The Ukrainian economy suffers under the political and military crisis, as does the Russian. Yet, President Poroshenko’s moves toward greater integration with the EU may let the country bounce back in 2015.
At the moment, Russian economic forecasts for the first half of 2014 indicate that the effects of the sanctions regime have been twofold. First, the individual sanctions (and the threat of comprehensive sanctions) have curtailed domestic growth and cut foreign investment in the Russian economy. Second, alongside the effects of prolonged instability in Ukraine, sanctions have sparked extensive capital flight from Russia.
A German government committee revealed a few weeks ago that the trade exchange between Russia and Germany – generally a useful indicator given the strength of German and Russian trade flows – had declined in volume by 13 percent between the first quarter of 2013 and the corresponding period in 2014.
Meanwhile, although there have been attempts at political rapprochement and a push for dialogue in the form of a contact group led by the Russian Federation and the EU, there will be several factors necessary to achieving a future resolution to the conflict.
Ukrainian economy hit the hardest
If the Ukrainian government’s move towards signing the economic part of an EU association agreement, and the apparently sincere willingness of Ukraine’s new president to Westernize are any indication, Ukraine will find itself moving closer to the European Union. Predictions in May by the European Bank for Reconstruction and Development (EBRD) suggest Ukraine may be well on its way to escaping a decline in growth by 2015. As part of the association agreement, Ukraine will enter a Deep and Comprehensive Free Trade Agreement (DCFTA), moving closer to joining the European common market.
All these moves improve predictability in regards to Ukraine’s economic risk, and with a rise in predictability, the level of market volatility in Ukraine will be staved off. Moreover, a regional containment of the conflict will also help dampen the effects of political risk on the Ukrainian economy.
Although Ukraine’s economy has been hit the hardest, an early resolution to the conflict could significantly improve Kyiv’s chances of bouncing back in 2015.
The end of a ceasefire on June 27th – a ceasefire that had been constantly violated – failed to create a stalemate in the confrontation between the Ukrainian government and the Russian Donbas minority in the largely industrial region of eastern Ukraine.
The economy of the Donbas region, centered around Luhansk and Donetsk and known for its coal, steel and shale gas production, has already declined 30 percent since the beginning of the year. It has also been declining since Ukraine’s independence in 1991.
Since the vested business and industrial interests in the region are largely geared towards ending the conflict, with the exception of staunchly pro-Russian businessmen like Viktor Medvedchuk and Oleg Tsariov, the decline of heavy industry if Rinat Akhmetov and like-minded oligarchs leave permanently and the threat of further standstills and worker flight, creates an incentive to end the conflict.
What about Ukraine’s oligarchs?
An important test of the Ukrainian government’s legitimacy by the end of the year will be the partial or complete elimination of financial interests linked to former President Viktor Yanukovych. Several prominent oligarchs formerly affiliated with pro-Russian business interests around Yanukovych, including Rinat Ahkmetov, continue to shape the conflict.
Still, the leverage these businessmen have in bringing about a solution to the conflict is sometimes overstated. Potential mercenaries and armed civil groups like the Russian Orthodox Army crossing into Ukraine across the porous Russo-Ukrainian border have used a lack of willingness to concede territorial gains into an almost total control of political outcomes on the ground.
Potential solutions to the conflict
A renewal of armed conflict in eastern Ukraine, whether that conflict ends in six months or twelve, or in an effective Transnistrian stalemate, unquestionably inspires longer-term effects. Two possible solutions to the conflict could develop.
First, a territorial containment or ‘managing’ of the conflict, such that military confrontation is made into some kind of political arrangement, could mirror the situation in Transnistria. Moldova recently signed an association agreement with the European Union, and the results of elections in November will reveal whether the Transnistrian model provides a viable alternative to Chișinău’s pro-European model.
The second possibility is an economic and political arrangement between Kyiv and regional separatists that offers the industrial east and displaced workers greater regional autonomy in economic affairs.
If Kyiv fails to capitalize on divisions in the region in the short-term, it can only offer economic and political concessions to separatists in eastern Ukraine. The European Union and Russia should help Ukraine in this effort.