and its allies, including Canada – have unveiled a staggering list of sanctions on Moscow, banning some Russian banks from the global financial system’s key communication tool and freezing the central bank’s foreign-exchange assets. Major corporations are divesting from Russian firms, the ruble has collapsed, and Russian residents are reportedly lining up to withdraw whatever cash they can.

Glencore PLC, the world’s largest commodity trader, said on Tuesday that it was reviewing its stakes in two of Russia’s biggest companies. Apple Inc. has halted all product sales in Russia. And Alberta Investment Management Corp. is divesting from less than $99-million in exposure to Russian securities, a minute portion of its assets.

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The Russian economy, the 11th largest in the world, is crumbling in short order, a clear risk to major economies that are still in fragile shape from the pandemic, and now attempting to raise interest rates and reclaim a sense of normalcy after two years of health restrictions.

“I have to be honest with Canadians, that there could be some collateral damage in Canada,” Finance Minister Chrystia Freeland said Tuesday at a news conference. “And that’s something that the G7 finance ministers discussed very early this morning. We spoke candidly with one another, and we said, in order to be really effective, in order to really have an impact, we are going to have to be prepared for there to be some adverse consequences for our own economies.”

Several economists on Tuesday tried to game out the broader fallout – estimates that are pencilled in, given military actions and sanctions that are changing by the day and rapidly altering the outlook.

Europe, which has deeper financial and trade ties with Russia, is the epicentre of any economic fallout that spreads west, particularly in countries such as Germany and Italy. The United States and Canada have relatively little direct exposure, but are hardly immune to blowback.

Toronto-Dominion Bank laid out “benign” and “severe” scenarios in a report on Tuesday. Both would lead to slower growth in the euro zone and North America, but not a decline in economic output this year.

Russia accounts for just 1.6 per cent of global trade, according to consulting firm Capital Economics, which should mute the economic impact. For Canada, trade with Russia is minuscule – less than 1 per cent of total goods trade in 2021.

Regardless, the war in Ukraine – and the prospect of it intensifying further – is rattling financial markets and offering a glimpse of where the pressure points will be greatest and unavoidable.

Commodity prices are spiking, which could keep inflation at decades-high rates for longer. Traders are also paring back on their expectations of rate hikes from the European Central Bank and Bank of England this year, a sign of how uncertainty is already playing into credit conditions.

“Russia is not a small economy, but neither is it one of the world’s giants,” said Eric Lascelles, chief economist at RBC Global Asset Management. “To me, the biggest consideration comes down to commodities,” both supply and price, he added.

For the most part, Western governments have avoided placing limits on their imports of Russian energy, which is a key fuel source for Europe.

“Restrictions on Russian hydrocarbon exports may have the most significant impact on the targeted country. At the same time, they would also impose the highest costs on some of the countries imposing them, in this case, Europe,” economists at the Institute of International Finance wrote Monday in a report. “Thus, we do not believe that such measures are particularly likely under the current circumstances.”

For Canada, there is potentially some upside benefit from tighter clamps on Russian industry and surging prices for crude, wheat and fertilizer, all of which it produces in great quantity.

“Canada has the luxury of actually having, in some ways, a similar economy to Russia,” given its resource base, said Mr. Lascelles. “Shortages on the global stage are less problematic for Canada, and in some sectors, even beneficial, to the extent that sellers can gain a higher price.”

At the same time, global supply chains that were already snarled because of the pandemic look set to get worse.

“I wasn’t terribly optimistic that we were going to untangle supply chains this year before any of this happened, and this has just set us back even further,” said Sarah Schiffling, an expert in supply chain management at Liverpool John Moores University in Britain.

“If we suddenly had peace falling from the sky tomorrow, the impact wouldn’t be long-lasting. But I can’t see the opening of Russian airspace any time soon. When are we going to see the resumption of shipping from Ukraine? And what delays is this going to cause for getting fields ready for crops?”

Several carmakers and auto parts suppliers in Europe have already been hit by the ripple effect of the invasion and sanctions placed on Russia. Europe’s largest car maker, Volkswagen AG, which had already suspended production at two of its factories in Germany, warned on Tuesday it would have to cut production at other sites, pointing to problems at its Ukraine-based suppliers.

Likewise, the Russia-Ukraine war is also heaping more havoc on the world’s semiconductor industry and has exposed the Western world’s reliance on the region for key materials used in microchip production.

For instance, 90 per cent of U.S. semiconductor-grade neon, critical for the lasers used to make chips, comes from Russia, and 60 per cent of that is purified by one company in Ukraine, according to Techcet, a San Diego-based market research firm.

More broadly, the conflict is raising the spectre of China and Russia becoming closer as key rivals to economic powers in the West.

“It is entirely possible to imagine Russia and China – both presently on the outs with the developed world – significantly strengthening their bonds,” Mr. Lascelles wrote to clients on Tuesday. “China is now in a position to purchase more Russian commodities and to support Russia financially via lending.”

With a report from Mark Rendell

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