Spiking oil and grain prices are intensifying inflationary pressure.
Spiking oil and grain prices are intensifying inflationary pressure.
R ussia has a relatively small economy, which accounts for less than 2 percent of world output. Yet it does have the ability to destabilize the global economy by triggering emerging-market debt crises.
It did so in 1998 when the default on its sovereign debt caused the Long-Term Capital Management bankruptcy that reverberated through the world financial system. It is now likely to do so again by its Ukrainian invasion. Not so much because Russia is once again poised to default on its sovereign debt. But rather because it is provoking a spike in international oil, grain, and metal prices that will accelerate the pace at which the advanced economies’ central banks will be forced to engage in monetary-policy tightening as they attempt to contain inflation.
Even before the Russian invasion, the World Bank warned that the emerging-market economies had become very vulnerable to another debt crisis as a result of the Covid-19 pandemic. That pandemic plunged the emerging-market economies into their worst post-war economic recession and caused their budget deficits to balloon. As a result, on the eve of the Russian invasion, emerging-market debt had skyrocketed to an average of 65 percent of GDP or to by far its highest level on record.
Over the past two years, despite the marked Covid-induced deterioration in their economies, emerging-market governments had little difficulty in financing themselves in an environment of ample global liquidity. That environment had been made possible by the approximately $9 trillion in bond buying by the Federal Reserve and the European Central Bank (ECB) in their efforts to help their respective economies emerge from their deepest post-war economic recessions.
The Russian invasion of Ukraine now threatens to put an abrupt end to the period of ample global liquidity by, as mentioned above, forcing the Fed and the ECB to slam on the monetary-policy brakes to put the inflation genie back into the bottle. This appears to be the case not least because the invasion is occurring at a time when the United States and Europe are already experiencing multi-decade-high inflation rates.
By causing a dramatic spike in international oil prices to $130 a barrel as well as by giving rise to a 35 percent increase in international grain prices, the Russian invasion is now bound to add meaningfully to already strong inflationary pressure in the advanced economies. So too are the likely supply-side disruptions to agricultural fertilizer production, of which Russia and Ukraine are major exporters, as well as to the production of natural gas and key industrial metals, such as platinum and palladium, of which Russia is a dominant world producer.
A more immediate way in which Russia is causing liquidity for the emerging markets to dry up is by having led the West to impose crippling sanctions on the Russian financial system, including its central bank. As those sanctions have caused the Russian ruble to plummet, the stock market to be shut down, and bank runs to begin, emerging-market investors in Russian paper have sustained large losses as the specter of a Russian sovereign-debt default has reappeared. That in turn is causing emerging-market investors to become increasingly risk-averse to the rest of the emerging-market asset class.
In a more challenging global liquidity environment, we should brace ourselves for the wave of emerging-market debt defaults about which the World Bank has been warning. This would be especially the case in those highly indebted countries that are also large energy and food importers. Such a wave of defaults could have serious consequences for the world economy, which will no longer be able to count on the emerging-market economies to be its main engine of economic growth.
All of this would suggest that in framing monetary policy, the Fed will need to keep a close eye on emerging-market developments. As has happened all too often in the past, those developments could have serious economic and financial-market spillover effects to our shores.