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Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.

Russia is not an economic super-power. It is the world’s largest country by landmass. Its population is large, at 145 million, but is falling. Ahead of this crisis, it was the eleventh biggest economy in the world, while the UK is fifth. Russia’s income per head is low. Its military (defence) spending is similar in dollar terms to the UK’s, although higher in relation to the size of its economy. In addition to being a military power, with nuclear capabilities, Russia is a major commodity and energy producer.

According to the International Energy Agency (IEA), Russia produced 10.72 million barrels per day (mbpd) of oil in 2021, second only to the US, at 16.39 mbpd. Russia produces more than Saudi Arabia, but exports less than her. Russia’s importance in terms of gas is even more significant, accounting for 45 per cent of the EU’s gas imports and 40 per cent of its consumption last year.

The most significant economic impact of the war will be contagion through higher energy prices. Ahead of the conflict, gas prices were already elevated and oil prices had been trending higher. War adds a risk premium into the prices of both.

Other commodity prices are already higher, particularly wheat, given Ukraine’s importance as a wheat producer. In 2019, I gave the keynote speech at the annual Ukrainian Financial Forum in Kiev, and it was noteworthy then how the economy was reforming, with a range of key exports including metals, minerals, agricultural products, a shift into digital exports, and also that roughly two-thirds of its public debt was foreign-owned. It is depressing that this move towards openness has been stopped in its tracks.

For many countries – including the UK – this rise in energy and food prices is occurring in an environment of rising inflation, not helped by lax monetary policy last year. Now, UK inflation will peak higher, possibly breaching 10 per cent, and persist for far longer, casting light on how low the Bank of England’s policy rate of 0.5 per cent is.

Financial markets are selling off sharply. This both reflects uncertainty about where the war might lead militarily and concern about future growth.

While high energy prices add to inflation, they also sharply squeeze peoples’ disposal incomes and add to firms’ costs. Also, while higher interest rates may be needed to curb inflation, these may slow the world economy later this year and early next. Recession is even possible for the UK.

Financial markets have repriced the outlook for interest rates: the direction has not changed, but the pace and scale of expected tightening has. Markets now see rates rising less rapidly than previously expected.

Another impact from the war is via sanctions. The scale of sanctions will see a deep recession in Russia. As Russia’s military spending is fiscally led, this may dampen its ability to spend more in this area. But there is little historical evidence of economic sanctions halting an aggressor’s military plans.

How will these sanctions impact the UK? Russia is the UK’s nineteenth largest trading partner with total annual bilateral trade of £15.9 billion. Russia is our 26th biggest export market and 15th in countries we import from.

Russia as an export market for luxury goods will be closed. Annual UK exports are £4.3 billion: cars being the largest item at £386 million, medicines and pharmaceuticals £272 million and capital machinery £199 million. Annual imports are £11.6 billion, with the largest items being: oil £3.6 billion, non-ferrous metals £1.3 billion, and gas £559 million, plus a vast array of other goods.

There will be an impact on financial flows. The UK has invested heavily in Russia and many firms may have to write-off these investments. By 2020, the stock of UK direct investment into Russia was £11.2 billion. By contrast, total foreign direct investment from Russia into the UK was £681 million. Although this is only 0.7 per cent of the total stock it may understate the Russian influence. The phrase “Londongrad” has been attributed to the City since the introduction of the golden visa in 2008 and the continuation of Russian involvement ever since.

This is an association we should seek to ditch – while bearing in mind the importance to differentiate between Russia and the Putin regime. Being open, transparent, non-discriminatory, not retrospective, and abiding by the supremacy of English Common Law are important in ensuring there are no unintended consequences from actions we take now. That is, we should punish the Putin regime whilst enhancing the reputation of the City.

In terms of wider financial flows, the UK financial sector does not appear heavily exposed to Russia. The Bank for International Settlements shows total international bank lending to Russia of $121.5 billion, of which the largest was $25.3 billion from Italy, $25.2 billion from France and $17.5 billion from Italy. The UK’s exposure was $3 billion, so relatively low.

The exclusion of Russia from international capital markets should have a profound impact on its economy. London’s role as a global financial centre should not be impacted.

A critical component of the sanctions was to cut many Russian banks off from the west’s global payments system: SWIFT. The impact of this, however, was slightly diluted because of Western Europe’s dependency upon Russian gas and the need to still be able to pay for this; hence some Russian banks are still able to access the system.

Critically, though, a key decision was taken to exclude the Russian central bank and thus limit its ability to access the large amount of foreign exchange reserves it had accumulated, over previous years, the bulk of which are housed in central banks outside Russia. This measure, like crossing the Rubicon, could have profound longer-term consequences. There is little doubt it adds to the financial and economic pressure on Russia.

It could accelerate the move towards a global currency system not dominated by the dollar and a payments system not dominated by the west. China, in particular, is keen for an alternative to the dollar dominated system. Also, Russia and China have both developed their own versions of SWIFT in recent years. Furthermore, we are already in an environment where, regardless of this war or wider geopolitical issues, there is a race underway across countries to develop new global central bank digital currencies.

Another aspect is global defence spending. The war strengthens the case for increased military spending, illustrated most vividly by Germany’s announcement it will increase defence spending to NATO’s target of two per cent expenditure of GDP. The UK already achieves this target, but may yet decide to boost defence spending further. The war also shows the importance of soft power and controlling the narrative, with the BBC being an important tool internationally in tackling disinformation from Russia

Many countries will be impacted by the humanitarian fall-out. The recent UN World Migration Report noted that there are 281 million international migrants. This represents an increase of, on average, six million per year globally over the last decade. Thus, if as some fear, there are five million migrants from Ukraine (population 44 million) it would be huge.

The war, plus sanctions, will trigger an implosion in both the Russian and Ukrainian economies. There will, however, be significant contagion too, via higher energy prices. The UK will witness higher inflation now and an economic slowdown – and possible recession – over the next year.