CREDITORS BEWARE

What Ukraine’s economy looks like without its Russian-speaking regions

Russian president Vladimir Putin revived the Czarist era term for a broad swath of southeastern Ukraine, Novorossiya, in a high-profile television appearance last month. “God knows” why Russia gave up the territory in 1920, he sighed.

Now that Crimea has been annexed by Russia, Donetsk and Luhansk have declared their independence, and tensions remain high in Odessa following bloody battles between factions earlier this month, the prospect of the government in Kyiv losing control of the southeast is rising by the day.

With this in mind, Vadim Khramov at Bank of America Merrill Lynch recently ran the numbers on several “separation scenarios” for Ukraine. If Putin’s dream of restoring Novorossiya came true, it would cut Ukraine in half. Literally.

Subtracting eight southeastern regions, along with Crimea, from what we currently know as Ukraine would cut the country’s estimated GDP and population this year by just under 50%. And since much of Ukraine’s heavy industry lies in the southeast, Kyiv would lose an even larger share of exports and industrial production:

Ukraine-economic-indicators-2014-estimate-GDP_chartbuilder

Many of Ukraine’s restive Russian-speaking regions take more from government coffers than they give back, so Ukraine’s budget deficit would actually improve without them. But since the breakaway regions are unlikely to take responsibility for their share of Ukraine’s national debt (following Crimea’s example), Kyiv’s debt-to-GDP level would surge to dangerous levels—roughly the same as Cyprus, currently in the euro zone’s intensive-care ward.

The loss of exports would see the bottom fall out from Ukraine’s trade balance, with only Mozambique and Liberia recording bigger current account deficits this year, according to IMF forecasts. In short, Ukraine would become even more beholden to international aid than it is already.

IMF chief Christine Lagarde recently said that Ukraine will need “much more” than the $17 billion in loans already pledged by multilateral creditors. For the Ukrainian economy, which was hardly in good shape before the crisis, the loss of Crimea, which accounts for only 4% of GDP, has been manageable. If the self-proclaimed “People’s Republics” of Donetsk and Luhansk were to fully separate, it would be much more serious, but Khramov of Bank of America reckons that Ukraine would still manage, thanks to the political will of its Western allies.

The restoration of historical Novorossiya, however, would push the IMF to demand a default and restructuring of Ukraine’s debts. The shrunken country’s daunting debt burden “would be unlikely to stabilize, even under reasonable assumptions about medium-term growth and cost of financing,” the analyst notes, ominously.

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