The economic war that the West launched against Russia in the days following the invasion of Ukraine has already cost developing nations $379bn, analysts estimate.

The figure is based on an assumption that Western governments are collectively burning through $2bn a week to cope with elevated commodity prices and losses caused by slowing economies during the six months the war has been going on, reports the Japan Times.

Reserves exhausted this year in crisis fighting represent less than 6% of total holdings, according to data from the International Monetary Fund for 65 developing nations, but that is the fastest drop since a 2015 currency meltdown led by China’s surprise devaluation. Ghana, Pakistan, Egypt, Mongolia, Bulgaria and Turkey are in the front line, having all lost a third of their reserves this year, according to the IMF, and all are having currency crises as a result.

Soaring bond yields and a $215bn wall of global debt payments due by the end of 2023 are set to worsen the situation over the next year, especially if interest rates continue to rise. Governments were already in a difficult position after balance sheets everywhere were strained by heavy social spending during the global pandemic that started in 2020. Now all that has been made worse by problems created by the escalating economic war between Russia and the West.

Within days of the invasion, EU Commission President Ursula von der Leyen said Europe will hit Russia with a “massive package” of sanctions following its attack on Ukraine on February 24, which are designed to “undermine Russia’s economic base”.

“The sanctions will target strategic sectors of Russia’s economy. We will freeze Russian assets in the EU and stop access of Russian banks to our financial market. This is designed to take a heavy toll on the Kremlin’s ability to finance war,” von der Leyen said at the time.

Sanctions are usually a tool of diplomacy used to try to cajole a wayward government to change its ways. Von der Leyen made it clear these sanctions were different: they were designed to damage Russia’s economy as much as it was possible. She in effect launched an economic war against Russia.

Cost of war

This war is already looking like it will be one of the most expensive ever. The total cost of the war to the Ukrainian economy is estimated to have risen to $660bn by Kyiv School of Economics (KSE), of which just the physical damage is $108bn, with $186bn needed to repair the essential housing and infrastructure should peace come. Others, such as former Ukrainian finance minister Natalie Jaresko, say the cost to rebuild Ukraine could easily run to $1 trillion or more.

But the cost to the West will be immeasurably higher. Donors have already committed $86bn in aid to Ukraine, with the US bearing the lion’s share of some $40bn in arms, including over $8bn in weapons.

Just this cost is starting to tell, as in July for the first time since the war started Ukraine’s allies made no new commitments to arms or aid at all, according to Kiel Institute of World Economy (KIWE) that has been tracking the promises.

And Ukraine is running out of money, as it is running a monthly deficit of some $5bn. Ukrainian President Volodymyr Zelenskiy has appealed to his partners to come up with some more cash to cover the budget outgoings but the promised Western financial aid has been dogged by bureaucratic delays. The US promised $9bn in loans and grants of budget support, but after dragging its feet for months it finally cleared a disbursement of $4.5bn to be paid immediately, which is still only half of the pledged full amount.

Europe has also been slow to react to the mounting economic crisis in Ukraine that has already seen the National Bank of Ukraine (NBU) double interest rates to 25% on June 2, and devalue the hryvnia by 25% on July 21 in an effort to shore up its collapsing finances, and the government let national gas champion Naftogaz default on a $335mn bond on July 26 after ordering the company not to pay in order to “preserve cash.”

The EU has also been sitting on a mirror €8bn loan to Ukraine to match the US money but said it could not send it in July or August as it didn’t have the ready resources. It has since said the money will be transferred in September.

Extreme sanctions

Until now the West has attempted to impose “one-way” sanctions – those that hurt Russia but do little damage to Western economies. However, with the failure to adopt the mooted oil price cap sanctions as part of the seventh package of sanctions introduced on July 21, the only option going forward is to use “two-way” sanctions that do as much damage, or more, to Western economies as they do to Russia.

As bne IntelliNews wrote in its first take of the damage the conflict will cause: “Russia loses from its war in Ukraine, even if it wins. China wins from Russia’s war in Ukraine irrespective of whether Russia wins or loses. The US also wins from both a Russian victory and a defeat, but its win is less if Russia wins. And everyone else, especially Ukraine, has already lost regardless of the outcome.” The economic consequences of the war were visible in the first month, but it is only now that they are starting to be felt in earnest.

In the first week, the West imposed the CBR sanctions that froze access to over $300bn of Russia’s gross international reserves (GIR) held in foreign banks that was totally unexpected and caused the Russian financial system a massive shock. Of all the possible sanctions discussed prior to the attack, freezing the CBR money was never even mentioned.

Then the SWIFT sanctions cut off seven banks – including giants Sber and VTB that between them account for half of Russia’s banking assets – from the international messaging system on March 2, effectively making it impossible for Russian banks to send dollars abroad. SWIFT sanctions were discussed only as a nuclear last-resort option, yet they were imposed in the first week.

And in a series of seven packages, sanction was piled on sanction targeting most of Russia’s dependence on Western markets, including the debilitating sanctions on technology and equipment that is Russia's sanctions soft underbelly, as bne IntelliNews detailed in a feature a year before the war started.

Even more devastating than the official sanctions was the self-sanctioning by major international companies that started to shutter their Russian businesses within weeks of the start of the war. In a widely quoted list, Yale claims over 1,000 companies with turnover equivalent to 40% of GDP have left the market, although a bne IntelliNews deep dive into the Yale report has since argued the pain from the multinationals exit will be a lot less dramatic.

Worse to come

These are the immediate calls on Western cash to prop Ukraine up while it fights tooth and nail on the battlefield. However, there is more to come as Russia brings its economic weapons into the fray. The fight so far has been concentrated in the kinetic war in Ukraine’s fields and forests, but as the autumn approaches it will be increasingly fought in bankers’ boardrooms and at the checkout of the local supermarket.

Gazprom threw Europe’s energy markets into a tizz after it reduced flows of gas to Europe by 60% in June and then followed up in July by reducing them further to only 20% of total capacity flowing through the Nord Stream 1 gas pipeline. The Kremlin is threatening all of Europe with a huge energy crisis this winter if Russia chooses to cut off all gas supplies even if Europe’s gas tanks are full at the start of the winter. Only Slovenia and Austria have gas storage tanks big enough to last the whole winter if imports of gas from Russia stop.

Europe has been racing to fill its tanks on time, which reached 75% of capacity on August 17, well ahead of schedule and on track to hit the 80% full deadline before the October 1 deadline set by Brussels. It has managed this by importing a record amount of expensive LNG and also by ramping up the production of European gas produced in the Netherlands and Norway.

But it has done this at enormous cost. Usually the EU spends a total of $12bn a year on LNG imports, but this year it has already spent $70bn on just LNG, according to estimates by Bruegel, and the winter has not even started.

Despite the comfortable levels of gas in the tanks, gas prices soared again this week to fresh highs above $2,700 per thousand cubic metres on August 16 – ten times their regular levels – on the back of energy crisis fears. Electricity prices are soaring in parallel, even though Europe is not particularly dependent on gas-fired power stations. Power prices are linked to the price of gas as gas-fired power stations cover peak demand while other fuels cover the baseload demand. That means power prices are coupled to the price of gas when demand is high, and with a scorching summer and the prospects of a cold winter, power prices are currently closely coupled to gas prices.

Germany has already announced there is likely to be a €1,000 power surcharge for residential homes this winter and in the UK the surcharge could be an even more extreme GBP4,000-5,000 per household. In July it was estimated that just the cost of this winter’s energy crisis could run to €200bn – more than the cost of reconstruction of the physical damage in Ukraine. And given that the energy crisis is likely to repeat itself for at least one more year as Europe looks for new sources of energy, plus it will have to invest into extensive new energy infrastructure, including new pipelines and retooling refineries, the costs could rise to over €1 trillion in the next three years, according to some estimates.

Commodity prices

Spiking oil prices is another vulnerability for Europe. After an initial spike in the first months of the war when oil rose to over $140 per barrel, but still short of its all-time high of $168 set in June 2008, it has since fallen back to just under $100 as Russia has found alternative buyers in India, China and Kingdom of Saudi Arabia (KSA) to take up the slack created by Europe’s reduction in demand and the self-sanctioning.

However, on December 5 the EU plans to halt Russian crude deliveries entirely, followed by refined products by February 5. No one is sure what will happen then. JP Morgan issued a warning saying that the disruptions to the oil market could send prices sky-rocketing to over $380 per barrel, although other analysts are more sanguine, which would cause a new shock to the global economy.

Putin controls the marginal markets in a number of key commodities. Russia is also the biggest producer of fertilisers in the world and while fertilisers have specifically not been targeted in the seven sanctions packages, he is in a position to squeeze this market too. Indeed, Russia has already banned the export of some fertilisers in order to “preserve stocks for domestic use” that has also sent prices to record highs.

If fertiliser exports are halted, not only will that raise costs for farmers around the world, but they will also inevitably reduce the use of fertilisers and that will reduce food production and feed more food-inflation.

Eurostat reports that annual inflation in the EU reached a record 8.9% in July – the highest level it has ever been since the euro was introduced in 1999. Consumer prices in the 19 countries that use the euro rose by 0.1% in July compared to the previous month and by 8.9% year on year, way ahead of the European Central Bank's inflation target of 2%.

Power and food are almost entirely responsible for the increases, says Eurostat. Electricity prices rose by 4.02% and alcohol and tobacco prices by 2.08%. According to Reuters, even if these most volatile components are excluded, prices were still 5.1% higher in July.

Russia also has the power to send wheat prices back up through the roof. The naval blockade of Ukraine that prevented its export of grain sent wheat futures to ten-year highs but as soon as Russia agreed to the Istanbul grain deal on July 22 under pressure from Russia's African friends and uncorked Ukraine’s ports, the price of wheat in Chicago fell back to pre-war levels. Since then grain ships have been leaving Ukrainian ports unhindered, but it would take little to halt that flow again.

Russia has similar market power in the metals' markets, as a major supplier of a range of key metals used across industry. Like wheat and fertilisers, Russian metals have also been exempted from sanctions, but if the West continues to escalate its economic war against Russia then that also could change.

In 2018 the US Office of Foreign Assets Control (OFAC) that runs the sanctions regime hit Oleg Deripaska, the owner of aluminium producer major Rusal, with a broad set of extensive sanctions. The result was to send the price of aluminium up 40% the next day on the London Metal Exchange (LME). When industry representatives explained that this could add 15 cents to the cost of a can of coke it quickly backed off. The sanctions were never imposed and eventually rescinded – the only sanctions to be withdrawn since the regime was introduced in 2014.

FX

Putin has plenty of weapons in his arsenal to fight an economic war. But maybe the most nefarious is to simply disrupt the global economy. One of the side-effects of the war has been to drive the value of the dollar higher, and it has gained a whopping 10% this year.

A strong dollar hurts emerging markets, and currencies from Ghana to Chile have plunged to record lows against it. Worldwide, 36 currencies have lost at least 10% of their value and ten of them more than 20%. And it's not just emerging markets that are feeling the pain of the strong dollar. The euro plunged to parity with the greenback for the first time in 20 years in July, pound sterling has been deeply devalued and the Japanese yen tumbled to its weakest since 1998 in the same month.

The currency collapses have exacerbated a global spike in inflation, impoverishing already poor populations and fanning simmering unrest that had been stoked by two years of economic malaise brought on by the pandemic.

Sri Lanka has gone into full-scale meltdown after crowds drove the president out of the country on the back of a fuel crisis. In Africa half a dozen countries have been driven into the arms of the International Monetary Fund (IMF) for emergency relief after it became impossible to cover their budget expenditure. Ghana in particular has been trying to go to the IMF for years, but in August put in a desperate plea for help and doubled its request for an immediate bailout to $3bn. Egypt has also become the IMF’s largest single debtor and together with Ghana is in the front line for possible defaults.

Across Africa millions of people have already been pushed below the poverty line and several countries have reported their first food riots. Europe has also seen its first protests in Albania in July demonstrating against the rising cost of living. Tensions there remain high, with fresh protests threatened this week.

Observers have already drawn parallels between the current ropey state of the global economy and the Latin America debt debacle in the 1980s or the currency crisis in Asia in 1997 that triggered a global economic crisis and caused Russia to collapse a year later in its first really big post-Soviet crisis that wiped out the top tier of the banking sector, amongst other things.

The stage is set for more FX pain for everyone. In June the World Bank issued a gloomy report downgrading its global growth forecast yet again and issuing a stringent warning of possible stagflation for the world in the rest of this year.

US Inflation hit a decades-long high of 9.1% in July that is putting pressure on the Fed to jack up rates that will inevitably send more global currencies tumbling and could trigger a global crisis. With reserves already dropping, if a country looks like it is running out of dollars, that could shut the weaker countries out of capital markets and trigger a full-scale and contagious meltdown, similar to the Asian crisis in 1997. Dollar capital flows into emerging markets have fallen this year to their lowest level since the period following the onset of the pandemic, a Bloomberg gauge shows.

There is still hope that stagflation can be avoided after US inflation fell to 8.5% in August. As bne IntelliNews reported, the tightening cycle in Europe also appears to be coming to an end after central banks across the region acted fast and aggressively. However, the economic war with Russia is still escalating and that could have unforeseen consequences for the global economy, as it is in Putin’s power to fuel more inflation via restricting more commodities.

The Central Bank of Russia is certainly planning for the worst. CBR governor Elvia Nabiullina included in a much talked about macroeconomic outlook released last week a “global crisis” scenario, so Russia at least will be ready.