Ukrainian economy overshadowed by war. OSW Commentary No. 148, 08.10.2014

Ukraine’s financial results over the past few months prove that the economic crisis which has been ongoing since mid 2012 has exacerbated. According to data from the Ukrainian Ministry of Economy, Gross Domestic Product for the first six months of 2014 shrank by 3%. In the second quarter, it fell by 4.6%1 and may further be reduced by as much as 8–10% over the year as a whole. After the first six months of this year, the balance of payments deficit reached US$4.3 billion. After deflation last year, prices grew by 12%, and the hryvnia dropped to a historic low. Although a surplus was seen in Ukrainian foreign trade in goods and services, reaching over US$3 billion at the end of June, its trade volume is shrinking. The main reason behind this deteriorating situation is the actions taken by Russia. Moscow has been fomenting the conflict in Donbas since April, has consistently imposed embargoes on imports of more and more Ukrainian goods and cut gas supplies to Ukraine in June. This has forced the government to focus on the current management of state finances and to carry out budget sequestration twice this year. The government has also used this as an excuse not to implement necessary systemic reforms. The increasing share of military expenditure, the shrinking exports (-5% in the first six months), including in particular to Russia, which until recently was Ukraine’s key trade partner, and the rapid fall in industrial production and investments have all made the situation even worse. All that saves Ukraine from an economic collapse is the loan from the International Monetary Fund and higher taxes, which allows the government to maintain budget liquidity. However, if the conflict in Donbas lasts longer and if Russia continues its economic blackmail, including withholding gas supplies, the economic crisis may prove to be long-lasting.