Forewarned is forearmed

What, if any, might be the fallout of the ongoing Ukraine crisis in Bangladesh? This is perhaps the question of the week. An easy answer is: It depends on how the ground war and the implementation of the sanctions against Russia unfold. While the instant impact of the crisis has been felt in global commodity, equity and currency markets, the ripple effects can go on for a while.

What has changed?

The US, Europe and Russia have returned to a deep confrontational relationship after decades of a degree of collaboration under distrust. Russia and China have found a common ground in their attempts to overhaul the existing architecture of global governance. The US and Europe are revisiting assumptions about their strategic posture. Circumstances have forced them to choose a strong transatlantic partnership for the time being. NATO will remain unified until the war heat tapers off. Maintaining this unity will be hard work.

Russian invasion of Ukraine can change the fundamentals of the existing global economic order. Three decades after what was supposed to be the end of Cold War, the conflict between the West and Russia has resurfaced as the primary fault-line in the global landscape. It has the potential of taking the global economy into uncharted waters.

Wars leave in their wake the victor and the vanquished. History 101 says neither the victor's triumph nor the defeat of the vanquished is permanent. Home grown resentments and grievances return eventually, throwing externally established security structures in disarray.

Bangladesh's national security and foreign policymakers will have to grapple with the new reality as they navigate a stance of strategic ambiguity. It is too early to predict how this strategy will play out and what will be its long-term implications. However, there are some immediate concerns about the impact on the economy which the government must be prepared to tackle.

The direct economic impact

The direct impact of the Russia-Ukraine crisis in Bangladesh in terms of bilateral trade is unlikely to be very significant, but a surge in energy and food prices poses considerable risk to the economy. Bangladesh's direct trade with the two warring parties is relatively small. A fall in demand for Bangladesh's exports to Russia and Ukraine is therefore unlikely to dent the post pandemic export rebound seen recently. However, there may be some setback on the supply chain and market diversification front. Exports to Russia doubled in the past five years and more was expected.

A much bigger worry is the surge in energy prices and the availability of LNG in the international market. Crude prices breached the $100-per-barrel barrier for the first time after 2014 on 24 February. Although the market has priced in the current projection of the endgame, changing news of developments on the political and war fronts will keep the price on a knife-edge.

The economic fallout of the conflict across commodities will aggravate pre-existing stress on the current account deficit and domestic inflation. Prices of wheat, corn, sunflower oil, and aluminium have come under pressure. Taka is likely to take a further beating. The Bangladesh Bank must not be complacent with its forex reserves and stand ready to pre-empt undue volatility as it has done in recent times.

The war may have tipped the balance towards stagflation in the near term in advanced economies. The ability of policymakers to tackle persistent inflation is being tested once again. The inflationary shock could derail the already slackening post-pandemic recovery in the global economy. The repercussions on Bangladesh's exports may then be highly significant. If global crude prices stay elevated, it could undo the Finance Division's FY22-24 macroeconomic projections. The logic of domestic dynamics dictating policy may well turn on its head if higher crude prices delay the cool-off in global inflation expected, in the absence of the war, in mid-2022.

The fiscal response to the renewed commodity price shock needs to be assessed closely as the budget for FY23 is crafted. The government is walking on an already elevated bank borrowing path. The fiscal space for an increase in subsidies is limited. However, a large hike in administered prices is bound to push inflation and increase economic pain. Policymaking is stuck between a rock and a hard place. The only escape is prioritisation of expenditures and stronger revenue mobilisation.

Beware of the knock-on effects of sanctions

Economic sanctions from nations opposed to the Russian militancy in Ukraine can have major knock-on effects on other countries, including Bangladesh. Just as we are beginning to accept some Covid realities in health, so may we need to live with the economic consequences of sanctions on Russia for as long as the conflict remains alive and well. The open battles on the air and ground may end with an inconclusive Russian victory, but the war may still go on.

Countries imposing sanctions on Russia together account for over half of the global GDP. Sanctions range from restrictions on banks as well as individuals, technology export controls, and disallowing access of important Russian financial entities to global financial markets. Excluding some key Russian financial institutions from the western payments and fast-messaging systems and targeting the Russian oil and gas industry would almost certainly drive oil prices even higher than the current $100/bbl. Russia is the world's third-largest producer of petroleum and other liquid fuels. Russia supplies Europe with 40% of its gas, half its solid fuel including coal and about a quarter of its oil.

Sanctions will impact regular trade if the war is protracted. Ukraine and Russia are important transit routes and exporters of agriculture products. The disruptions in global trade will depress global growth at a time when the world is just about passing through the Omicron phase of recovering after two big Covid hits in 2020 and 2021. Interruption of energy supplies will deepen the stagflation shock.

Financial and trade settlement complications could extend well beyond dealings with Russia at government and business levels. Working out some means for wading through the sanctions requires a clear understanding of how they are applied. Business and financial transactions directly or indirectly involving the sanctioned entities are likely to fall within the purview of the sanctions.

You are not insulated from sanctions even if you do not have a direct relationship with the sanctioned entities. Business could be in jeopardy if the entities you deal with have a direct relationship with those subject to sanctions. Watch both the front and back doors.

Bangladesh depends on Russian nuclear power technology and bilateral aid. Russia must be able to complete the remaining technology transfer, provide maintenance services and disburse the committed aid in internationally tradable currencies. It will struggle to do so if it cannot transact through the normal banking and trade channels.

Watch and learn like housework

The upshot is, for now, that a wait-and-watch mode is required to learn about how yet another new normal will emerge, this time in the geopolitical arena. We need to be ever ready to face the unintended consequences of the sanctions. The butterfly effects of sanctions on other nations in the global trade and financial system may be overwhelming even though Russia is a much smaller player in terms of the global GDP.

To think that we may be immune is akin to living in a fool's paradise. The Bangladesh Bank, the Finance Division and the commerce ministry must proactively monitor the evolving escalation in the design and application of the sanction regime against Russia to continuously gauge its likely impact on the Bangladesh economy.

Zahid Hossain is the former Lead Economist at  World Bank's Dhaka office.