It has become more apparent than ever that economics and finance are intertwined with national and global security. Sanctions confront armies. Banks take on tanks. And the collateral damage from economic and financial warfare is significant, as Russia is now discovering.
The economic implications of Russia’s war are potentially large and global. Inflation will be higher everywhere. Economically vulnerable groups will be worse off. Global growth is expected to be weaker.
War and sanctions create long-term, profound ramifications for economic systems. Supply chain vulnerabilities, already laid bare by COVID-19, have been further exposed. There will be no turning the clock back to the pre-pandemic, pre-war, globalized, and efficient world economy.
China is not spared from these shifts. China’s import and export supply chains are long and potentially exposed to risks. In a world where warfare and conflict exist as much in the towers of finance as on the plains of the battlefield, China may be forced to reckon with the consequences and adapt to new realities.
The Impact of Russia’s Invasion Will Be Global
Russia’s invasion of Ukraine has unleashed both supply and demand shocks that are now reverberating around the world economy and financial markets. Disruptions to Russian, Ukrainian, and Belorussian production and distribution of energy, food, and industrial metals are already pushing up many commodity prices. This partly reflects genuine supply shortfalls amid tight inventories—panic or speculative buying is exacerbating moves.
Surging prices for oil, natural gas, grains, fertilizers and industrial metals will feed through into higher producer and consumer price inflation worldwide—in advanced, emerging, and lesser- developed countries. China will not be spared. Even in countries with large domestic supplies of energy and food resources, such as China (coal, grains) or the United States (crude oil, natural gas, various agricultural products), prices are set in world markets, meaning that increases are felt universally.
Soaring energy and food prices redistribute income from consumers to producers, but that outcome typically leads to lower overall global spending and weaker global gross domestic product (GDP) growth. That is because higher prices for necessities reduce purchasing power of cohorts with high propensities to spend and transfers income to businesses and individuals with lower propensities to spend. Consequently, total spending sags.
Also, on the demand side, it is plausible to assume that consumers and businesses may postpone discretionary “big ticket” purchases. Those effects may be largest in Europe, for understandable reasons. If demand slumps, its effects will reverberate via trade channels. One significant reason for this is that Europe is China’s second-largest export market.1
For China, the impact of war and sanctions will be to lower demand for its exports, given weaker world growth. Domestic Chinese spending will also be hit, owing to higher petrol and food prices that dampen consumption.
Earlier this month, China has set a modest 5.5% growth target for 2022.2 As we’ve noted before, China was already likely to buck the trend of global monetary and fiscal tightening this year. That outcome looks even more likely now.
This time, however, China is less likely to ease monetary and credit policy given the challenges of a significant property development overhang. Accordingly, it is also likely that Beijing will deploy government spending, including on infrastructure, defense, and economic security measures, both to address fundamental needs as well as to stoke domestic demand.
China Will Likely Intensify Efforts to Bolster its Long-Term Economic Strategy
Beyond the cyclical impacts of weaker growth on the Chinese economy and macro-policy, events in Russia-Ukraine will have longer-run ramifications for China’s development strategy. “Dual circulation” is the buzz-phrase around China’s 2021-2025 five-year plan, a strategy that emphasizes domestic consumption, investment in technology, and greater self-reliance by reducing import dependency in areas such as silicon chips.
In recent years, one of the most highly-talked about development has been China’s “Belt and Road” initiative, which focused on establishing transportation and commercial networks into commodity producing parts of the world, including via the ancient “Silk Route” across central Asia.
Belt and Road has been integral for China to create and secure its own trade routes. After all, Ukraine and the surrounding areas of Russia and Belarus are historically one of the world’s greatest bread baskets. Russia and Ukraine account for 14% of global wheat production and 30% of global wheat exports.3 Both countries also supply nearly 20% of global corn exports, and Ukraine is one of China’s largest sources of corn feed. Russia and Ukraine also account for 19% of global barley production and nearly one third of global barley exports.4 They also make up 60% of global sunflower oil production and 75% of global sunflower oil exports.5
However, disruptions this year to planting and harvesting of wheat, barley, corn, and sunflower in Ukraine will impact China. Financial sanctions on financing and insuring Russian shipments may also pinch supplies of foodstuffs.
To the extent those disruptions become long lasting (if, for example, conflict and sanctions carry on for years), China will need to seek other, more reliable suppliers. For foodstuffs, that means turning to North and South America. Indeed, given China’s well-known water-supply challenges, it is unlikely that China can rely on domestic grain production to offset a lasting loss of Ukrainian and Russian supply.
Financial Sanctions May Impact China’s Foreign Reserve Philosophy
Finally, China should contemplate the possible impact of financial sanctions on its foreign reserve philosophy. A quarter century ago, China drew the lesson from the Asian financial crisis that large foreign exchange reserves were essential for national financial security. But the freezing of Russia’s foreign exchange reserves and the expulsion of large Russian banks from the SWIFT international payments system has exposed fault lines and gaps in that strategy.
China is far more economically and financial integrated in the world economy than Russia, which makes it more painful for the West to potentially impose on China the kinds of draconian financial sanctions that it has on Russia. But that same interdependence also implies a potentially high economic and financial cost on China, should sanctions nevertheless become a plausible scenario.
Plenty of discussion in China is apt to focus on other ways to hold foreign exchange reserves or to devise an alternative international payments system to SWIFT. But there is no quick fix. Existing institutions and networks that underpin the world’s financial system are not easily dislodged. Just as in social media or search, a single payments network and global reserve currency offer enormous network benefits. Global commerce works best on one platform rather than many.
And, as economist Robert Triffin pointed out over 60 years ago, if a country wishes to issue and oversee the world’s reserve currency, it must provide for its supply in international finance and commerce via persistent trade deficits and a relatively open capital account.6 Present-day China has little appetite for either, which will continue to hinder the renminbi’s development as a genuine global transactions or reserve currency rival to the US dollar.
As I’ve noted before, writing on topics that stem from human tragedy is an immense responsibility. My colleagues and I undertake this duty with great care and professionalism as part of our fiduciary responsibilities.
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1. Source: Statista as of December 31, 2021.
2. Source: People’s Bank of China as of March 5, 2022.
3. Source: United States Department of Agriculture (USDA) as of October 2021.
6. Source: Investopedia. How the Triffin Dilemma Affects Currencies, June 25, 2019.