The economies of Russia and Ukraine could plunge into the sharpest contraction in over 25 years due to Moscow’s war on its neighbor, the European development bank warned Thursday.
The Feb. 24 invasion has savaged Ukraine and seen Moscow slapped with sweeping sanctions, severing Russia from the global financial fabric and pushing commodity and energy prices sharply higher.
As the conflict causes "the greatest supply shock" in 50 years, the two countries' economies will contract by 10% and 20%, respectively, this year, the London-based European Bank for Reconstruction and Development (EBRD) said.
For both countries, the contraction would be the steepest since 1994, when economic turmoil in the wake of the fall of the Soviet Union ripped through the region.
The territory in which military activities are taking place accounts for 60% of Ukraine’s pre-COVID-19 gross domestic product (GDP), according to EBRD’s chief economist Beata Javorcik.
"Ukraine, which was a poor country to begin with, will become poorer," Javorcik told Reuters. "We understand that between one-third and a half of the firms stopped operations, and electricity consumption is at 60% of the pre-war level."
Before Russia invaded its pro-Western neighbor, the EBRD had been penciling in the growth of 3.5% for Ukraine and 3% for Russia.
The development bank, issuing emergency forecasts, said it was the first international financial institution to update its guidance since the outbreak of the war in Ukraine last month.
The latest prognoses "assume that a cease-fire is brokered within a couple of months, followed soon after by the start of a major reconstruction effort in Ukraine," it said.
Under such a scenario, Ukraine’s gross domestic product (GDP) should rebound by 23% next year.
But the heavy economic sanctions imposed on Russia by the West would mean that it would register zero growth.
"Sanctions on Russia are expected to remain for the foreseeable future, condemning the Russian economy to stagnation in 2023, with negative spillovers for a number of neighboring countries in Eastern Europe, the Caucasus and Central Asia," the EBRD said.
"With so much uncertainty, the bank intends to produce a further forecast in the next couple of months, taking into account further developments."
Russia already lost 2% of GDP
The report calculates that Russia lost around $30 billion of export revenues due to recent oil and gas sanctions, equivalent to around 2% of its GDP.
"Even if sanctions are removed, Russia’s reputation as an investment destination is going to be damaged," Javorcik said. "The talks of nationalization of assets of multinationals will be remembered for a while."
Belarus – which borders both Ukraine and Russia, and also faces Western sanctions over its role in the conflict – was forecast to shrink by 3% this year and then stagnate in 2023.
Founded in 1991 to help former Soviet bloc countries switch to free-market economies, the EBRD has since extended its reach, including to countries in the Middle East and North Africa.
The bank predicted that its investment zone, excluding Belarus and Russia, would grow by 1.7% this year, less than half of the previous growth forecast of 4.2% in November.
Growth is then expected to pick up to 5% in 2023.
High uncertainty
"Projections are subject to an exceptionally high degree of uncertainty, including major downside risks should hostilities escalate or should exports of gas or other commodities from Russia become restricted."
The world economy faced "the greatest supply shock since at least the early 1970s," it said, pointing out that Russia and Ukraine "supply a disproportionately high share of commodities, including wheat, corn, fertilizer, titanium and nickel."
Javorcik said that inflationary pressures, which were already high before the invasion, "will certainly increase now, which will have a disproportionate effect on many lower income countries where" the bank invests, "as well as on the poorer segments of the population in most countries."
The bank earlier this month unveiled a 2 billion euro ($2.2 billion) "resilience" package to help citizens, companies and countries affected by the war in Ukraine, including those hosting refugees.
"Europe has also seen the greatest forced displacement of people since the Second World War, and the report examines the potential consequences of this migration," it said.
"Skilled workers from Ukraine may provide a boost to some economies in the longer term, particularly in countries with aging populations," it said.
But "in the short-term, economies are facing fiscal pressures and administrative challenges as they scale up the provision of housing, healthcare and schooling."
Fallout to be felt far and wide
The fallout from the conflict would be felt far and wide, Javorcik said, saying there was a "considerable risk" some emerging market economies would ramp up exports restrictions to shield domestic consumers from further price increases. Central banks' rate hikes would accelerate in this scenario.
Turkey was one of the countries facing "strong headwinds" due to a mix of rising energy and grain import costs while a lack of revenues from Russian and Ukrainian tourists added to the pressure.
Growth for Turkey, the single biggest recipient country of EBRD funds, was trimmed by 150 basis points to 2% this year and 3.5% in 2023.
EBRD governors – representatives from its member countries – will decide within days on a proposal to suspend Russia and Belarus indefinitely from access to its financing, Javorcik added.
The EBRD, which has condemned Russia’s invasion of Ukraine, said Tuesday that it will close its Moscow and Minsk offices in an "inevitable outcome of the actions taken by the Russian Federation with the help of Belarus."
The EBRD has not put new money to work in Russia since Moscow annexed Crimea in 2014 and introduced a moratorium on new investment in Belarus following its disputed 2020 election.
The lender usually provides its economic updates in May and November.