Russia’s invasion of Ukraine darkens economic outlook

This year, the economy will grow more slowly than previously anticipated in Europe and Finland and country´s . gross domestic product will grow by 1.5% in 2022, according to the Economic Survey published by the Ministry of Finance on Wednesday.

The Finnish economy was making good progress in recovering from the COVID-19 crisis before Russia attacked Ukraine in late February. The EU, the United States and other Western countries responded to Russia’s invasion of Ukraine by imposing economic sanctions against Russia. The sanctions have further accelerated inflation, which decreases household purchasing power.

The sanctions will practically stop Finland’s foreign trade with Russia, which will cut Finland’s economic growth this year. Finland’s gross domestic product (GDP) is forecast to grow by 1.5% in 2022, by 1.7% in 2023 and by 1.5% in 2024.

“The Finnish economy was taking off. Then Russia’s invasion of Ukraine blurred the outlook and turned the takeoff into a gradual economic slowdown and accelerating inflation. In the longer term, the effects of the war will merge into the structural change in the economy and society,” said Mikko Spolander, Director General of the Economics Department.

The assumption in the forecast is that the sanctions imposed against Russia and by Russia will remain in force for a long time.

The forecast does not assume any new restrictions to prevent the spread of the COVID-19 pandemic that would have negative economic events.

Russia’s invasion of Ukraine will have far-reaching repercussions for the global economy as it erodes confidence, raises energy prices and accelerates inflation.

Global economic growth will slow from just over 6% in 2021 to an average of 3% in 2022–2024. Trade in goods will continue to grow by around 4.5% annually in 2022–2024.

Russia has sunk into a deep economic crisis. Foreign enterprises are relocating their operations away from Russia, and exports are declining, as Western countries are restricting energy imports from Russia. Imports are reacting even more strongly than exports. Payment system restrictions are hampering the functioning of the economy. The sharp hike in inflation is reducing the real income of wage and salary earners. According to the forecast, Russia’s total output will decrease by 15% in 2022 and by 2% in 2023.

The war has rapidly clouded the economic outlook for the euro area. A role greater than that played by the direct impacts on trade with Russia is played by the rise in energy prices, caused by energy market uncertainty, and by the confidence effect reducing economic activity.

In the United States, the surge in inflation is cutting consumers’ purchasing power and, consequently, slowing economic growth. The increase in COVID-19 infections in China has resulted in strict lockdown measures that hamper industrial output and disrupt global production chains.

The impacts of the war in Ukraine will also extend to Finland’s general government finances due to the deteriorating economic situation. At the same time, the war and growing geopolitical tensions are reinforcing the need for preparedness, creating spending pressures, some of which will be permanent in nature.

In its spending limits discussion, the Government decided on a significant package of preparedness and support measures that will increase public expenditure especially in the short term. In the medium term, general government finances will be made weaker by the earlier decisions on defence investments and by the slowdown in economic growth. However, general government deficit will continue to shrink in the next few years before it starts to grow again in late 2024. The drop in the debt ratio came to a halt last year, and the debt ratio will start growing moderately already this year. Growth in the debt ratio will accelerate in the longer term, particularly due to ageing-related expenditure, slow economic growth and growing interest expenditure.

Good growth in employment has narrowed the sustainability gap, but the war and the measures taken as a result are also reflected in the sustainability gap estimate. The long-term structural imbalance between revenue and expenditure is approximately 2.5% in ratio to GDP, or approximately EUR 7 billion at 2026 levels.

The assumption in the forecast is that the sanctions imposed against Russia will remain in force for a long time. It is very likely that the war in Ukraine will expand in such a way that all imaginable economic sanctions will be deployed. If the supply of raw materials and energy from Russia ceases completely, it will have a significant impact on accelerating prices and weakening the availability of energy. This would weaken Finland’s export demand both directly and indirectly as a result of the slowdown in growth in the euro area.

There is a risk that Russia will seize Western assets and production facilities and isolate itself further from cooperation. Russia’s countermeasures will undermine confidence and further accelerate inflation. Price increases will erode household purchasing power and private consumption will decrease. In Finland, both output and demand will decline and their recovery will take a long time.

There is a great deal of uncertainty in the forecast for general government finances, and the risks are mainly weighted to the downside. First, the impacts of the war in Ukraine may be bigger than currently estimated. Second, the COVID-19 pandemic may still cause waves that are stronger than anticipated, which in turn may require more support measures. Third, the brisk growth seen in tax revenues in the early part of the year may fade faster, pulled down by a major erosion in consumer and business confidence. In addition, the already rapid pace of interest rate increase may accelerate further, which will affect interest payments and the debt ratio over the longer term.

The uncertain outlook of the investment environment may push back investments even further or cancel them altogether. The outlook for private investments may be more positive than forecast if the energy sector makes investments to become independent of Russian fossil fuels.