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Russia is destroying Ukraine’s economy, raising costs for U.S. and allies

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KYIV, Ukraine — Two months of relentless missile and drone attacks by Russia have decimated Ukraine’s critical infrastructure and blown a hole in projections for the country’s war-ravaged economy.

Before those strikes, Kyiv expected to need at least $55 billion in foreign assistance next year to meet basic expenses — more than the country’s entire annual prewar spending.

Now, with its energy systems severely battered, and more Russian attacks likely, some officials believe Ukraine could end up needing another $2 billion a month, and political leaders have begun trying to brace Western supporters for such worst-case scenarios.

“What do you do when you can’t heat your house, you can’t run your shops, factories or plants, and your economy is not working?” said Oleg Ustenko, an economic adviser to President Volodymyr Zelensky. “We are going to be requiring more financial assistance, and Putin is doing this to destroy unity among allies.”

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At a closed-door meeting last week at the National Bank of Ukraine, which now has a military checkpoint just outside its headquarters, central bank officials pondered what might happen if Russia’s attacks intensify. People could flee Ukraine in droves, taking their money with them, potentially crashing the national currency as they seek to exchange their Ukrainian hryvnia for euros or dollars.

The Ukrainian government could be left without international reserves to pay for critical imports and unable to meet its foreign debt obligations — a doomsday scenario known as a balance-of-payments crisis.

One dire scenario predicted that Ukraine’s economy could contract by another 5 percent next year, on top of the 33 percent contraction this year, according to a person familiar with the bankers’ report who spoke on the condition of anonymity because it was not public.

Ukrainian Prime Minister Denys Shmyhal, at an international donor conference in Paris on Tuesday, said the contraction next year could reach 9 percent depending on the severity of continued Russian attacks.

As Russian President Vladimir Putin persists with his 10-month-old war, Ukraine’s survival hinges as much on outside economic aid as on donated weapons, and Putin now seems intent on making such help so costly that Kyiv’s Western backers give up.

Before the infrastructure attacks began on Oct. 10, Ukrainian officials were optimistic that Western financial aid would allow them to close most, if not all, of their enormous budget gap in 2023.

The European Union and United States collectively have pledged to send more than $30 billion to Ukraine next year, though not all of that money is formally approved. On Thursday, the E.U.’s 27 heads of state and government, meeting in Brussels, agreed to provide 18 billion euros, or just over $19 billion, in loans to Ukraine next year.

Some aid promised for this year was slow to materialize, forcing Kyiv to print money and devalue its currency to ensure its economy remained competitive, contributing to a spike in inflation of more than 20 percent.

But this help, even if it does come through, is intended only to keep the country afloat day-to-day. It doesn’t remotely begin to address the hundreds of billions in damage wrought by the war.

Russia’s invasion has destroyed hospitals, ports, fields, bridges and other parts of the country’s critical infrastructure. Agricultural exports have been decimated, despite an international accord to maintain some grain shipments. Huge swaths of Ukrainian industry are now in occupied territory. As much as one-third of the country’s forests have been destroyed.

In September, United Nations officials estimated that nearly 18 million Ukrainians needed humanitarian aid. With the country on the brink of a financial cliff, some advisers to Zelensky in recent weeks weighed asking Western governments to finance direct cash payments to Ukrainian citizens, according to two people familiar with the internal talks.

Now, with energy systems decimated, Kyiv and its partners face a head-splitting challenge. Key pillars of the economy — coal mining, industrial manufacturing, information technology — cannot function without electricity or internet service. The World Bank has warned that poverty could explode tenfold. Unemployment, already close to 30 percent, is likely to climb further.

“In case of full blackouts for longer periods, we will definitely need to get more resources to avoid humanitarian catastrophe,” Sergiy Nikolaychuk, Ukraine’s deputy central bank governor, who attended last week’s meeting, said in an interview.

The dire assessments reflect something Ukrainian officials and their Western supporters do not like to admit aloud: The Kremlin has made Ukraine’s economy a pivotal theater of the war — one in which Moscow is arguably having far more success than on the front lines, where its troops have struggled.

“How does an economy function at all — while supporting the war effort — with this level of damage to civilian infrastructure? I don’t think we’ve ever seen this,” said Simon Johnson, an economist at MIT who is in communication with Ukrainian officials. “I can’t think of any economy that’s ever tried to do this.”

Life without power

Blackouts take up roughly half the workday. Valentyn Nyzkovolosov, co-owner of the Salt and Pepper catering service in Kyiv, and his partner, Andrii Boyarskyy, have their staff arrive at 5 a.m. — as early as possible under the wartime curfew in Kyiv. When the power goes out after sunset — before 4 p.m. these days — employees work with flashlights.

When Washington Post journalists arrived at Nyzkovolosov’s business recently, there was no electricity. Moments later, air raid sirens sounded and Salt and Pepper’s staff descended into a cramped cellar that serves as a bomb shelter. “This is the best example of the conditions that we work under,” Nyzkovolosov said. During a previous alert, a few weeks earlier, explosions were heard nearby, employees said.

Ukrainians are adamant that Russia’s missile attacks will not break their fighting spirit. But businesses and workers are struggling to adapt. For many, it is impossible to function without electricity.

Mining and manufacturing — which make up roughly one-fifth of Ukraine’s economy — are among the hardest-hit sectors. Two of the country’s biggest steel plants, located in the industrial southeast, shut down last month because of blackouts. Dozens of coal miners had to be rescued after a power failure trapped them underground.

“For large industrial and metallurgical plants, these blackouts are very dangerous,” said Dennis Sakva, an energy analyst at Dragon Capital, a Ukrainian investment firm, which recently downgraded its economic forecast for 2023 to a 6 percent contraction in economic output from 5 percent growth.

“If you’re in the middle of a technical complicated process with high temperatures and have a power outage, it can cause all sorts of problems,” Sakya said.

Ongoing internet outages could also wreak financial havoc. Information technology, for example, has emerged as a pillar of Ukraine’s economy, and was the only sector to have grown over the past year, said Mykhailo Fedorov, a vice prime minister who oversees digital transformation.

Yet due mainly to the recent attacks, the internet connectivity rate is down to 35 percent of its prewar level. Ukrainians are importing Starlink terminals for internet via satellite, but there are unlikely to be enough to manage widespread outages. And the internet disruptions impair not just the IT sector but basic public and private financial services, such as pension payments, mobile banking, tax collection and digital sales.

The biggest economic threat, however, is not a loss of connectivity but a loss of people. A lack of heat and water service during winter could set off a mass population exodus. Kyiv has already warned residents to be prepared to leave if its heat goes offline amid freezing temperatures. In that scenario, the city would have no choice but to cut off water to prevent pipes from freezing and rupturing.

In the southern cities of Mykolaiv and Kherson, authorities are urging citizens to evacuate, warning of a lack of critical services during winter. European countries are already sheltering millions of war refugees, and experts warn of a new crisis.

“You need to have a place to evacuate so many people,” Sakva, the Dragon analyst, said. “When the number of affected residents is in millions or the tens of millions, that’s a very hard question. I’m not sure anyone has a clear answer to it.”

Pressure on Kyiv and its supporters

Ukrainian Finance Minister Sergii Marchenko was already in the midst of asking Treasury Secretary Janet L. Yellen for billions in aid when he first alerted her to Russia’s bombing of infrastructure.

At the time, on Oct. 16, it appeared that the United States and Europe could help stave off an economic disaster in Ukraine. The Biden administration was helping to close a significant portion of Ukraine’s budget deficit. The E.U., while behind on pledges, was also providing aid.

Dominated by oligarchs and perennially in need of bailouts, Ukraine was a financial mess long before Russia’s invasion. Full-blown war sent its economy into a tailspin.

After Ukraine halted Russia’s assault on Kyiv last spring, the immediate emergency stabilized. By summer, Western officials had even started talking about forcing Russia to pay for postwar reconstruction, which the World Bank estimated would cost $350 billion. Ukrainian officials talked up a modern-day “Marshall Plan” that would also forge closer economic ties to the West.

When he met Yellen in October, Marchenko warned that the energy attacks could unravel previous calculations, but he had no idea how bad things would get. “Even at that week, we couldn’t estimate how far Russia could reach to destroy our energy infrastructure,” Marchenko recalled in an interview at the Finance Ministry on Monday, shortly after he and his team took cover in a parking lot amid another air raid siren.

The Zelensky and Biden administrations were already on edge about the rhetoric from U.S. Republicans who won a slim majority in the House, including the potential future speaker, Kevin McCarthy (R-Calif.), who warned that there would be no “blank check” for Ukraine.

As the humanitarian needs grow, Ukrainian economic officials have sounded out Western officials about the potential for an income support program to provide roughly $50 per person per month — at a cost of $12 billion over six months, one person familiar with the matter said.

They found a cool reception, however, from Western officials who were already wary of appearing to support too much aid for Ukraine, the person said.

After the energy attacks, some experts argue the West may be doing too little, not too much.

“We’re already giving them just enough to avoid hyperinflation,” said Jacob Kirkegaard, a senior fellow at the German Marshall Fund of the United States. “But there’s clearly a risk of a more serious economic contraction, and the only way to stop that will be to provide more financial assistance.” But, Kierkegaard added, “I don’t know if the will is there.”

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Bond correction coming: What an economist and an investor say about inflation – Financial Post

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Bond correction coming: What an economist and an investor say about inflation  Financial Post

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Freeland meets with provincial, territorial finance ministers in Toronto

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TORONTO — Deputy Prime Minister and Finance Minister Chrystia Freeland is hosting an in-person meeting Friday with the provincial and territorial finance ministers in Toronto to discuss issues including the current economic environment and the transition to a clean economy.

The meeting will focus on the economic situation both domestically and globally, according to a federal source with knowledge of the gathering, including discussions on how to provide incentives and supports to be competitive with the U.S.’s Inflation Reduction Act.

U.S. President Joe Biden’s Inflation Reduction Act includes electric-vehicle incentives that favour manufacturers in Canada and Mexico, as well as the U.S.

The incentives, which were already revised to include Canada and Mexico after originally focusing on the U.S., are now facing criticism from Europe about North American protectionism.

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The source, who spoke on the condition they not be named to discuss matters not yet made public said the ongoing challenges with health care in Canada will also come up at the meeting. More substantive discussions on that will be held next week when the prime minister meets with premiers on Feb. 7.

In her opening remarks, Freeland said it’s essential for Canada to have its rightful place in the transition to a clean economy, calling it one of the biggest challenges of the moment.

We are in a situation with a lot of economic uncertainty globally, said Freeland, adding that later in the day, the ministers will have a discussion with Bank of Canada governor Tiff Macklem.

“I think that conversation with the governor will be useful and important for all of us,” she said.

Despite the need to address health care challenges, Canadian jobs and the transition to a clean economy, Freeland said the government recognizes it also has to contend with real fiscal constraints.

Freeland will hold a closing news conference at 3:30 p.m. local time.

The meeting comes at a tense time for many Canadian consumers, with inflation still running hot and interest rates much higher than they were a year ago.

The Bank of Canada raised its key interest rate again last week, bringing it to 4.5 per cent, but signalled it’s taking a pause to let the impact of its aggressive hiking cycle sink in.

The economy is showing signs of slowing, but inflation was still high at 6.3 per cent in December, with food prices in particular remaining elevated year over year.

Interest rates have put a damper on the housing market, sending prices and sales downward for months on end even as the cost of renting went up in 2022.

Meanwhile, the labour market has remained strong, with the unemployment rate nearing record lows in December at five per cent.

— With files from Nojoud Al Mallees in Ottawa and James McCarten in Washington

This report by The Canadian Press was first published Feb. 3, 2023.

 

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Pakistan PM warns of IMF bailout conditions

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Pakistan’s Prime Minister Shehbaz Sharif has said that the government will have to agree to International Monetary Fund (IMF) bailout conditions that are “beyond imagination”.

Sharif’s comments on Friday came after an IMF delegation landed in Pakistan this week for last-ditch talks to revive vital financial aid which has stalled for months.

The government has held out against tax rises and subsidy-slashing demanded by the IMF, fearful of a backlash before elections due in October.

“I will not go into the details but will only say that our economic challenge is unimaginable. The conditions we will have to agree to with the IMF are beyond imagination. But we will have to agree with the conditions,” Sharif said in televised comments.

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The global lender has set strict conditions before resuming the bailout programme for Pakistan, such as asking the government to allow a market-determined exchange rate for the local currency, ease fuel subsidies, and control circular debt in the power sector.

Pakistan’s economy has been in dire straits, stricken by a balance of payments crisis as it attempted to service high levels of external debt, amid political chaos and a deteriorating security situation. On Wednesday, year-on-year inflation had risen to a 48-year high leaving Pakistanis struggling to afford basic food items.

Before the IMF visit, Islamabad began to bow to pressure with the prospect of national bankruptcy looming and no friendly countries willing to offer less painful bailouts.

The government loosened controls on the rupee to rein in a rampant black market in US dollars, a step that caused the currency to plunge to a record low. Artificially cheap petrol prices have also been raised.

Letters of credit are no longer being issued, except for essential food and medicines, causing a backlog of thousands of shipping containers at a Karachi port stuffed with stock the country can no longer afford.

Sajid Amin, a senior official at the Sustainable Development Policy Institute, a research institute in Islamabad, said Sharif’s statement revealed the depth of the challenges facing the economy.

“Without any doubt, the economic situation is tough. Pakistan is facing multiple crises, including balance of payment crisis, political instability – issues which have delayed decision making from government,” he told Al Jazeera. Amin further said that the delays in the last few IMF reviews have led to increased uncertainty and panic in the market.

“Two of the major IMF conditions, market-determined exchange rate and petrol price increase, are majorly met already. The talks are now more focused on how to meet Pakistan’s circular debt target in the power sector. The fund has not accepted the government’s plan and has asked for a revised plan to deal with the circular debt problem,” he added.

Uzair Younus, director of the Pakistan Initiative at the Atlantic Council’s South Asia Center said that the major hurdle in the IMF negotiations seemed to be the scale and pace of actions required to reduce the fiscal deficit and circular debt. He noted that the IMF’s terms did not seem unreasonable, especially considering the number of times Pakistan has reneged on promises.

“A key issue that remains is the increase in electricity prices and a credible plan to reduce the circular debt. Pakistan has paused these increases for several months, citing floods and other challenges. The IMF wants a rapid increase in rates to reduce the circular deficit, but the government wants to stagger these increases,” the Washington, DC-based analyst told Al Jazeera.

It was no surprise that the IMF was not eager to agree to a staggered approach, given that Pakistan did not have much credibility left when it comes to following through on its agreements, Younus added.

Amin said that given the precarious economic situation in the country, the government must do whatever it takes to get the IMF on board.

“The government must understand, and I think it does understand to some extent, that inflationary pressure and other costs are much higher than the costs of IMF conditions. I think this statement, therefore, may be preparing ground and making people ready for tough measures that the government is going to take to meet the IMF conditions.”

The tumbling economy mirrored the country’s political chaos, with former Prime Minister Imran Khan heaping pressure on the governing coalition in his bid for early elections while his popularity remains high.

Khan, who was removed last year in a no-confidence motion, negotiated a multibillion-dollar loan package from the IMF in 2019.

But he reneged on promises to cut subsidies and market interventions that had cushioned the cost-of-living crisis, causing the programme to stall.

It has been a common pattern in Pakistan, where most people live in rural poverty, with more than two dozen IMF deals brokered and then broken over the decades.

 

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