Jul 9th 2015

Russia’s War on Ukraine’s Economy

by Anders Åslund


Anders Åslund is a senior fellow at the Atlantic Council in Washington and author of the forthcoming book Russia’s Crony Capitalism. 
 

WASHINGTON, DC – Ukraine’s economy may no longer be in free fall, but it remains in dire straits. The country’s GDP contracted by 6.8% last year, and is forecast to shrink by another 9% this year – a total loss of roughly 16% 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% of Ukraine’s GDP. Since then, Russian-supported armed forces have occupied territories in eastern Ukraine that accounted for 10% of the country’s GDP in 2013. With the Donbas region’s production having plummeted by 70% in the months since, this has cost Ukraine some 7% of its 2013 GDP.

Since 2013, Russian trade sanctions have slashed Ukraine’s exports to the country by 70% – accounting for a drop of 18% 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% 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% of GDP before the start of hostilities, has evaporated. This amounts to a corresponding reduction of 3% 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% from lost production in occupied eastern Ukraine, 6% losses from trade sanctions, plus 3% from lost foreign direct investment amounts to 16% 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 US 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 US dollars, they are liable to American prosecution. Ukraine should not be left to face Russia on its own.


Anders Åslund is a senior fellow of the Atlantic Council in Washington and author of Ukraine: What Went Wrong and How to Fix It.

Copyright: Project Syndicate, 2015.
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