Economic consequences of the Ukraine conflict

14 October 2014

The Ukraine conflict is having serious consequences, not only for Russia and Ukraine. On 13th Oct, Peter Havlik and Vasily Astrov presented their findings to the press.

The Ukraine conflict is having serious consequences not only for Russia and Ukraine, but potentially threatens to damage the still frail economic recovery in Europe. The Western sanctions imposed on Russia since March are no longer of a purely symbolic character: apart from travel bans and asset freeze of more than 100 individuals, there are now (mid-October 2014) bans on borrowing by the leading Russian banks and companies, as well as restrictions on the exports of military and dual-use goods and oil extraction technologies to Russia. Russia has retaliated with a ban on agri-food imports and restricted travel to the West. The general climate between Russia, Ukraine and the West has been seriously damaged.

Clearly, Ukraine has been the main victim of the conflict. In Donbass, which used to account for 16% of Ukraine’s GDP and a quarter of its exports, the war-related damage is currently estimated at some EUR 6 billion (or 6% of GDP), and industrial production has nearly come to a standstill, largely as a result of power cuts and railway disruptions. On top of that, the enacted ban on exports of military and dual-use goods to Russia has further contributed to the export decline. At the same time, domestic private consumption has been eroded by the spike in inflation and the IMF-imposed austerity measures. All in all, Ukraine’s economy may contract by up to 10% this year, and the stabilisation prospects are unclear.

In Russia, the country which was ‘stuck in transition and stagnation’ already before the Ukraine crisis, the impact of the conflict is increasingly felt as well. The Western (first of all financial) sanctions and the related increased political risks are hampering investments, economic growth and modernisation still further. A crude estimate of economic effects – lower GDP growth by about 1 percentage point compared to the pre-conflict scenario – yields a loss of Russian GDP close to EUR 20 billion in 2014, and more than EUR 30 billion in 2015 and EUR 50 billion in 2016.

The effects on the individual EU countries differ depending on their varying exposure to the Russian (and Ukrainian) markets. Despite the relatively low EU trade exposure to Russia (and especially Ukraine) on average, there are a number of EU countries which trade quite a lot with Russia: the Baltic states (in particular Lithuania), other NMS and also Finland. Austria is not too much exposed: just 1.4% of Austrian GDP was exported to Russia in 2013 (respectively, only 0.6% of Austrian GDP in terms of domestic value added of exports). Cyprus, Greece, Great Britain, Portugal and Spain have very little goods trade with Russia, though the two former have extensive exposure in tourism and finance.

For the EU as a whole, there are five industries where the share of Russia in total exports exceeds 3%: textiles, pharmaceuticals, electrical equipment, machinery and transport equipment. In Austria it is machinery, equipment and pharmaceuticals which play the key role in exports to Russia. Food products (banned by Russia as a retaliatory measure since August) do not feature prominently among EU exports to Russia. In EU services exports to Russia, travel (tourism) and transportation are important, and the number of Russian tourists has already suffered a blow, by 20% in some cases. The import exposure of individual EU countries to Russia differs as well: Lithuania imports nearly 30% of all goods from Russia, Bulgaria and Finland nearly 20%, Greece 14%. The bulk of these imports – 80% on the EU average – consist of energy: crude oil, natural gas and refined petroleum.

On the assumption of a 10% loss in exports of goods and services to Russia, the estimated GDP loss would be 1% in the case of Cyprus, 0.7% for Lithuania, 0.6% for Estonia, and less than 0.1% for Austria. In absolute figures, Germany might lose nearly EUR 3 billion, followed by Italy (EUR 1.3 billion), France and Poland (EUR 0.8 billion each). Austria could lose close to EUR 300 million in this scenario. The estimated impact of Russia’s ban on meat, dairy products, fruit, vegetables and fish imports from the EU imposed in August 2014 is expected to be the highest in the Baltics. The banned products amount to more than EUR 5 billion of EU exports to Russia, with Lithuania, Poland, Germany and the Netherlands affected the most in absolute terms. Austrian exports of banned agri-food products amounted to only EUR 100 million in 2013. In the case of an escalating spiral of sanctions, trade disruptions would result in bigger losses for the EU. For instance, Russia might consider imposing an embargo on car imports from the EU, restrict state purchases of pharmaceuticals or even freeze some Western assets. These losses are undoubtedly painful, yet manageable (a trade decline bigger than 10% would obviously lead to greater losses).