Costly War: Is Ukraine’s Economic Recovery Feasible?

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Ukraine’s industrial production has slowed down by a record 21.4 percent since last year, the National Bank said in its September statement. It confirms a dangerous trend: The country’s economy has been shrinking dramatically since the revolutionary events of February 2014, when peaceful protests in downtown Kiev drew fire, leaving dozens of people killed and hundreds injured. After former President Viktor Yanukovych fled the country and Ukrainian political elites did little to prevent Russia from annexing the Crimean peninsula, the country has tried to revive its ailing economy by adjusting its foreign policies and introducing austerity measures.

Ukraine is suffering from currency overflow and a slowing of the key sectors of the economy, such as heavy industry and exports of minerals and rolled metals. The Ukrainian hryvnia lost around half of its value over just several months. Foreign debt is approaching 60 percent of the gross national product.

The Ukrainian government has had to make significant public-sector budget cuts to cope with a magnifying foreign debt and to satisfy the growing needs of the Ukrainian army as it fights the pro-Russian rebels in the East. Still, despite the crisis and negative projections, tax revenues have grown by 9 percent in the third quarter. Ukrainian economist Dmytro Boyarchuk says the Ukrainian government has employed situational measures to cover the budget deficit, such as using securities for value-added-tax refunds.

“Speaking of the budget, its main filling comes from consumption,” said Boyarchuk. “Sales tax accounts for about 30 percent of the total budget, and there are also excise taxes, import tax and others.”

Pro Journo / Olga Dorovskykh

Back to a Medieval Economy?

The economic stagnation is being caused by military operations, according to the National Bank’s analysis. The war has brought devastation to Ukraine’s industrial center: In August industrial production in the Donetsk and Luhansk regions declined by 59 percent and 85 percent, respectively.

“Since the most severe phase of the conflict in Donbas took place in July-August, this is when most damage was done to both the industrial and infrastructure potential of the region,” said Vasyl Yurchyshyn, director of economic programs at the Razumkov Center, a Ukrainian think tank.

Ukraine’s mining industry has also suffered heavily from the political and military unrest. Seventy percent of coal mines in the Donbas region, where military conflict is occurring, have shut down, and coal production has dropped 60 percent, breaking the value chain of iron and steel producers, which are using coal to keep the industries running. If the fighting continues, these numbers might drop even lower. Meanwhile, all chemical plants located within the area of the military conflict have halted production.

Military actions in eastern Ukraine have caused destruction of many industrial sites and transportation systems. According to the Ministry of Regional Development, 14 trade sites and 132 industrial facilities have been destroyed in Donetsk and Luhansk. As of September 5, 962 miles of public roads and 24 bridges and overpasses have been destroyed or have had varying degrees of damage. The U.N. estimates that losses from infrastructure destruction in Donbas are at $440 million since the armed conflict started. Two-thirds of businesses in Donbass have closed down, including all Ukrainian banks and major trade companies.

The Da Vinci Analytic Group, based in Kiev, said in its recent report that by conducting a hybrid war, Russia is trying to destroy the industrial potential of Ukraine, its closest competitor.

“The Kremlin’s strategy involves disruption of the economy and infrastructure of eastern regions of Ukraine for the sake of strengthening the positions of Russian national companies in both domestic and foreign markets,” the report says. While industrial production in Ukraine dropped by 4.6 percent in the first five months of 2014, in Russia the situation is the reverse. The Russian industrial index grew 1.7 percent during the same period.

“By removing Ukrainian competitors from Russia’s internal market and nipping off part of the world’s [steel] market, Russia supported its own industry. Its method is destabilization of the situation in Donbass and trade war,” the report continued. Ukraine accounts for 98 percent of Russian steel imports. Over five months, rolled steel imports to Russia dropped by 38 percent. Russia routinely denies its involvement in the armed conflict in eastern Ukraine.

Boyarchuk said the war has pushed Ukraine closer to the inevitable: shutting down Soviet-era industrial plants, which can no longer sustain themselves. “There’s more negative than positive in the war, because everyone is scared and nobody is investing, but there is another side of the coin,” he said. “Ukraine has always been pulled back by its underdeveloped heavy industry. The depreciation of the assets in our economy is under 80 percent. This is very painful, but it leads to the purification of the economic system.”

European Economic Future

While Ukraine’s political future is still unclear, with the implementation of the European Union Association Agreement postponed, the economic aftermath of the revolution and military conflict is obvious. It will take decades for the region to recover after the war and to rebuild its infrastructure.

Almost a year ago, Ukrainians took to the streets to express their hopes for a better future as part of the European family. On September 29, the Council of the European Union decided to postpone the implementation of a free trade agreement between the EU and Ukraine until December 31, 2015.

“The delay means that the Association Agreement is suspended and even the synchronous ratification by the Parliament of Ukraine and the European Parliament is purely decorative in nature,” said former diplomat and Ukrainian parliament deputy candidate Vadym Triukhan. “A lot can change during the delay, and the implementation of this agreement is under question.” According to Triukhan, this means that “Russia could press not only Ukraine but also 27 countries-members of EU.”

Ukraine, “a country that cannot reform itself,” as Triukhan puts it, has failed to undertake essential reforms during its 23 years of independence, as it couldn’t bring professional, independent political parties to power. In the near future, Ukraine will be facing a series of economic ups and downs. The country will need extensive help from its foreign partners to recover from the military conflict, which so far shows no signs of coming to an end.

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