Ukraine's economy is in shambles. On Feb. 5, the Ukrainian hryvnia fell by about 30 percent against the U.S. dollar as news emerged that the National Bank of Ukraine would no longer hold foreign currency auctions. Announcements that the bank plans to raise its key interest rate from 14.0 to 19.5 percent and that Ukraine has reached an agreement with the IMF on new aid failed to slow the currency's depreciation. Moreover, Ukraine has only enough currency reserves to sustain imports for another five weeks.
The country's financial crisis has begun to impact the daily lives of ordinary Ukrainians. Inflation of consumer prices reached nearly 25 percent last year, and the central bank expects to see an inflation rate as high as 18 percent in 2015. In accordance with the April 2014 deal for a $17 billion IMF package, the Ukrainian government has also begun implementing a number of austerity measures, including raising energy prices and cutting social spending. Officials will likely announce further cuts during the parliamentary session in late February. Kiev has a popular mandate to proceed with some reforms and reach a deal with the IMF, helping it avoid the social unrest that normally accompanies budget cuts. Still, the impact of inflation and austerity measures will only add to the pressure the government is facing.
Kiev is hoping to alleviate this pressure with a $15 billion bailout from the international community. Details on the new IMF package have not been released yet, but there are indications that the IMF is not willing to provide another $15 billion on top of its current $17 billion package. This means Ukraine will have to call on individual governments and other international institutions to contribute a significant portion of the aid it seeks. The United States announced in late January that it will give Ukraine $2 billion in loan guarantees in 2015, and European foreign ministers promised an additional $2 billion. Still, this aid alone may not be enough to help Ukraine avoid bankruptcy, and the West may be forced to make additional contributions to keep the country afloat. Meanwhile, Russian President Vladimir Putin put further pressure on Ukraine's finances with his Feb. 3 statement that Kiev should repay Russia's $3 billion loan, though he has yet to make a formal request for the payment.
Other Sources of Pressure
Ukraine’s economic troubles are growing at a time when the country is facing the prospect of a natural gas cutoff in the spring. Ukraine’s interim natural gas contract with Russia expires at the end of March, and Ukraine’s Naftogaz and Russia’s Gazprom have failed to hold any significant negotiations on a contract for future supplies. While Ukraine continues to import reverse flows of natural gas from Slovakia, flows from Poland and Hungary have stopped, at least for now. Though the spring weather will reduce Ukraine's demand for natural gas in the short term, pressure for Ukraine to reach a compromise with Gazprom will grow throughout the year as the country looks to refill its storage tanks before the winter months. Ukraine has only 8.9 billion cubic meters of gas in its storage facilities — 47 percent less than at the beginning of last winter. If Ukraine does not forge a deal with Gazprom by the fall, the country may not have enough natural gas to meet demand in the winter season, making it more likely that Ukraine will siphon off gas destined for downstream customers — an outcome European leaders will try to avoid.
Rising public discontent with the security crisis in Ukraine's east have only ratcheted up the pressure on the Ukrainian leadership. In early February, volunteer battalions rallied in front of the Presidential Administration Building in Kiev, where they called for the dismissal of top defense officials and the imposition of martial law. This kind of protest has taken place in the past and remains marginal, but it echoes a growing public concern about difficult conditions on the front lines and continuing losses in long-standing clash points such as Debaltseve. Many Ukrainians are also becoming increasingly unhappy with the government's antiterrorism efforts and with the West's perceived lack of support for Ukraine's defense operations.
As negotiations move forward, each party involved will be keeping an eye on more than just the military situation in Donbas. Ukraine's economy now depends on international aid, which has given its Western partners added leverage with Kiev in talks to de-escalate the conflict in Donbas. Russia, for its part, can continue to use its requests for the repayment of loans and Ukraine's reliance on Russian natural gas to improve its own bargaining position in talks with Ukraine and the West. Ukraine’s domestic challenges will therefore play a significant role in shaping the ongoing negotiations for the future of the country's east. The Ukrainian dependency on Western funds weakens the government's negotiating position, allowing European leaders to press Kiev to compromise on certain issues such as autonomy and grant some concessions to the Kremlin.