Economic toll of conflict builds up for Ukraine

There seems to be no bottom for Ukraine’s economy.

The extent of the damage caused by the conflict in the country’s east was highlighted in a report showing the economy had shrunk by almost a fifth since the violence began last year.

Other indicators likewise show a country on the edge, with inflation rampant and the state out of money.

With much of the country’s industry in the hands of pro-Russian rebels in the east, stabilizing the economy has become a big, if immensely difficult, task for President Petro Poroshenko’s government.

Here’s a look at the economic decline affecting this country of 45 million people.

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RECESSION

Ukraine’s economy contracted by a stunning 17.6 percent in the first quarter of 2015 compared with a year earlier, when the separatist conflict erupted.

The drop was worse than expected and illustrates the huge impact of the rebels taking over much of Ukraine’s industrial heartland in the country’s east.

“In 2014, Ukraine lost approximately 20 percent of its economy with industrial sector output in Donetsk and Luhansk regions falling by 30 to 40 percent,” Ukraine’s U.S.-born Finance Minister Natalie Jaresko told The Associated Press.

It was the tenth quarter of economic contraction in the last 11. The country had already spent large periods in recession during the two years before the separatist conflict broke out.

For average Ukrainians, that has translated into a drop in living standards. The economic decline has caused a plunge in the value of the national currency, which in turn pushed inflation to highs of 60.9 percent, meaning the cost of goods has soared far above modest increase in wages.

The region held by the rebels since last spring includes some of the country’s most important industrial sites, including major coalmines and steel producers. Companies based in pro-government territory have also been hit hard as the conflict disrupts supply chains.

That has meant the economy refocused toward services such as IT and agriculture, the main economic engine in western Ukraine. The country is a major producer of wheat and sunflower oil, and some see opportunities for investors to modernize Ukrainian farms, many of which are the successors to Soviet-era collectives.

“Agriculture is massively untapped in Ukraine,” says Graham Conlon, who heads Eastern Europe-focused law firm CMS Cameron McKenna’s Ukrainian corporate operations. “It doesn’t actually take much to improve productivity in that area, because productivity is anyway, compared to the world as a whole, still very low.”

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DEBT

Ukraine is battling to avoid default as the slide in the economy has dried up the state’s revenues.

Public debt has jumped to 73 percent of GDP from 41 percent last year, according to the International Monetary Fund, and is rising.

Finance minister Jaresko trying to renegotiate debt terms with an array of creditors, part of an IMF rescue plan that also includes new loans.

The IMF announced the plan in February, saying it would raise some $40 billion. But only $15.5 billion of that amounts to new IMF funding, with smaller sums from other sources. More than a third of the total is meant to be unlocked by the renegotiations of debt.

Ukraine’s attempts to negotiate with a group of its creditors who hold around $10 billion of debt have so far been fraught.

Both sides stand to gain from a deal, however. If creditors hold out, that could push Ukraine to default on its debts, leaving the creditors with nothing at all.

Some state-owned companies are also struggling, especially the rail network Ukrzaliznytsya, which defaulted on its domestic debt last week and is restructuring all its private-sector debt.

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REFORMS

Modernizing Ukraine’s economy to lay the ground for a recovery has proved hugely difficult.

Since protests ended the rule of pro-Russian President Viktor Yanukovych in February 2014, Ukraine’s new leaders have tried to push through anti-corruption measures and open up state-dominated sectors of the economy, especially the energy market, to competition.

However, many efforts have become mired in political rivalry. Parliament voted to create a new anti-corruption agency in October, but it took six months to appoint a chief for the bureau and the body has yet to start work.

Efforts to cut red tape have been slow, while measures to remove allegedly corrupt officials with ties to the Yanukovych regime have run into accusations of a political witch-hunt.

As a result, the challenges facing Ukrainian businesses remain huge, says Oleg Ustenko, the Kiev-based executive director of the Bleyzer Foundation, a non-profit offshoot of venture capital firm SigmaBleyzer.

“There’s a high level of corruption here, there’s a high level of administrative pressure on business, there’s a low-quality justice system,” he says. “And on top of all that, there’s a war.”

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TRADE

Even though Ukraine’s crisis was sparked by protests in late 2013 calling for closer relations with the European Union and has since signed a deal strengthening its ties with the bloc, all of that has yet to translate into an economic gain.

EU countries cut import tariffs on Ukrainian goods after the agreement was signed, but it “didn’t lead to much of a tangible result,” Ustenko says. He believes the closer ties could have a bigger impact when free trade rules come into force Jan. 1, 2016.

The falling currency has also failed to help exports. Already the worst-performing currency in the world last year, the Ukrainian hryvnia has lost more than a quarter of its value so far this year. Instead of helping, exports to major EU economies fell in January and February, headlined by a one-third annual drop to Poland, Ukraine’s largest EU neighbor.

One aspect where Ukraine has seen some benefits from closer EU ties is that it gets more energy from the bloc, whereas it used to get almost all its gas from Russia.

“Today we receive almost two-thirds of our gas imports from the European Union, improving our energy security and reducing the overall costs in the process,” said Jaresko, the finance minister.

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