Indermit Gill :
The war in Ukraine could not have come at a worse time for the global economy-when the recovery from the pandemic-induced contraction had begun to falter, inflation was surging, central banks in the world’s largest economies were gearing up to hike interest rates, and financial markets were gyrating over a formidable constellation of uncertainties.
Many of the world’s developing economies remain debilitated by the pandemic. The healthy recovery that advanced economies have experienced over the past year has largely bypassed them: By 2023, economic output levels in developing economies will still be 4 percent below their projected levels before the pandemic. Total debt in these economies now stands at a 50-year high. Inflation is at an 11-year high, and 40 percent of central banks have begun to raise interest rates in response.
The Ukraine crisis could make it harder for many low- and middle-income economies to regain their footing. Besides higher commodity prices, the fallout is likely to arrive through several other vectors: trade shocks, financial turbulence, and remittances and the flight of refugees. Countries closest to the conflict-by virtue of their strong trade, financial, and migration links to Russia and Ukraine-are likely to suffer the greatest immediate harm. But the effects could ripple far beyond.
Food and fuel costs
Some developing economies are heavily reliant on Russia and Ukraine for food. These two countries supply more than 75 percent of the wheat imported by a handful of economies in Europe and Central Asia, the Middle East, and Africa. These economies are particularly vulnerable to a disruption in the production or transportation of grains and seeds from Russia and Ukraine. For lower-income countries, disruption to supplies as well as higher prices could cause increased hunger and food insecurity.
Russia is also a major force in the market for energy and metals: It accounts for a quarter of the market for natural gas, 18 percent of the coal market, 14 percent of the market for platinum, and 11 percent for crude oil. A steep drop in the supply of these commodities would hamstring construction, petrochemicals, and transportation. It would also lower economywide growth: Estimates from a forthcoming World Bank publication suggest that a 10 percent oil-price increase that persists for several years can cut growth in commodity-importing developing economies by a tenth of a percentage point. Oil prices have risen by more than 100 percent during the last 6 months.
The conflict has already caused tremors in financial markets, prompting a sell-off in stocks and bonds in the main global markets. An increase in investor risk aversion could lead to capital outflows from developing economies, triggering currency depreciations, falling stock prices, and higher risk premiums in bond markets. That would create acute stress for the dozens of developing economies with high debt levels. Economies with high current account deficits or large shares of short-term debt denominated in foreign currencies would struggle to roll over the debt. Alternatively, they would face higher debt service obligations.
Financial stress could be aggravated by central banks’ response to higher inflation. In many developing economies, inflation is already at the highest level in a decade. A further boost from surging energy prices could lead to an inflationary spiral as expectations of higher long-term inflation become entrenched. That, in turn, could prompt central banks to tighten monetary policy more rapidly than has been expected so far.
The economic pain, moreover, could radiate beyond Eastern Europe to countries that rely heavily on remittances in the affected countries. Several countries in Central Asia, for example, are heavily dependent on remittances from Russia-in some instances, these remittances account for as much as 10 percent of the country’s GDP. Many Central Asian countries are likely to see a decline in remittances as a result of the conflict.
It’s time to act. The World Bank Group, in tandem with the International Monetary Fund, is moving quickly to provide assistance to Ukraine and other affected countries. A $3 billion package of support in the coming months will include $350 million for Ukraine by the end of this month. Governments in developing economies should also move quickly to contain economic risks. Building foreign exchange reserves, improving financial risk monitoring, and strengthening macroprudential policies are vital first steps. Policymakers will need to be vigilant-and make careful course corrections-in their response to rising inflation. They should also start to replenish fiscal policy buffers depleted by COVID-19-by eliminating inefficient expenditures and mobilizing domestic financial resources wherever possible. And they should strengthen the social safety nets needed to protect their most vulnerable citizens in a time of crisis.
As devastating as it has been, the coronavirus pandemic was an object lesson in the power of policymakers to respond effectively to a catastrophe. However, prevention is better than cure. Governments in developing economies would be wise to act now.
(Indermit Gill is Vice President, Equitable Growth, Finance and Institutions, World Bank Group).
