The impact of war on the rural economy

CLA Senior Economist Charles Trotman examines what the implications of the Russia-Ukraine war are on the rural economy in the UK

When we consider the impact of the ongoing Russia-Ukraine war, there are many interlocking interests that have the potential to affect members’ businesses. The full economic consequences are, so far, difficult to quantify, but there will inevitably be a series of knock-on effects, whether they be increases in energy prices or price surges on the cost of fertiliser.

Looking at the data in trade the UK has with Russia and Ukraine, there are some clear short to medium-term impacts:

  • Ukraine and Russia account for 23% of the global wheat trade;
  • Russia is the world’s largest exporter of wheat with Ukraine third, and accounts for around 28% of total global exports (20% Russia; 8% Ukraine);
  • Ukraine supplies 12% of global barley exports, 13% of global maize exports and 40% of global sunflower oil exports;
  • Ukraine and Russia deliver 55% of global exports of pig iron and 15% of global exports of semi-finish iron/steel products;
  • Russia supplies 20% of total nickel exports (used for lithium-ion batteries) and is the fourth largest exporter of aluminium, and Ukraine and Russia account for 90% of world neon supplies, a vital component in the production of semi-conductors;
  • Russia is the world’s largest exporter of fertilisers, with Russia and Belarus producing 17m tonnes of potash per year.

What we are seeing so far is that production systems are being disrupted, which will reduce supplies and invariably increase market prices.

How reliant is the UK on Russian gas and oil supplies?

Assessing the data, Russia only provides 5% of the UK’s gas imports, it provides 40% of supplies in the EU (including 55% of German gas imports). But complications in the EU supply chain could have indirect negative effects on UK producers. And once more, if future supply is restricted due to the war, wholesale gas prices will inevitably increase again.

However, when we look at the oil market, Russia accounts for 13% of UK oil imports, and reduced supply will increase fuel prices. This is already being reflected in the price of Brent crude. Interest in supplies other than Russian oil has further restricted supply and led to prices well above $100 per barrel. This will mean that prices at the pumps and for red diesel will increase, possibly by as much as 20%.

How will disruption to supply chains affect the UK agrifood sector?

Ukraine’s transport and delivery infrastructure are vital to its export supply chain. Some 90% of Ukraine's grain exports are transported by sea, and the reliance on the Black Sea ports means that any disruption will have knock-on effects on prices. Therefore, Russian military attacks on the Black Sea ports are exacerbating transport problems. When the unavailability of both insurance and shipping is considered, it is likely that the negative effects will be long term and will be more destabilising than originally thought.

Although Russia is not considered a main export market for the UK - it accounts for around 1% of trade - the UK has been reliant on imports from both Russia and Ukraine as already described. These are now threatened and it will take time for UK businesses to source alternatives. Such disruption in trade will inevitably have negative impacts.

It is in financial markets that UK businesses could be adversely affected if global payment systems are interrupted. In addition, this could have knock-on effects on global stock markets that will increase uncertainty.

Are the sanctions imposed on Russia by the west going to work?

It has been thought that the imposition of sanctions has been deliberately limited to reduce disruption to Russia’s key commodity exports to its main partners. This may have been the case before the war erupted, but the sheer scale of the Russian invasion would suggest this is no longer the case. Further and tougher sanctions appear inevitable, and these will reduce the economic viability of Russia. Of course, this will be dependent on the actual length of the conflict.

The effect will be to cause instability in commodity and financial markets that will cause a series of ripple impacts on the UK (as well as the EU).

As importantly, it will lead to further instability on world markets at a time when national economies are looking to recover from the Covid-19 pandemic. This would suggest that the timescale for recovery needs to be extended from three to four years to five to seven years.

What are the short and medium-term impacts for the UK economy?

All forecasts point to increasing pressure on the UK inflation rate, with increasing energy, input and food prices. For example, over the last six months, fertiliser prices have increased three-fold, and there will likely be further increases over the next six-month period.

Given the potential impact of disruption to Russian fertiliser production and export capacity, there will also be further restrictions on carbon dioxide production, which will have knock-on effects for a number in agrifood sectors as well as hospitality.

We would assume that the Bank of England’s inflation forecasts will need to be revised. According to the CBI, a number of forecasters are already estimating inflation to rise above 8% by April (inflation was 5.4% in January 2022). The target inflation rate is 2%.

Increasing inflation leads to a squeeze on household spending and spending on other goods and services. For businesses, it will lead to increased pressure for higher wages, together with higher energy costs and other inputs. This will further reduce business margins unless businesses can increase efficiencies.

In addition, this type of inflationary pressure will increase the need for higher interest rates to counteract inflation. The CBI assumes that there will need to be between three to four 0.25% interest rate increases (+0.75% - 1.0%) over the next 24 months. The effect will reduce the ability of businesses to invest in the future.

So, it is likely that post-Covid recovery will take longer to emerge. This recovery will be slower than previously forecast, and increased inflationary pressures together with the likelihood of higher interest rates will further slow recovery.

What should members consider?

  • Any opportunities to reduce costs and increase operational efficiencies;
  • Plan business operations in the short and medium-term that takes into account the impact of global and domestic impacts on the business;
  • The possibility of greater collaboration to reduce costs;
  • Assessing current energy use and look at any cheaper options in the short to medium term.

Key contact:

Charles Trotman
Charles Trotman Senior Economics and Rural Business Adviser, London