The War Against The East Has Ruined An Already Weak Ukrainian Economy

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WASHINGTON – A few weeks ago I wrote that Ukraine should cut its losses by letting its Eastern provinces go. Let them become independent. Let them join Russia. But let them go.

Let the East go

I wrote this advisedly. I recognized then as now that this would have been an unprecedented, truly drastic action, with major repercussions, domestic and global. Giving in to Russia’s political and military pressures, disguised as a spontaneous local rebellion, would have had consequences, none of them positive. It would have meant that the Russian bully wins.

Ukraine is fighting all alone

All true. However, this choice would have allowed the Kiev government to cut its losses and truly focus on the urgent need to fix a horrible economy.

But Ukraine decided instead to fight the rebels, whatever the level of Russian direct or indirect support, even though Ukraine is in an extremely difficult situation, because it has to engage Moscow and its proxies all by itself.

Ukraine is not a member of NATO, therefore no direct support from the West. And, as it turned out, little or zero appetite in Washington and in Brussels for any military support whatsoever, (the US offered meals ready to eat and socks to the Ukrainian army), in order to minimize the chances of an open confrontation with Moscow. Therefore, a few nice words to the Kiev government, some gestures, but that’s about it. The sanctions against Moscow, even if a bit more serious now, still fail to hit the Russian economy really hard.

Ukraine is broke

In the meantime, let’s keep in mind that the Kiev government now fully engaged in this war is essentially broke, while it desperately needs natural gas supplies from Russia, its enemy.

But newly elected president Petro Poroshenko, following God knows what kind of game plan, decided to step up the military effort against the Moscow backed rebels. And it looks as if the situation on the ground has improved. The Ukrainian army is squeezing the rebels.

A deteriorating economy

But these military successes, while relevant, come at a huge cost. As I said, Ukraine is essentially insolvent. It relies for its survival on loans and lines of credit from the IMF, the EU and the US.

An already poor performing economy is in a recession: -4.7% in the second quarter. The official forecast is for a GDP decline of 6 to 7% for 2014. At least 3 percentage points of this steep decline can be ascribed to the cost of the war. Manufacturing output is down 5%. construction is minus 9%. Unemployment is up to 9.3%.

The war is costing too much

From the above it is easy to see how this war in the East, whatever the military successes on the ground, is simply hastening Ukraine’s economic demise. And, even assuming the ability to finally crush the rebellion in the East, (this would also assume that Putin would stop aiding the secessionists), then what?

How would Kiev deal with millions of unhappy and still restless ethnic Russians? Where is the money to rebuild destroyed cities and shattered economies in the East?

I have no idea if anybody even attempted to add all this up. But I suspect, even assuming a quick and favorable end of the hostilities, that we are talking about spending tens of billions of dollars before Ukraine can become a quasi-normal country again.

Tens of billions needed to fix Ukraine

Indeed, if you put together money needed to revitalize the semi-comatose (and sadly very corrupt) overall economy, money needed to rebuild the virtually destroyed East, money to pay old energy bills with Russia and additional funds for future gas supplies, and whatever will be needed to resupply the armed forces, we are talking about billions and billions of dollars, money that Ukraine does not have.

Beyond all this, forget about any campaign to attract new foreign investors. No one will seriously consider a country at war as a good place to set up shop.

To sum it all up, whatever the future of this military campaign, from an economic standpoint Kiev’s all out effort to crush the rebellion has been a major disaster. And the longer the fighting, the worse the economic impact.

Give up the East, focus on the economy  

As I said above, to unilaterally give up the Eastern provinces would have been a terrible loss for Ukraine; but a loss that would have allowed the central government to end this political crisis and redirect all its energies on the economy. Fighting this war, even if in the end there is military success, has made an already bad economic situation a lot worse.

Expect Ukraine to be a basket case supported by Europe and by the IMF for years to come.

 

 

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