Russian troops massing at Ukraine’s border. Western leaders and intelligence officials issuing warnings and threatening sanctions. The Ukrainian public, politicians and the media alarmed, while the army prepares to defend the country.
This is the picture we’ve been seeing in recent months as Russia escalates its military buildup from several directions.
War is a terrible thing which we all hope can be avoided. Indeed, we hope this period of tension will end the same way as on previous occasions – with Russian troops retreating to their barracks and the danger fading away (at least, temporarily). Nevertheless, we need to understand the consequences (besides military) of a possible Russian invasion
So, what would happen to Ukrainian economy if the unthinkable happens and Russia launches an invasion?
Instinct would probably tell us that the effects would be devastating, but the reality could be more nuanced.
Arguably, the Kremlin is not planning to get stuck in a prolonged attrition war (after all, they have already created one in Donbas). So, the scenario we’re envisaging is a relatively short conflict, which would no doubt impact the economy in several ways.
Firstly, there’s the financial impact. Ukraine is dependent on foreign investment to keep its public finances and economy afloat. Of course, any kind of open military conflict would keep the investors away, which is a danger to financial stability and risk for the national currency, the hryvnia.
Yet, thanks to prudent macroeconomic policies – both monetary and fiscal – adopted after the Maidan revolution, the country is in relatively good shape. The reserves of the National Bank have recently exceeded $30 billion and, of course, they would be used in this type of crisis to sustain the hryvnia and to provide support to the financial system.
The projected fiscal deficit of 3.5% of GDP is relatively low and there is no doubt that, in the event of open conflict with Russia, Western partners and IFIs would provide financial support to the Ukrainian state, as they did back in 2014.
If the conflict is short, these resources should be enough to soften the financial impact of war.
Secondly, there’s the wider business and economic impact. Undoubtedly, many industries would have to temporarily shift to military mobilization mode – e.g., railroad transport would mainly serve military needs, while the energy sector would have to concentrate on ensuring secure and stable supplies to support the military effort.
Other sectors would temporarily freeze with fewer people going to cafes and entertainment venues, and new investment projects on hiatus until the conflict is resolved, etc.
In a way, there are similarities to the COVID-induced lockdowns. They are quite disruptive, but certainly neither deadly to the economy nor a prelude to a prolonged economic slump. The moment normal economic life can resume, it typically does.
We can only speculate what the Russian military aims would be in a conflict with Ukraine. Among potential scenarios are occupation of large areas of the country. One such move could be to occupy Ukraine’s southern coastal areas, cut the country from the sea and allow Russia to create a land bridge to the already occupied Crimea.
This kind of territorial loss would, of course, have a massive negative economic impact by directly taking away GDP generated by the newly occupied territories. Indirectly, it would sever existing production chains and create a further drop in production in the non-occupied areas. Being cut away from the sea – if indeed taking the South is the Russian military aim – would be particularly devastating, as Ukraine’s economy is dependent on commodity exports which are mostly facilitated through seaports.
Clearly, Ukraine’s economic resilience in the face of a Russian invasion depends heavily on the ability of the army and territorial defense units to protect the country’s territory from occupation. If they can deny Russia the ability to take and hold major areas of Ukraine, the country can weather the storm. If Russia takes major territories (the South in particular), then the losses would be much bigger.
This kind of analysis is, of course, predicated on the “as is” global situation. Ukraine is classified as a small open economy dependent on exports (which constitute 40% of the country’s GDP) and foreign investment flows. This type of economy can be severely impacted by negative outside events. If the world sneezes, Ukraine falls sick.
Eurasia is already beset by the energy crisis. Rising inflation has now hit the whole world. Defaults among China’s huge construction sector companies have created fears in major financial markets. In short, there is potential for a major economic or financial crisis in the world, though we can never be sure in advance when exactly that will hit.
Such a crisis would automatically make Ukraine’s economic position much more vulnerable. NBU reserves and foreign aid would have to be spent on keeping the economy afloat. Trade, which is dependent on exports, would be in much worse shape due to the wider global situation. In these conditions, it might be enough for Russia to simply create a military disturbance – without occupying any major areas – to force Ukraine into a significant economic crisis.
Perhaps that’s exactly the kind of opportunity that Russia is looking for. It’s important for Ukrainian and Western leaders to understand this strategy and to counter it by strengthening the country’s economic resilience. Intensifying reforms and improving the investment climate in Ukraine are good ways to achieve this.
Op-ed disclaimer: The Kyiv Post is not responsible or liable for any content in this article, which expresses the personal viewpoint of the author only.
