Europe is strongly affected by the war in Ukraine on different levels. Given the history of occupations of East European States by Soviet Union during the previous century, the Russian invasion is seen as an existential threat. Nato countries have been quick to strengthen their cooperation and embark on armament programmes, entailing new spending items on public budgets.
On the humanitarian level, the war has unleashed the largest refugee movements in Europe since the Second World War.
At the end of March, four million people - close to 10 per cent of the population of Ukraine - had fled to other European countries. Another six million are internally displaced. The Organisation for Economic Co-operation and Development (OECD) has estimated the cost of accommodating the refugees in the first year at more than $50 billion. In addition, the reconstruction of Ukraine, according to Ukrainian authorities, could cost more than $500 billion.
The insecurity and humanitarian effects have, first and foremost, impacted European economies. But the economic impacts are reverberating through the world economy. The war is causing large negative global supply shocks on two fronts: Supply of oil and supply of grain and fertiliser.
The conflict is also affecting international trade structures and international supply-chains through broad and deep sanctions imposed by countries and private companies on Russia. Altogether, Russia is being partly excluded from international financial and economic systems that have evolved around US and Western Europe from the mid 20th century. One thing seems certain: We have entered a phase with a more unstable international political and economic order.
Instability has a cost that among other things makes investors more reluctant to invest; they will require an extra premium, that is higher expected returns, to cover the risks associated with new projects.
Russia produces around 11 per cent of the world’s oil. If US and EU, as part of the economic sanctions, should completely halt imports of Russian oil, the overall world supply of crude oil to the rest of the world could contract by more than three per cent. However, the immediate impact will be less as the sanctions are being implemented gradually and not in full.
Europe is presently highly dependent on Russian oil and gas, an immediate cut off of imports will have dramatic impacts on its own economy. Even after sanctions are fully implemented, Russian oil will find its way to other international buyers. Additionally, there will be pressure on OPEC to increase production quotas, something that will counteract price increases.
Ukraine and Russia, which together account for a quarter of the world’s wheat supply, have introduced export restrictions to secure sufficient domestic supply. Wheat and maize prices, which constitute the largest supply of grain globally, are up around 30 per cent.
Increased oil and food prices will exacerbate inflationary pressures that have been building up in the wake of the Covid-19 pandemic and contribute to further monetary tightening and higher interest rates that will further dampen international growth. The hike in food prices also comes at a time when African countries are faced with the negative impacts of changes in seasonal climate patterns on agricultural production, causing droughts in some areas and floods in others.
Turning to economic impacts of the increase in the global oil price on Kenya, a first observation is that the strong price hikes in the international oil market this year has had no impact on fuel retail prices. This is due to price regulations and an increase in subsidies.
The present regime, with regulated prices and subsidies, is not likely to be sustainable with an international oil price at the present level. If the international oil price stays at the level of March for the rest of the year, the subsidies per litre of petrol would have to increase by Sh39.
The increase in total subsidies needed to keep petrol and diesel prices unchanged from September last year could increase in the fiscal deficit of around Sh168 billion or $1.4 billion in 2022. EPRA publishes a breakdown of the retail price for petroleum products in cost components.
The data shows that as per September 16, 2021 around Sh60 reflects the price of imported petroleum products, around Sh59 covers taxes and levies, and the rest, Sh16 covers profit margins and costs in distribution.
Let us assume that only changes in the import price will affect the retail price of petrol. This requires that the government adjusts tax and levy rates so that collected revenues from gasoline remain constant, and furthermore does not use subsidies to counteract changes in the retail price. It furthermore requires that the oil companies keep profits and operating costs constant.
We assume that the price of imported petroleum products in Kenya reflects the oil price with a delay of one month, thus the August price first influenced domestic petrol price in September 2021. The price increase caused by the war in Ukraine will first be fully reflected in retail prices in Kenya this week.
The present regime with price regulations and subsidies is additionally causing significant market distortions manifested in hoarding and rationing (queuing).
Consumption of wheat amounts to 2.2 million tonnes per year, while maize amounts to four million tonnes. Kenyan grain prices follow, with a delay, movements in the international price. International prices in March, both for wheat and maize, were about 30 per cent higher than the average for last year. Assuming this trend continues, a rough calculation indicates that the cost of grain products will increase by about $1 billion annually relative to 2021. Add to this the effect on domestic prices of all agricultural products from the increase in the price of fertiliser.