What are the economic consequences of an armed conflict in Ukraine?

Published on: 27 January 2022

Current issues related to economics, (responsible) investment, pensions and income: every week an APG expert gives a clear answer to the question of the week. This time: macroeconomist and senior strategist Charles Kalshoven on the possible economic consequences of an armed conflict in Ukraine. “An investor should not be scared off too quickly by geopolitical risks.”


With the amassing of more than a hundred thousand Russian military troops at the Ukraine border, and the response of the U.S. and NATO, tensions have now risen high. It looks like a Russian invasion, followed by an armed conflict may be imminent. The threat is not without repercussions on financial markets. The gains that the AEX recorded in the past six months (about 12 percent) have now completely evaporated - although concerns about the omicron variant of Covid, high inflation and expected interest rate hikes by the U.S. central bank also played an important role. Russian shares lost as much as a third of their value during this period.


Supply Shock
When it comes to the possible economic consequences of a conflict in Ukraine, you cannot ignore Europe’s dependence on Russian gas. Kalshoven: “Our dependence on Russia is very high in that respect (35% of European consumption concerns Russian gas, ed.). If an actual military conflict in Ukraine leads to Putin turning off the gas tap, this will probably mean a sharp rise in the price of gas and electricity. It would be a supply shock, which could lead to a decline in purchasing power and economic stagnation. Because, if there is a shortage of gas, our government would rather shut down factories than literally leave households out in the cold.”

Such a combination of stagnant growth and high inflation doesn’t usually work out well for equities, Kalshoven says. “And the uncertainty that accompanies an actual conflict doesn’t help either. But perhaps there would be one stroke of luck: oil prices don’t have to follow gas prices. When economies slow down a notch, that pushes the price of oil down. As a result, inflation may not be as bad in the end. It is true that Russia is also a major oil producer and can therefore also influence the price by turning off the oil tap just like the gas tap. But waging war is expensive. The question is therefore whether the country can manage without the income from oil in addition to a loss of income from gas.”

The threat of a Russian gas shutdown may also bring an advantage

Don’t run away
From an investment perspective, Kalshoven sees the situation in Ukraine as a realistic threat. But he adds that an investor should not be too easily put off by such geopolitical risks. “We are seeing movements in financial markets that can be attributed to the threat in Ukraine. And of course, as an investor, you can think about all kinds of consequences if tensions are rising somewhere. But it certainly doesn’t necessarily mean that you should just run away from the risks by selling everything. Antti Ilmanen, an investment expert, compares it to participating in a lottery: it could pay off, but usually it doesn’t. Research shows that it usually pays for investors to stay put, because there are plenty of returns against the risks, and geopolitical tensions usually get resolved.”

Moreover, it is always good for an investor to diversify, including with regard to the risks of geopolitical tensions, the economist says. “If there is unrest in Ukraine, it does not necessarily mean that somewhere else in the world things will immediately get out of hand. Of course, all the attention of the international community is focused on this conflict. That could provide an opportunity for countries elsewhere to take controversial steps that suit them.”


Profitable sooner
That threat of a gas supply cutoff by Russia could also bring a benefit. “It makes Europe face up to its dependence on Russia for its energy supply. This makes the importance of the energy transition even clearer. In any case, if you don’t want to be dependent on Russia, you will have to think seriously about accelerating the alternatives. The energy shortage that will arise if Russia’s gas supplies are cut off cannot entirely be solved immediately by means of solar and wind energy.”

For investments in renewable energy, Kalshoven says, a cutoff of Russian gas supplies is likely to mean they would benefit.  “When energy prices rise, sustainable energy projects become profitable sooner. On the other hand, of course, investments in companies or projects that consume a lot of energy suffer.”