How sanctions on Russia can backfire against global economy

As the West acts against Moscow, governments are now faced with the tricky task of tackling inflation, supply chain problems and soaring debt

Things have been getting very hot on the war front with Russia’s invasion of Ukraine, which has so far masked the growing danger of crises on the global economic front.

For the embattled leaders of Russia, China and the US, among others, these events are a distraction from having to deal with galloping inflation, soaring debt levels, rising interest rates and fiscal problems (not to mention Covid-19 and climate change).

The distraction will be temporary, however, because even if the Ukraine invasion stops short of becoming a full-out hot or cold war, the mess accumulating in the global economy will engulf all players on the world stage.

The biggest immediate threat is inflation and events are fuelling the fires. Economic sanctions are being hurled at Russia with impunity and we are now realising that the world outside Russia will also suffer economic pain.

Sanctions further damage supply chains already disrupted by trade wars, and they fuel inflation, especially for oil and gas prices – just what the world does not need.

International Monetary Fund managing director Kristalina Georgieva and World Bank Group president David Malpass declared in a joint statement: “Commodity prices are being driven higher and risk further fuelling inflation, which hits the poor the hardest … The sanctions announced over the last few days will also have a significant economic impact.”

That risk is very high. Supply chain disruptions caused by Donald Trump’s trade wars against China set inflation in motion, and it has since gone from a canter to a gallop.

Oil prices are almost certain to continue rising, along with metal and food prices. The critical question is how central banks will react. The US Federal Reserve, for one, does not appear willing to hold off on raising interest rates – so look for further collateral damage.

Global financial conditions, as the IMF noted, “are set to deteriorate as central banks in advanced economies tighten policy to fight unexpectedly persistent inflation pressure”. Or as Georgieva and Malpass said: “Disruptions in financial markets will continue to worsen should the conflict persist.”

This is where the rush to apply sanctions will become really interesting. Once the impact of sanctions on market sentiment begins to manifest itself – in other words, once the “supply chain” of investment to stock markets is affected – the double-edged sword impact of sanctions will begin to sink in. This is not the end of the story, unfortunately. There is another monster lurking – and that is the beast of global debt.

In an unusually frank discussion in the IMF’s Finance and Development publication, World Bank chief economist Carmen Reinhart and IMF director of strategy, policy and review Ceyla Pazarbasioglu revealed just how close the world may be to entering another debt crisis.

Their analysis deals with emerging market and developing country debt, where the surge has been greatest in recent times and, chillingly, they note that “economies are entering perilous waters that evoke memories of past debt defaults”.

Many emerging market and developing economies “have encountered crises at lower debt levels” than those now, they said, adding that: “Tighter monetary policies in advanced economies are poised to push up international interest rates, which tends to put pressure on currencies and heighten the odds of default.”

Heavy debt burdens are by no means limited to emerging markets. The sensitivity of the household, corporate and government sectors in advanced economies is also such that prospective (and almost certain) rises in interest rates could threaten debt crises too.

Much of the surge in government debt is due to fiscal stimulus designed to avert a Covid-19 economic recession but, as the IMF noted in a recent blog, “now, the bill is coming due. Governments face the tricky task of reducing unprecedented debt”.

The world is obsessed with the Ukraine situation and a desire to punish Russia with economic sanctions. But sanctions in themselves can be weapons of mass destruction in causing a fallout in global economic activity. When you take a wrecking ball to a task, remember that the ball can also swing back and hit home.

The world outside Russia will also suffer economic pain from the sanctions