A simple economic ready reckoner on the Ukraine crisis and Australia

With Russia invading Ukraine, this is a simple qualitative reckoner on the potential economic impact of the crisis on Australia. This is an exceedingly narrow focus on the crisis, where tragically the human cost of the invasion is quickly building with a substantial loss of life and a humanitarian crisis is unfolding with many Ukrainians forced to flee their country to safety.   

A long period of high world energy prices would naturally have greater economic spillovers to Australia, but most potential negative effects appear relatively minor, while high prices would actually boost incomes given Australia is a large exporter of energy.

Unfortunately working out how long prices may stay high is very difficult and on this score, it is worth noting that commodity futures have found it hard to work out where prices will end up in past military conflicts/energy shocks.

With that in mind, the potential negative and positive effects are as follows.   

Potential negative economic effects appear relatively minor.

• Direct trade with Russia.   Australia trades practically nothing with Russia, just a tiny amount of mainly exports of live animals, Russian students and Russian tourists, and a tiny amount of imports of mainly fertiliser and oil.

• Higher world energy prices and Australia’s trading partners.  Higher world energy prices are most likely to affect growth in Europe in the near term, where Australia trades very little with Europe. Energy prices will affect oil importers in Asia, which would curb Australia’s trading partner growth at the margin.

• Higher world energy prices and Australian inflation. Higher oil prices will quickly be reflected in headline consumer price inflation, but models find it hard to identify any statistical relationship between oil and underlying inflation. Higher world gas prices are unlikely to spill over to Australia’s domestic gas market.

• Lower world stock prices and Australian household wealth.  Australian stock prices are highly correlated with world stock prices, but the direct ownership of equities by households is relatively small, with house prices driving household wealth.

• Global uncertainty and Australian investment/hiring. Increased uncertainty tends to spill over to Australia and can have some effect on business investment, where companies are planning to lift spending over the coming year. There can also be some effect on hiring, but it would be hard to judge and probably insignificant given the demand for labour is so strong at present.

• Other central banks and the RBA. Depending on the duration and impact of the crisis, the ECB might delay its plan to stop buying bonds around the middle of this year and start raising interest rates later in 2022, while the Fed is likely to opt for a 25bp rate rise next month over a 50bp increase. Neither decision would likely have much impact on the RBA, where Governor Lowe recently said he wants to see two quarterly CPIs before making a decision on rates, which means August is the first likely window for a hike (the RBA would also want to avoid hiking either side of a late May federal election for political reasons). The RBA might be a little concerned by higher headline inflation as there is a risk it could feed into higher expected inflation, but it would factor in little if any direct effect of the crisis on underlying inflation.

Positive effects are likely more important

• Higher world energy prices and Australia’s income and the Commonwealth/state budgets. Australia is a significant net exporter of energy and higher oil prices feed into higher LNG export prices, which boosts Australian company profits. Much of this windfall is repatriated overseas, but the boost is also reflected in Commonwealth company tax given miners are among the largest corporate taxpayers in Australia. There is also a benefit to the WA/QLD/NT budgets. 

The image below pays homage to the "Ghost of Kyiv", which you can read about more here.