Factories destroyed. Roads blown to pieces. Power plants put out of action. Steel exports decimated. A flood of refugees out of the country. Ukraine – the poorest country in Europe – has paid a heavy economic price for a two-year war against Russia waged almost entirely on its own soil.
The figures are stark. More than 7 million people – about a fifth of the population – have been plunged into poverty. Fifteen years of human development have been lost. In the first year of the war, the economy contracted by 30%.
Yet it could have been even worse. Beata Javorcik, chief economist at the European Bank for Reconstruction and Development, said 90% of businesses in the areas of Ukraine where there was no fighting are still going concerns. Inflation has come down from a peak of 27% to less than 5%.
Even so, Ukraine’s economy remains on a knife edge. It needs more than $40bn (£31bn) of western aid this year to balance the books and keep the military equipped. The costs of piecing the country back together again is put at $486bn over 10 years – up from $411bn a year ago. “The last two years have seen unprecedented suffering and loss for Ukraine and its people,” said Antonella Bassani, World Bank vice-president for Europe and central Asia.
By contrast, Russia has emerged from two years of war looking relatively unscathed. Soon after the war started, the International Monetary Fund said it expected the Russian economy to suffer a severe two-year recession – contracting by 8.5% in 2022 and a further 2.3% in 2023.
The economy did shrink in 2022, but only by just over 2%, and in 2023 it grew – according to the latest IMF estimates – by 3%. There is no hard evidence that the war effort has forced ordinary Russians to tighten their belts. Generous welfare benefits have underpinned incomes while a tight labour market has supported strong wages growth. Illustrating the point, consumer spending rose 6% last year.
Moreover, Russia entered the war in a strong position financially. Vladimir Putin planned for an invasion with a high oil price that filled his exchequer with funds, and with a debt-to-GDP ratio down about 20%. Last year, Russia’s budget deficit was limited to just over 1% of GDP.
On the downside, labour shortages caused by conscription have pushed up prices. The official inflation rate has almost halved, from 11.5% last autumn to 6.6% in January, but this month the central bank maintained its tough stance to prevent a resurgence, pegging interest rates at 16%.
There are a number of reasons for Russia’s resilience. Its economy was 10 times the size of Ukraine’s when the war started. Its physical infrastructure has not been flattened. A huge increase in the defence budget has boosted growth. Finally, Putin has been preparing Russia for the conflict for years – using oil and gas proceeds to accumulate reserves and taking steps to sanction-proof the economy.
Tim Ash, a Russia expert at the Chatham House thinktank, said Russia’s resilience was unsurprising. “Only Putin knew there was going to be a war and he had prepared for it. But it’s clear that sanctions are removing some of the financial buffers and stockpiles built up ahead of the invasion.”
Mark Harrison, an economic historian and emeritus professor at Warwick University, said Putin had ramped up defence spending from 3% of national income to nearer 7%, and it could hit 10% over the next year. “But Putin doesn’t know any more than we do where the tolerance of the Russian people lies. The process of feeling for those limits is different for an authoritarian leader because he knows the people won’t tell him, or at least not until it is too late for his leadership to survive.”
Javorcik said it was unrealistic to expect the first wave of sanctions to bring the economy to its knees. Domestically produced goods were replacing western imports, while Russia was also able to source goods directly through China and Turkey and indirectly from countries acting as intermediaries for western products.
“Sanctions are working,” Javorcik said. “But they are working slowly.” Being cut off from western technology, capital, knowledge and management techniques will lead to weaker productivity growth, the impact of which will be amplified by the loss of human capital caused by skilled workers leaving the country.
Mark Sobel, of the thinktank OMFIF, said: “A cursory examination of current Russian data – such as growth and inflation – might suggest that the economy is ‘resilient’ in the face of the costs of Russia continuing its ruthless invasion. That view may contain elements of validity in the short term. But it overlooks weaknesses and realities. Significantly greater isolation and economic degradation are baked in the cake for the Russian economy and people.”
The scale of the damage to Ukraine coupled with the failure of sanctions to force Putin to back down have forced the west to consider what to do next. One option – favoured by both Ash and Harrison – is to tighten sanctions still further. Harrison draws a comparison with the western front in 1918 and the collapse of German morale after the allies tightened their blockade, preventing vital supplies reaching civilians and the army alike.
“Russia is not at this stage yet, but if sanctions are tightened, who knows when war-weariness takes hold,” he said. “A war plan involves your enemy running out of options as it runs out of resources. And in the interests of the west, that needs to be Russia.”
Ash said there were signs of sanctions becoming tougher. Big lenders in the United Arab Emirates (UAE) are reported to have begun closing bank accounts of Russian nationals and limiting settlements with Russia.
Some Chinese banks and Turkish lenders are understood to have reacted to US threats in December to cut off access to foreign banks doing business with companies that support Russia’s defence industry.
There is also also pressure on the G7 to seize Russia’s frozen reserves and use them as collateral to raise debt for the reconstruction of Ukraine. Almost $300bn of Russian assets have been immobilised since the invasion two years ago.
The UK and the US have warmed to this idea but EU members of the G7 warn there is no basis in international law for seizing the assets of a foreign country. Since more than half the Russian reserves are held in the EU – mainly in Belgium – there are fears seizure could lead to international investors dumping the euro on currency markets. A compromise could be to seize the interest on these reserves, which amounts to an estimated $15bn.
While that debate goes on, Ukraine faces an immediate cash crisis and needs financial help to fill a $39bn black hole in its budget. Spending this year is expected to be just over $81bn while revenues are forecast to be a little more than $43bn. The defence budget alone comes to just under $42bn.
The EU and the IMF have continued financial support but US aid is being blocked by Congress.
“It would be extremely unfortunate if a lack of money meant that Ukraine’s macroeconomic stability, which has been achieved during wartime, were thrown out of the window,” Javorcik said.
Without further funding, Ukraine would become a failed state, he said. “And that would affect European countries through a potential second refugee wave and instability on its eastern border.”
