Structural drivers of inflation, Russia’s war economy, reconstruction in Ukraine & European energy markets

These days are marked by a sobering rather than celebratory anniversary in Ukraine. Our feature this week analyzes the current economic situation in Russia, including the impact of Western sanctions. We also explore three related themes – the reconstruction of Ukraine, the situation in global energy markets, and the path forward for energy inflation in the Eurozone. In another report this week, we study the evolving nature of structural drivers of inflation in greater detail.

In focus: Russia’s war economy

Despite Western sanctions, the Russian economy held up much better than expected: real GDP contracted by just -2.1% last year. However, the outlook is challenging. We expect a further contraction of -1% this year.

Business insolvencies decreased by -12% y/y in 2022 thanks to several public support measures, including a debt moratorium (until October 2022), tax deferrals and preferential terms for corporate loans. Given the government’s continued fiscal space to maintain support for firms, we expect insolvencies to remain stable in 2023, close to the low posted last year.

While Russia’s (available) FX reserves have recovered since September 2022, the fiscal deficit will rise to -3.2% of GDP (from -2.3% in 2022) due to rising military spending and declining energy export revenues. The government will fund the fiscal gap through domestic bond (OFZ) issuance and withdrawals from the National Wealth Fund. Beyond 2023, budget financing may become more difficult.

You’ll find the complete ‘hot’ topic report including the feature story here.

What to watch

Ukraine’s reconstruction needs to start now. The priority will be investment in infrastructure, health services, housing and schools, as well as digital and energy resilience. We believe that this will require at least EUR100-150bn of private investment (in addition to EUR350bn of foreign aid).

Global energy markets ‒ Fossil fuels remain expensive amid global trade reshuffling. Oil and gas prices dropped over the last months, but constrained supply and resilient demand will keep oil prices at USD92/bbl in Europe in 2023. Natural gas prices will be at 75 EUR/MWh on average.

Eurozone energy inflation, quo vadis? Overall inflation will remain uncomfortably high, but energy inflation will drop precipitously during the coming quarters (due to strong disinflationary base effects), contributing less than 10% of overall inflation this year.

You’ll find the complete ‘hot’ topic report including the feature story here.

The “five Ds” of structurally higher inflation: Demographics, decarbonization, deglobalization, debt, digitalization

The complete report for you here.

Over the last decades, and especially since the global financial crisis (GFC), structural factors, such as globalization, digitalization and aging populations, have caused a secular decline of inflation.

The negative supply-side shocks from the recent crises have reversed this trend – inflation has surged on the back of containment measures (constraining supply chains) or sanctions on energy imports from Russia (raising gas and oil prices). While creating more resilient supply chains and onshoring could slow the pace of globalization (and thus reboot inflation due to tighter labor markets), higher energy prices represent a new structural factor, which is likely to persist even if the war in Ukraine comes to an end.

We see five structural factors – the five Ds – that will determine the course of inflation over the longer term: decarbonization, demographics, digitalization, deglobalization and debt. The net effect of the factors will be inflationary, with significant variation across countries. Overall, the five Ds might significantly lift annual inflation (by up to 1 percentage point).

The complete report for you here.