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Background
The sounds of war roared once again in the wake of the 24 February, earlier on this year, sending tremors throughout the European continent and beyond. As much as it led to a humanitarian and political crisis, especially in Ukraine, the Russian invasion of the ex-Soviet nation also negatively affected the global economy as it had been recovering from the effects of Covid-19. Ironically, despite the historical benefits that Malta would have derived out of such conflicts, as exemplified by the Crimean War 1853-1856 and the First World War, today exists a different reality. Malta is no longer a war economy where trade and opportunity flourish in times of war. Rather, the emphasis on the services industry and its dependence on foreign importation of goods has implied several costs which the general populace is enduring. This should come to no surprise given the promise of relative peace created by the inception of the European Coal and Steel Community and, in the grand scheme of things, the United Nations, as the rubble settled after the Second World War. To this extent, this policy paper will look at the effects of the Russo-Ukrainian War on the Maltese economy, ranging from the obvious to the subtle.
Supply Chain Shortages: Inflationary pressures
The most evident strike at the Maltese economy is the observation of higher prices, specifically on foodstuffs. As economic theory would have it, a situation of excess demand, also known as a shortage, exerts inflationary pressures. The conflict in the east has disrupted the exportation of agricultural goods around the globe from Ukraine which happens to be a very significant artery of the global corn and wheat exports. Malta has not been spared from this fate, recording food inflation 1.2 percentage points higher than the euro area as of April 2022. One should not forget, after all, that these islands import some 70% of its food, making it vulnerable to the volatilities in the international theatre.
A more thorough analysis implores us to explore the effects imposed on the input of other industries, not only on those imports where we derive the output directly. Here, the Malta Chamber of Commerce raised the red flag in relation to the prospects of the manufacturing industry. It is not only the fact that a war-torn Ukraine is unlikely to provide as much items such as rice starch and crude sunflower oil from whom we import some 80% of the imports for each respective good, but what of the deteriorating relationship with Putin’s regime? NSO statistics show that 98% of exports of machinery and apparatus for welding go to Russia. The retaliatory action that the EU has taken in the face of hostility, in the form of economic sanctions and the freezing of Russian assets, implies that Maltese businesses would need to find alternative hubs for their supply. In total, Malta imports €53 million worth of commodities from the clashing countries, with €47.5 million from Russia, and the rest from Ukraine.
Should there be a positive to all of this, is that Maltese individuals were not also victims of fuel and energy inflation. Fortunately, the government has intervened adequately in maintaining fuel prices stable, where diesel and petrol stand at €1.21 and €1.34, respectively, at the time of writing. Compare this with the likes of Germany where diesel is just shy of the €2 mark. Finance Minister Clyde Caruana revealed, however, that such assurance has an allocated budget of €200 million, paid for by the taxpayer, which could potentially become greater. How long this trend can be maintained is a question of resilience.
When faced with higher costs of living, the most logical reaction of the working population is to demand higher wages. The potential risks of wage inflation cannot be emphasised enough. The wage-price spiral phenomenon is a vicious cycle whereby companies will react to higher wage demands from their employees with a higher price mark-up for their products, inviting an even higher wage demand once more. Last April, wage inflation in Malta stood at 5%.
Looking at this aspect from a general point of view, there is quite an optimistic belief that Malta would emerge out of this war without bearing too much harm. The Central Bank’s current projection is that, despite the acceleration of inflation from 0.7% in 2021 to around 5% in 2022, it is its opinion that the rate will slow down to under 3% by 2023, though the European Commission has suggested higher rates more recently. This, however, happens to be the lowest forecast throughout the EU.
Migration: Divisions and Bridges
In spite of the fact that immigration has not featured as a hot debate in our recent news stories as extensively as it did in the middle of the last decade, the war of conquest could just be the trigger for another wave of illegal migration to take place. Stemming from a greater likelihood of famine, the islands could witness a rising tide of economic migrants from the African continent. One should understand how globalised the world has become, where the disorder and suffering in one part of the world spreads to the rest.
The skirmish itself has led to more than a thousand Ukrainians, of which 4% are minors, to receive temporary protection in Malta. This number, whilst sizeable in our country’s context, is insignificant given the total of ten million individuals who have been displaced since the beginning of the war. 76% of the incoming population from Ukraine to Malta are women, which shouldn’t be surprising since men capable of fighting are disallowed to leave the country. The sad truth is that many families have been torn apart from each other.
But it could also be seen that these divisions could lead to bridges being built. Ukraine, Georgia, and Moldova all submitted their application to join the EU with two out of the three (Ukraine and Moldova) successfully reaching candidacy status on 23 June 2022. As regards to Georgia, the EU recognised that the country has serious European aspirations but demanded that a number of reforms occur before candidacy is awarded. This could mean further inbound migration to Malta in the future via legal means, facilitated by the principle of freedom of movement embraced by the EU. Yet we cannot speak about broadening the borders of the EU before the borders of Ukraine are restabilised.
The Central Bank’s Gambit
Policy decisions are always a dilemma, involving a gamble. This does not only concern the instruments at the disposal of the Central Bank of Malta or the European Central Bank (ECB), formally known as monetary policy, which is what this section will mainly focus on. But it is also a headache to governmental decisions in relation to its budget allocation, called fiscal policy. They are indeed a gamble since, on the one hand, these discretions could lead to the stabilisation of the economic cycle. On the other hand, if the magnitude and timing of the policy manipulation is misconstrued, one could end up in an even more undesirable position than previously. A case in point is the concern surrounding Biden’s extensive spending for the pandemic recovery plan. Whilst it has definitely helped push for a quicker recovery from the recession, such spending saw the inflation rate soar to around 8%, before news of war broke out. For context, the ECB pushes for an inflation rate of lower but close to 2%.
In keeping price stability in check, the European Monetary System has a range of tools available, though the world of finance looks primarily to the interest rate. Just a couple of weeks ago, on 21 July, the Governing Council announced that it will be raising three key ECB interest rates by 50 basis points, or 0.5%. The interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility have increased to 0.50%, 0.75% and 0.00%, respectively. By making borrowing from the Central Bank more expensive, Commercial Banks would have less incentive to borrow and expand their operations, which should have a contractionary effect, driving down inflation. The same conclusion can be made with the increase of the deposit rate, since Commercial Banks are incentivised to leave their liquidity with Central Banks, meaning less cash is available to make loans to the public, slowing down the economy and hopefully, inflation.
Fortunately, this trend has unlocked the interest rate as being a monetary policy tool available for the next recessionary period. The situation in the last decade was one where the interest rate reached what economists call the ‘zero lower bound’. In simple terms, commercial banks who had deposited in Central Banks either earned no interest or sometimes, had to pay interest themselves. This occurred as a result of the Great Recession back in the late 2000s where monetary authorities attempted to revitalise the economy by lowering the cost of borrowing up to the point where it could not be lowered more i.e. the zero lower bound. Now that the rate is being raised again to control inflationary pressures, there is no more a binding effect on the movement of the rate of interest.
Upsetting the Euro
The last economic effect to be discussed is the depreciation of the Euro. Many of the widely used currencies of today are described as floating/flexible as opposed to fixed. The distinction is that whilst the former is determined via market forces, the latter is set by the Central Bank, usually acting on behalf of the state’s wishes. The Euro falls within the first category and, consequently, is vulnerable to the perception of international investors. Unsurprisingly, the Euro has experienced a decline in its value during the war’s length, falling by about 10% since the start. Almost twenty years have passed since the Euro and the Dollar were on par, back in December 2002. On July 12, this circumstance reappeared, if only for a short while. The Dollar, contrary to the Euro, has reached a 20-year high against several other currencies.
The weakening of the Euro comes as a result of previously mentioned issues. Supply-side shocks, higher borrowing costs, and a European-wide energy crisis, do not make Europe as a very attractive investment destination. And similar to when the price of clothing falls as they become obsolete, the value of the Euro faces the same predestination.
But what does this mean for the Maltese consumer? If before one could purchase $1.10 worth of American goods for €1, that same €1 can only obtain about $1 of goods at present. Effectively, the purchasing power of the Euro has diminished in the face of American commodities. Of course, this is good news for the U.S. citizens who wish to purchase from Malta, or from any other Euro Area member state for that matter. The USD appreciates at the expense of Euro depreciation. Be that as it may, a currency depreciation as allowed under a floating exchange rate regime is in itself a softening cushion. Now that purchases of European goods from outside are cheaper, the demand for the euro would rise, and this can serve as a partial reversal of the initial depreciation.
Concluding Remarks
A general overview of the present or expected economic effects of the Russo-Ukrainian War on Malta was provided within this policy paper. These ranged from short-term impacts such as a higher cost of living, medium-term effects including the future capacity of monetary policy tools, to even longer-term consequences as regards to migration should EU borders expand. Economic fallouts are, by no means, the only form of ramifications that this war has fraught. The political and diplomatic implications are the other side of the coin which need to be seriously evaluated. Europe is a battlefield once again, and the winner will be the one that manages to outlast the other’s undermining attempts.
But there is never a winner when lives are reduced to numbers. It seems that the bloodshed in the previous century has not deterred certain individuals from resorting to their weapons once more, and history is doomed to repeat itself. ‘War does not determine who is right, only who is left’ Bertrand Russel.