The course of the Russia-Ukraine war was always going to be uncertain, given the rather recalcitrant stance taken by the former even after sanctions were imposed. The emerging situation in China and the EU embargo on Russian oil over the next six-eight months have added a new dimension to global prices, growth and trade.

With the war, commodity prices had spiked with supply distortions getting exacerbated as energy, metals and farm products like wheat and edible oils became vulnerable. This resulted in a spurt in commodity prices for the second time after 2021. Central banks sprang into action by commencing the process of raising interest rates. With higher interest rates and inflation, economists started talking of stagflation as a global slowdown and inflation looked very much on cards. All growth forecasts were revised downwards gradually, but surely. The war became a new crisis affecting all countries and the difference from the pandemic is that it is a man-made one. The war has crossed 100 days with no end in sight.

In China, fear of a new wave of Covid led to a stringent lockdown for two months. With the Chinese economy coming to a virtual standstill (though different from 2020), the overall demand in the world economy slowed, thus providing some relief from the relentless price increase. This was unexpected and hence reduced the pace of economic activity.

A China slowdown meant two things for the other economies. The first is that demand slowed and exporters from other countries had to search for other markets. The second is with limited movement of goods from China, importers had to also scout for other suppliers as prices increased.

Russian oil

Meanwhile, the EU embargo on Russian oil implies that Russia will be pushed back further in terms of forex earnings, and the EU will have to get oil from other sources. Now the oil dynamics is quite interesting. Russia would be the third largest or joint second largest producer of crude oil based on 2021 data. As per IEA, out of the total production of 95.6 mbpd, Russia produced 10.78 mbpd while Saudi Arabia was a tad ahead at 10.84 mbpd. The US is the largest producer with 18.9 mbpd.

Russia exports nearly 10 per cent of its production, which at 1.1 mbpd may not look big. But the limited scope for expansion in production in other nations due to under-investment in the past has pushed up the price. Of this, around 750,000 mbpd goes to Europe. With this amount being blocked, it means that the EU will have to look at alternative sources that will push up demand in the global market and put pressure on prices.

Crude oil price had been largely stable, in the $110/barrel range, for quite some time and it was felt that the worst was over for the global economy in terms of commodity prices. But now clearly this is not the case. With a rather tenuous demand-supply matrix emerging in the oil market after Russia being nudged out, a slight increase in demand would put pressure on prices and make them volatile. This means we should be prepared for higher volatility in prices as hopes of crude prices going down to double-digit levels look distant now.

This development goes along with China emerging from the lockdown. With two months of static or limited economic activity, China will be aggressively focussing on growth and this comes at a time when inflation is already high. China is one of the largest consumers of metals and agrarian products. A sudden revival driven by the quest for rapid growth has the potential to further ratchet up up inflation.

Two scenarios

Hence if the two developments are put together, two things look likely. The first is while the West may slide in terms of growth with the aggressive monetary policy positions being taken by central banks, inflation will continue to accelerate with China re-entering the market. Hence the commodity boom in 2021, which was expected to end in 2022 with stability being predicted by the World Bank, may reappear with a difference.

In 2021 it was due to good times emerging as countries came out of the Covid-induced lockdowns and moved to normalcy and economies boomed on the back of low base effects. This was manifested in both commodity prices and growth rising, which is not a bad thing for policymakers as jobs get created as consumption and investments accelerate. This time, the difference is that while growth is slowing in most countries, inflation will be moving at a faster pace. This is why economists are talking of possible stagflation, though technically the concept of stagflation requires growth to be negative for two successive quarters, which is not presently being witnessed. But going forward one cannot tell.

The Russia-Ukraine war has been quite singular from other battles that have been fought, especially in West Asia in the past. A war which is still entirely localised to one country has global economic effects, mainly because the tool being used by the Western powers to push back Russia from Ukraine are economic tools rather than direct military intervention. Iran was different because it had nothing except oil to offer and hence the spillover effects were minimal.

This combination of war and sanctions has turned out to be more pernicious in terms of supply disruptions of food, fertiliser and energy in particular, leading to fresh rounds of inflation. It has led to an economic contagion over which there is little control as globalisation has made economic borders extremely porous. Polices have to be alert while in reactive mode.

The writer is Chief Economist, Bank of Baroda. Views are personal