Russian Annexation Detriments Ukrainian Economy

Posted on Posted in 2014-2015
By Josef Singson, Aaron R. Salvan and Antonio J.Y. Martinez

The recent power struggle between Russia and Ukraine over the control of the Crimean Peninsula is known internationally as the “Crimean crisis.” The region was administered by Ukraine until its annexation by the Russian Federation last February, a move not recognized by about 100 member states of the United Nations (UN).

In the midst of the takeover and civil unrest, Ukrainian President Viktor Yanukovych fled the capital of Kiev on February 21, resulting in his deposition by the Parliament and the appointment of the interim President, Oleksandr Turchynov.

The newly-established Turchynov government was recognized by the United States and European Union. However, Russia condemned it as an illegitimate move, referring to it as a coup d’état. Russia began to accuse the United States and EU of conspiring the ousting of Yanukovych, with the Eastern-European behemoth calling the move illegal and uncalled for. Later that week, pro-Russian forces began advancing towards the Crimean Peninsula and sources have later reported spotting Russian military personnel without insignia or proper identification within the peninsula. As troops sieged Crimea, its parliament decided to dismiss the existing government, replace its Prime Minister, and call a referendum for autonomy.

The referendum on whether to join Russia had an official turnout of 83%. On March 17, the peninsula declared independence from Ukraine and officially joined the Russian Federation.Later that week, the treaty of accession of the Republic of Crimea and Sevastopol into the Russian Federation was signed. However, this was just the start of greater conflict. The seemingly smooth majority decision was followed by heavy economic, social, and political backlash.

Economic Backlash

The annexation resulted in a negative economic impact for Ukraine. The Monday after the weekend of escalated tensions in Crimea saw the Ukrainian equities index (UX) fall by almost 12 percent to 987.96, as compared to its previous close of 1119.23. The tension in the region also stalled tourism, a primary source of income. Ukraine’s gross domestic product (GDP) contracted by 12.5% in the first quarter of 2014[1].  The World Bank forecasts a 5% decline in Ukraine’s 2014 GDP.

Ukraine’s currency, the hryvnia (UAH), was pegged at 8 UAH to a US dollar prior to the crisis. However, when it was allowed to float due to the crisis and low international reserves, the rate stood at 10.7 UAH/USD on February 27. The hryvnia continued to depreciate further into the 12 UAH/USD range from May to June. The depreciation of the hryvnia has set the inflation forecast for 2014 at 12 percent year-on-year (y-o-y), higher than the 0.5% in 2013[2]

The weakening of the UAH looms most prominently over the nation’s energy reserves. At least 40 percent[3] of Ukraine’s energy requirements are reliant on natural gas. However, only 37% of the required gas is domestically produced and Russian natural gas feeds the rest of the system. Previously, the Kharkiv Pact of 2010 extended the lease of Russian naval facilities for Russia’s Black Sea Fleet in Crimean waters. In turn, Ukraine bought Russian natural gas at a 30% discount. However, Moscow unilaterally scrapped the treaty soon after it’s annexation of Crimea. Russian natural gas was priced at $485/1,000 cubic meters on April 1, a sharp spike from $268.50/1,000 cubic meters. Although Ukraine has natural gas in storage, the weakened hryvnia and the cancelled discounts can lead only to rising energy prices when the supplies dwindle, further diminishing household purchasing power.

Industrial sectors will feel the blow of additional manufacturing expenses due to higher energy prices. This puts Ukraine in an uncertain position given that its top exports include semi-finished iron (10 percent) and hot-rolled iron (6.1 percent.)[4]. In April, total goods imported shrunk by 30 percent y-o-y, while exports contracted by 12.1 percent y-o-y[5]. With Russia as its largest trading partner, Ukraine remains in a very precarious position.

In addition to supplying most of Ukraine’s natural gas, the pipelines that snake through Ukraine also provide around 25% of the EU’s natural gas. If the current friction prevails, Russia may threaten to shut off gas to the EU, as seen in the previous rows the two countries have had. This would result in, among others, steep price increases due to the increase in the costs of manufacturing.

Beyond Ukraine

Given the peninsula’s reputation as a tourist destination, the Crimean people can benefit from their switch in loyalties to the Kremlin once the situation stabilizes. Moreover, Mr. Putin’s plans to build a Las Vegas of sorts in the region may draw even more business, especially from Russians.

Sanctions on Russia have left the Kremlin unshaken. Canada, the European Union, the United States and other governments issued travel bans and froze assets against Russian and Ukrainian individuals and companies that may have had a hand in the Crimean crisis. The Kremlin answered these sanctions by issuing sanctions of its own against some Canadian and American individuals.

The economic effects of the annexation of the Crimea have been and will continue to be felt by Ukraine. However, the effects have yet to be felt by the world market. An increase in world crude oil prices was expected due to the crisis, but after tensions eased, prices fell by 0.7 percent in March to an average of $104.0/bbl[6]. The redrawing of the borders of the Crimea have put Ukraine in a precarious situation, Crimea in an uncertain, but hopeful situation, and Russia in an overwhelmingly mighty position while the world nervously watches.


Sources
[1] Europe and Central Asia. (2014). Global Economic Prospects. World Bank. Retrieved June 22, 2014, from http://www.worldbank.org/en/publication/global-economic-prospects/regional-outlooks/eca#2

[2] Pogarska, O., & Segura, E. (2014, April 17). Ukraine-Economic Situation – April 2014. UNIAN news. Retrieved June 23, 2014, from http://www.unian.info/politics/908836-ukraine-economic-situation-april-2014.html

[3] Independent Statistics and Analysis. (2014, March). U.S. Energy Information Administration (EIA). Retrieved June 26, 2014, from http://www.eia.gov/countries/country-

[4] Simoes, A. (n.d.). OEC: Ukraine (UKR) Profile of Exports, Imports and Trade Patterns. Observatory of Economic Complexity. Retrieved June 26, 2014, from http://atlas.media.mit.edu/profile/country/ukr/

[5] Business Monitor (2014). Ukraine / Business Forecast Report (Q3 2014). Business Monitor International.

[6] Streifel, S., Greenwood, D. R., & Rousset, M. (2014). Commodity Market Monthly (April 9, 2014). International Monetary Fund. Retrieved June 24,2014 from: http://www.imf.org/external/np/res/commod/pdf/monthly/040114.pdf

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