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Russia’s war on Ukraine’s economy

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Ukraine’s economy may no longer be in free fall, but it remains in dire straits. The country’s GDP contracted by 6.8 percent last year, and is forecast to shrink by another 9 percent this year — a total loss of roughly 16 percent over two years. While things seem, to some extent, to be stabilizing — depreciation of the hryvnia has eliminated the country’s current-account deficit, and a massive fiscal adjustment brought Ukraine’s budget into cash balance in the second quarter of this year — the situation remains precarious.

Ukraine’s primary economic challenges are not homegrown; they are the result of Russian aggression. The country’s belligerent eastern neighbor has annexed Crimea, sponsored rebels in eastern Ukraine, pursued a trade war, intermittently cut off its supply of natural gas, and is threatening financial attack. So far, Ukraine has miraculously managed to withstand these assaults with little international support — but it is in desperate need of assistance.

Russia’s annexation of Crimea in March 2014 seized 4 percent of Ukraine’s GDP. Since then, Russian-supported armed forces have occupied territories in eastern Ukraine that accounted for 10 percent of the country’s GDP in 2013. With the Donbas region’s production having plummeted by 70 percent in the months since, this has cost Ukraine some 7 percent of its 2013 GDP.

Since 2013, Russian trade sanctions have slashed Ukraine’s exports to the country by 70 percent — accounting for a drop of 18 percent in Ukraine’s total exports. Last year alone, Ukraine’s exports to Russia — which included machinery, steel, agricultural goods, and chemicals — fell by half. Logistical issues, the lack of commercial links, and the specialization of some products meant that the goods could not be redirected in the short term. I estimate that the loss is likely to correspond to a 6 percent decline in Ukraine’s GDP.

Businessmen everywhere are aware of Russia’s assault on Ukraine, and, unsurprisingly, few want to invest in a war zone. As a consequence, Ukraine’s net foreign-direct investment, which was slightly over 3 percent of GDP before the start of hostilities, has evaporated. This amounts to a corresponding reduction of 3 percent of GDP. In addition to this, Ukraine has faced an intermittent gas war. A financial assault may be yet to come.

Leaving Crimea aside, we can attempt conservatively to sum up Ukraine’s economic losses from Russia’s aggression. Roughly 7 percent from lost production in occupied eastern Ukraine, 6 percent losses from trade sanctions, plus 3 percent from lost foreign direct investment amounts to 16 percent of GDP — that is, the total amount Ukraine is estimated to have lost from the beginning of 2014 to the end of this year.

Russia’s apparent but undeclared aim is to make sure that democratic Ukraine fails, without looking entirely guilty of having caused that failure. This leads to an important conclusion: Ukraine is not the culprit but the victim, and it should be treated accordingly. One does not counter military aggression only with stabilization credits, but also with military support.

European countries should note that, given the Kremlin’s saber-rattling in the Baltic and the Balkans, there is little reason to believe that the Russian threat is limited to Ukraine. Delivering arms to Ukraine before Russia attacks, openly or covertly, should be a priority.

On July 1, Russia opened a new front in the economic war on Ukraine when the energy giant Gazprom, which is majority-owned by the Russian state and slavishly pursues Russian foreign-policy objectives, decided unilaterally to cut off the country’s gas supply. Given the global gas surplus, Europe is in a position to tell Russia in no uncertain terms that its corrupt practices are no longer acceptable. In particular, the European Commission should insist that Ukraine be able to continue to import gas from Gazprom in order to augment European supplies.

Furthermore, the economic war is making it almost impossible for Ukraine to deal with the humanitarian emergency that Russian aggression has caused: more than 6,000 citizens killed, tens of thousands injured, and 1.3 million people internally displaced. The international community, again with the EU in the lead, must provide substantial humanitarian assistance.

Ukraine’s stabilization program with the International Monetary Fund is sound but underfunded. An additional credit of roughly $10 billion is needed to raise Ukraine’s international reserves and stabilize its currency so that controls can be lifted. This money should come from the EU and the United States. Meanwhile, the EU should make Russia’s trade war with Ukraine the focal point of any trade negotiations with the Kremlin. And it should abolish its remaining strict import quotas for Ukrainian goods.

Finally, every legal avenue to holding Russia to account must be pursued. Sanctions against Russian President Vladimir Putin’s cronies should not only be continued, but also deepened. And the U.S. should follow on its success in tackling FIFA by exposing criminals in former Ukrainian President Viktor Yanukovych’s regime and Putin’s entourage. Given that many of them have international bank accounts in U.S. dollars, they are liable to American prosecution. Ukraine should not be left to face Russia on its own.

Anders Aslund is a senior fellow of the Atlantic Council in Washington and author of “Ukraine: What Went Wrong and How to Fix It.” © Project Syndicate, 2015 www.project-syndicate.org

  • justin bristow

    There’s a problem with this idiotic accounting.

    The Ukrainians do not separate Donbass from Ukraine when making economic assessments. The Donbass economy, 7 percent of the total, is still factored in Ukraine’s total. Right there is half of the GDP loss supposedly ascribed to Russian aggression.

    Of course much of that 7 percent has been destroyed, by Kiev’s own artillery foremostly. This article cleverly steers passed that admission. Not that the Russians didn’t help the rebels, they absolutely did.

    If you read reports like that of the Brooking’s Institution a year ago, you would know that 50% of Ukraine’s GDP was dependent not only on trade with Russia but on subsidies achieved by its relationship with Russia.

    Those economic ties continue to unwind, resulting in non-competitive businesses across Ukraine coming to a screeching halt. Industrial production is off 18% from last year, GDP off 17 percent.

    Without investment, there will be no re-orientation on Europe. Whole new industries which can fit in the European market must be built, it is not possible to restructure most of the Russian oriented business in Ukraine to sell goods to Europe.

    Total foreign debt in Ukraine, private and public, already exceeds 100 percent of GDP. In a few years, public debt alone will reach 100 percent of GDP. The Ukrainian budget, despite austerity, has a budget that still exceeds a 5 percent to GDP deficit.

    The business climate in Ukraine hasn’t changed significantly for the better for investors. Corruption remains as bad or worse as it was 2 years ago. In a declining economy with mass poverty, petty and bureaucratic corruption will flourish.

    The only way for Ukraine to meet its debt obligations is to print money. It did a lot of that last year, hence the 70% devaluation of its currency. Now it just wants to default on its debts. Once it does that, it will just finance its 5 percent GDP deficit with printing money each year. Nothing attracts investors like soaring inflation for years on end.

    Ukraine’s economy is a complete mess without a linkage to Russia, aggression or not. It needs tens of billions in free money (not investment, not loans, just cash). To get passed all its issues. The US and Europe can just do that.

    Why don’t they?