Image courtesy of Kiev Post

The Economic Impact of Ukraine's War
| published August 25, 2014 |

By R. Alan Clanton
Thursday Review editor

The United Nations estimates that the fighting in the Ukraine, which has intensified in recent weeks, has so far left more than 2000 people dead. The vast majority of those deaths have occurred in eastern Ukraine, near the stronghold cities and towns held by pro-Russian militants. The dead include Ukrainian soldiers, rebels, and also civilians caught in the crossfire between combatants.

Last week, more than 260 trucks crossed the border from Russia into the Ukraine—ostensibly carrying humanitarian supplies to beleaguered civilians, but Kiev has complained that those convoys may in fact be little more than a mechanism for resupplying rebels. This week, witnesses at border checkpoints have reported seeing Russian tanks and personnel carriers entering the Ukraine—this despite Moscow’s frequent statements that Russia is neither supporting nor supplying the separatists. Military analysts say that the fighting will surely escalate as more firepower and more armed personnel enter those areas around the eastern Ukraine.

Can this cycle of violence be stopped? German Chancellor Angela Merkel hopes that this week—when Ukrainian President Petro Poroshenko and Russian President Vladimir Putin bump into each other at an already-scheduled trade conference in Minsk, Belarus—the two leaders can agree to find some sort of starting point for de-escalation, and peace.

Merkel, like many European heads of state and EU business leaders, is deeply concerned about a Ukrainian civil war continuing into fall and winter. Disruptions to the supplies of oil and gas could wreak havoc on European economies at the very moment when those markets are struggling back from the long effects of recession and austerity programs. Worse, the Ukrainian economy—already suffering from a continuing mortgage crisis and a slumping technology sector—must now pay for a vast increase in military spending. Poroshenko announced this weekend that Kiev will need to increase spending on war by at least 40 billion hryvnia (roughly $3 billion) this year alone.

The Ukrainian army has been on the move the last five weeks, regaining territory lost to the militants, and retaking cities and towns recently held by the pro-Russian rebels. But the cost has been enormous for both sides. Kiev says that the heavily-armed militants have been receiving assistance from their Russian sponsors back east, and the Ukrainian military has had to deploy nearly all of its forces and equipment across the Dnieper River to combat the separatists.

The civil war began after protests in Kiev forced the ouster of pro-Russian president Viktor Yanukovich. After Yanukovich fled the Ukraine, Putin declared that the revolution was illegal, and sent Russian troops into Crimea to seize the ports and military facilities. Barely weeks later, after a referendum on Crimean self-determination, Russia annexed Crimea. Within days, fighting broke out in eastern Ukraine, with heavily armed separatists seizing control of dozens of cities and towns east of the Dnieper River.

Moscow began a long, massive build-up of troops and equipment along its 800 mile border with the Ukraine. Over a period of months, Russia moved thousands of soldiers, hundreds of tanks, and scores of attack helicopters and fighter jets to a dozen staging areas near Ukraine. As of now, there are roughly 21,000 Russian troops massed along the border, according to intelligence reports by the United States and the U.K. Russia has said that the huge deployments are part of a large military exercise.

Fighting has ebbed and flowed, but the Ukrainian military made substantial gains in July and early August, taking all but a handful of rebel strongholds, such as Donetsk and Luhansk. Last week, after days of wrangling over details, Russia forced its hand by sending in approximately 260 large trucks loaded with what Moscow says are humanitarian supplies. Officials in Kiev have said that the trucks—most of which have not been inspected by independent or neutral groups—may contain military supplies, weapons and ammunition (possibly even personnel) to resupply the beleaguered militants in those cities under siege. Kiev says that those convoys may be nothing more than a Trojan horse. More troubling this week has been the arrival of more convoys from the east. In the areas around Donetsk and Luhansk, shelling has become intense, and gunfire now rages nearly 24 hours a day. Fighting has also intensified near Ilovaysk.

The war has now raged on for six months, with the violence increasing during recent weeks. The economic toll has been large for all sides. The United States, Britain and other countries struck back at Russia by imposing sanctions—some aimed squarely at Putin’s billionaire friends and political allies. The sanctions include traditional trade limitations and product bans, but some measures also impose freezes on assets and transactions among banks, investment groups, and other large companies inside Russia.

Some of the early sanctions by U.S. President Barack Obama against Moscow were not embraced wholeheartedly by all EU member states. Trade between EU nations and Russia has grown steadily in the last 15 years, and that trade in 2013 amounted to, by some estimates, more than $2 trillion dollars. Germany did $88 billion worth of business with Russia in 2013; Norway has at least $900 billion tied up in Russian investments; and France, Italy and Spain combined did over $250 billion in routine business with Russian companies. And almost every European Union member state relies of a heavy percentage of oil and gas from Russian suppliers.

That dependence on Russian oil and gas—much of which flows through the Ukraine—is what worries economists the most, and continues to spook investors and speculators on Wall Street, where market ebbs and flows recently have been blamed in large part on a combination of tensions in the Middle East and in the Ukraine. But EU reluctance evaporated after a Malaysian airliner was shot down over a rural area of eastern Ukraine, killing all 298 civilians on board. The jetliner was apparently shot down using a Russian-made missile system which had been supplied to the militants. Within minutes of the plane’s destruction, militants were monitored on radio transmissions taking credit for the downing of a plane, but a little later that same day, the rebels denied that they had fired any rockets.

Outrage in Europe quickly altered the template for the applications of sanctions against Russia for its interference in Ukraine’s troubles, and EU leaders and politicians agreed to tougher economic measures. The U.S., the U.K., and dozens of EU member states have begun to tighten the market pressures on Russia, and Moscow has retaliated with measures of its own.

Pressure has been exerted against Putin cronies, including Arkady Rotenberg, a leading figure in SMP Bank, InvestCapitalBank OAO, and other financial institutions, and a billionaire whose fortune has come largely from profitable investments in other companies across Russia and in other countries. Also targeted by the U.S. and the EU is Yury Kovalchuk, a majority stockholder in Bank Rossiya, and the owner of National Media Group, a mega-media conglomerate with holdings in TV networks, radio and TV stations, popular news programs, and a host of print publications. Reporters and editors for National Media Group are generally favorable to Putin and his policies. And another subject of harsh sanctions has been Nikolay Shamalov, also connected to various Russian banks, and the owner of several popular—and decidedly pro-Putin—websites and web news services. In addition to his banking and media assets, Shamalov is also a high-ranking manager of media relations and press policy for the Kremlin.

The cost of the war, and the results of some of the sanctions, may be paying political dividends, but they are also suppressing the Russian markets. Russian media stocks have steadily fallen, and this week has already started out badly for the owners of newspapers, TV stations and other media ventures. Yandex NV—Russia’s biggest internet provider, email platform, and owner of the most-often used search engine in Russia—lost value last week and again this week as investors migrated away amid worries about the Ukrainian war and a sagging technology sector. And on the London exchange, Mail.ru saw its value drop by more than 12%. Mail.ru is not only Russia’s largest email provider, but also one of Russia’s most popular developers of online games, dating sites, and social media applications.

And it isn’t just the media side of the equation which shows that sanctions may be working. The Micex (Russian’s stock index) has fallen slowly but steadily for months now amid worries about the continuing crisis within the Ukraine, and deep concerns that as sanctions have become more stringent, the Russian economy may begin to show signs of long-term damage. Its economy may already be in the early stages of recession, and some business analysts suggest that a full-blown recession could arrive within months if a solution to the crisis cannot be found.

But, as European economists have frequently pointed out, the door swings both ways. Russia’s markets are now deeply interwoven into the economies of almost all of Europe, and few EU member states can easily slip from the long shadow cast by Russia’s oil and gas might. Agreements in late July by a dozen European countries to target Russia’s technology sector by blocking or banning the sale of some forms of computer technology, military equipment, and communications hardware to Russia will have serious blowback to those companies most affected. Tech firms in Germany, Italy, France, Finland, and the Netherlands will surely suffer.

Russia has retaliated in its own way—issuing sweeping, outright bans on products coming from those countries engaged in the most costly sanctions. The ultimate cost may be a constricting, shrinking economy for not only Russia, but all of its major trading partners west of the Ukraine.

For the Ukraine, which agreed just last month to a $17 billion bailout from the International Monetary Fund, the costs continue to spiral upward. The staggering cost of the war has come at the worst possible time for the Ukraine, a once-booming and tech-centered economy now squeezed by a severe housing crisis, a shortage of goods and cash, and the very real possibility of running out of energy reserves by mid-winter.

Many citizens west of the Dnieper River want closer ties to the European economy, and some are hopeful of joining with the EU. Among the elite in Kiev, there has even been talk of joining NATO. These westward inclinations are an affront to Putin, who has made it clear that he considers the Ukraine to be a part of Russia’s wider sphere of influence—economically and strategically.

Poroshenko and Putin will meet this week in Minsk (in Belarus) to discuss possible solutions. For Putin, the pressure is extreme. On the one hand, he has high levels of approval back home where many Russians applaud his assertive, proactive role in Eastern Europe. Now that the stakes have risen so high—especially in what has become a challenge between Obama and Putin—it has become increasingly difficult for Putin to back down. For that reason, western analysts still fear an all-out invasion by Russian forces: an option which could, for Moscow, bring a quick but dramatic (and violent) end to the crisis. Putin may well be willing to subjugate economic concerns for political unity and popularity at home.

But Putin may also be already engaged in backdoor solutions, which would explain his insertion of weapons and supplies across some of the unguarded areas of the frontier. NATO (and U.S. spy satellite imagery) has confirmed large shipments moving across some porous stretches of Russian-Ukrainian border. According to this theory, the convoys of white trucks are not so much a Trojan horse as a classic diversion: trucks carrying little of consequence; meanwhile heavy weaponry and personnel are slipping across unguarded miles of border identified by nothing more than wire fence. (Example: while researching this article we looked at Google satellite imagery of the border near the Russian town of Kucherov, a few miles northwest of Kondratovka; there are clearly scores of miles of border which had no apparent obstacles at all—only minimal fencing running through farmlands and fields, or through wooded areas. Similarly, long stretches of border near the Ukrainian towns of Slavhorod and Porozok have what appear to be only minimal demarcations between farmlands split by the border).

NATO has also accused Russia of using columns of long-range artillery—deployed in neat rows on the Russian side of the border and with gun barrels facing into the Ukraine—to fire upon forces loyal to Kiev as they have closed in on militant forces, and there have been concerns for months that some of the rebels may themselves be Russian soldiers.

As for those hundreds of unmarked, white trucks—European authorities want the Red Cross and other humanitarian groups to be responsible for the distribution of the aid supplies. More trucks are on the way, and in Kiev—where officials were quietly hopeful that forces loyal to Kiev were turning the tide on the war—there is fear that protracted, more violent war could crush what little economic strength is left in an economy already pained by seven months of civil unrest and war.


Related Thursday Review articles:

Sanctions Talk, Money Walks; R. Alan Clanton; Thursday Review; July 31, 2014.

Convoy of Trucks: Is Russia Invading Ukraine?; R. Alan Clanton; Thursday Review; August 22, 2014.