The offshore pipeline Nord Stream 2, the $11 billion project designed to double gas flows between Russia and Germany, is now idle and abandoned. Germany stopped certifying the pipeline altogether after Russia officially recognized two pro-Russian regions in eastern Ukraine, creating a pretext for the subsequent invasion.
Axel Schmidt | North Stream 2 | via Reuters
German economists are predicting a recession in Europe’s largest economy if Russian gas supplies were halted, and the impact could spread across the continent.
In their semi-annual joint economic forecast published on Wednesday, the five largest German economic institutes sharply reduced their forecasts for gross domestic product as the war in Ukraine slows the recovery from Covid-19.
The RWI in Essen, the DIW in Berlin, the ifo Institute in Munich, the IfW in Kiel and the IWH in Halle now expect German GDP to grow by 2.7% in 2022 and 3.1% in 2023, under assuming that there will be no further economic escalation in connection with the war in Ukraine and gas flows to Europe from Russia will continue. The institutes had previously forecast growth of 4.8% for 2022.
Ukrainian President Volodymyr Zelenskyy and the European Parliament have called on the European Union to impose a full embargo on Russian oil, gas and coal imports in the face of atrocities against civilians by Russian forces in Ukraine.
The EU plans to ban Russian coal imports and is working on sanctions against Russian oil to cut the Kremlin out of the world economy, while Russian President Vladimir Putin has also repeatedly threatened to cut off gas supplies to Europe.
However, it is expected that such a move will have serious economic consequences for both sides. According to the European statistics agency, Germany bought 58.9% of its natural gas from Russia in 2020.
The Nord Stream 2 pipeline, the $11 billion project designed to double gas flows between Russia and Germany, is now idle and abandoned. Germany stopped certifying the pipeline altogether after Russia officially recognized two pro-Russian regions in eastern Ukraine, creating a pretext for the subsequent invasion.
In the event of a total failure of the Russian energy supply, the German institutes are forecasting cumulative damage of around 220 billion euros for this year and next, which corresponds to over 6.5 percent of annual economic output. That would translate to just 1.9% growth this year and a 2.2% decline in 2023.
inflation headache
“If the gas supply were to be cut off, the German economy would fall into a severe recession. In terms of economic policy, it would then be important to support marketable production structures without stopping structural change,” said Stefan Kooths, Vice President and Research Director for Business Cycles and Growth at the IfW.
“This change will accelerate for gas-intensive industries even without a boycott, like
the dependency on Russian supplies, which were previously available at low prices, should be overcome quickly anyway.”
Kooths advised governments to avoid “ill-targeted transfers” to cushion higher energy prices.
“If such support programs are distributed across the board, it will continue to push up inflation and undermine the important signaling effect of higher energy prices. That, in turn, exacerbates the problems of low-income households and increases the overall economic cost,” he said.
The European Central Bank faces a unique, contradictory challenge of containing record-high inflation without stamping out already flagging economic growth, which is likely to be hit further by supply shocks as the war in Ukraine continues.
Inflation in the eurozone was 7.5% on an annualized basis in March, according to Eurostat, and the German institutes are forecasting an overall annual average of 6.1% for 2022, the highest level in 40 years.
They forecast an increase to a post-war record high of 7.3% in the event of an energy disruption. The rate of 2.8 percent forecast for next year will also remain well above the average since reunification and will rise to 5 percent in the event of an energy blockade, the report says.
“The shockwaves of the war in Ukraine are weighing on economic activity on both the supply and demand sides,” Kooths said.
“Government stimulus packages during the pandemic have already had an inflationary effect. Rising prices of critical energy commodities following the Russian invasion further intensify upward pressure on prices.”
Geraldine Sundstrom, portfolio manager at PIMCO, told CNBC on Friday that the risk of a recession in Europe is far greater than in the US right now.
“The European economy is not in the same strong position as the US economy and a potential industrial recession could be on Europe’s doorstep depending on the disruptions from the conflict, what is certainly happening in Asia and we have it seen – particularly in the automotive sector – a number of factories have had to close due to missing parts and this has resulted in some workers in Germany being furloughed again,” Sundstrom said.
“Europe is also facing a very important supply and inflation shock and, if anything, the ECB seems more willing to normalize monetary policy, even though the risk of a recession is much greater in Europe than in the US.”