THE BLOG

The Economics of the Ukrainian Crisis

06/03/2014 12:23 GMT | Updated 05/05/2014 10:59 BST

In the current Ukrainian situation, Europe is facing its most significant geo-political crisis since the break-up of Yugoslavia and the wars that followed. The fall of the Ukrainian government, the subsequent flight of President Viktor Yanukovych and the military posturing by Russia, have come together to evoke uncomfortable memories of the Cold War.

To be honest, Ukraine has very much flown under the collective media radar in recent months, and it has taken the killing of protestors and the subsequent political upheaval to really get the world to sit up and pay attention, the markets shifting, and investors scrabbling for an exit.

Putin's moral argument as to why the US, UK and other Western powers cannot intervene is rooted in "Whataboutism"; a defence mechanism that allows the user to protect its own reputation by reminding us of the past transgressions of its critics. It's straight out of the Soviet propaganda tricks manual.

Diplomacy may end in sanctions on the Russian state, a situation that hurts all the wrong people. Sanctions didn't work on Iraq in the 1990s and there's no reason while they will be effective in Russia. Unfortunately, sanctions hit the poorest hardest, while the rich ruling classes remain unaffected.

Crimea has deeper ties with Russia than anywhere else in Ukraine. 60% of those living on the peninsula are of Russian stock and, whatever the outcome of the new political machine in Kiev, it's highly likely that the Crimea will no longer be part of Ukraine. Whether it forms its own independent state or is subsumed into Russia we will have to wait and see.

The economic impact of this crisis is obviously more pronounced for those in Ukraine at the moment. The hryvna, Ukraine's battered currency, has tumbled quickly and decisively since the beginning of the political upheaval. Prices on where it is trading are difficult to come by and when you do the spread, the difference between the price to buy and the price to sell, is enough to fly a jumbo jet through.

The Ukrainian central bank has imposed capital controls in the country in an attempt to control the money supply and prevent a run on the nation's banks - Ukrainians are allowed to withdraw the equivalent of USD1500 a day and no more. Taxes are not going to be collected, public services will fail and the economy as a whole will come to halt before falling quickly into reverse.

As for Russia's economy, it too has had to deal with a significant fall in the value of its currency. The rouble has actually been on a precarious path for a number of months as growth has slowed. Monday's ratcheting up of fears, with chatter of deadlines for surrender and troop movements on the border, saw the rouble move to record lows versus the US dollar, euro and sterling.

The Russian central bank has tried to control this by selling chunks of its foreign currency reserves to buy rouble and stabilise the price. It also decided to raise interest rates from 5.5% to 7.0% - a dangerous move given the poor growth dynamics in country.

Inflation becomes an issue when currency values fall as imports become more expensive. Russia's huge energy reserves will limit the effect of a currency fall on consumers' pockets, but the Russian populace will see wider prices rise if the rouble maintains its downward spiral. We do anticipate greater falls in the value of the rouble through 2014, regardless of how the situation in Eastern Europe pans out.

As for Russian companies, those with large amounts of corporate debt denominated in foreign currency are in for a hiding. Those debt piles have become around 10% more expensive this year.

Here in Western Europe, the key is energy. Russia has closed the taps, and choked supply before when it felt like it. Europe gets roughly 25% of its oil from Russia although a negligible amount is transported through Ukraine.

However, natural gas is. 33% of Europe's natural gas comes from Russia and 50% of this comes through pipelines currently in harm's way. The two things that prevent this becoming a drastic issue in the short term are that we are moving into spring and therefore gas demand does slip, as heating systems are turned off. Secondly, thankfully most of Europe has enjoyed a rather mild, if wet, winter. This means that gas storage tanks in Europe are brimming and pose little risk of running out soon.

Like any significant crisis the economic threat to our collective well-being is always much less visible or obvious to detect, but make no mistake the Ukrainian-Russian stand-off has the potential to hit us all in the pocket.

Jeremy Cook is chief economist at World First