REPCO

Policymakers in Russia and Ukraine have been bracing themselves for a potentially seismic shift in US foreign policy. Trump may believe that starving Ukraine of aid will force it to the negotiating table and compel a ceasefire. However, his vow to end the war in 24 hours has been dismissed by Kyiv as unrealistic and by Moscow as dangerous. With the future of the war looking murkier than ever, how are Russia and Ukraine set to fare on the economic front? 

Less aggressive approach?

Trump has often expressed a desire for a more conciliatory approach towards Russia, especially when compared to other adversarial countries like Iran and China. Days before his inauguration, Trump indicated his openness to lifting sanctions, stating, ‘If you get along and if Russia is really helping us, why would anybody have sanctions if somebody’s doing some really great things?’ Trump also broke with convention during the 2018 Helsinki Summit, when Trump appeared to side with the Russian government in denying election interference despite the findings of his own intelligence officials. 

Despite these statements, Trump did authorize sanctions in response to Russia’s election meddling and its military operations in Ukraine. However, the enforcement of these policies left much to be desired. For instance, the administration missed deadlines for issuing reports and designating entities to be sanctioned under the ‘Countering America’s Adversaries Through Sanctions Act’. This pattern, concurrent with a reluctance to criticize Putin, gave the impression that sanctions were more of a formality than a genuine attempt to apply pressure. In this case, history could very well repeat itself. 

The existing sanctions regime is unlikely to be lifted but Trump could prove reluctant to implement new measures and strengthen enforcement. In the face of an unprecedented sanctions regime, Russia’s economy has proven resilient. The Russian economy has not only failed to collapse as many had hoped, but its economic growth has surpassed many of the countries that imposed the sanctions. 

Russia’s evasion of sanctions has been a notable point of frustration for Western policymakers, particularly in relation to the poor performance of the G7 oil price cap. When the G7 imposed this in September 2022, it initially put a stranglehold on Russian oil revenues by capping the price of Russian crude at US$60 per barrel. The cap had a dramatic impact on Russian oil and gas revenues, which fell by 47 per cent in the first six months of 2023 compared with the same period in 2022. However, the impact was ultimately short-lived as evasion tactics and enforcement lapses allowed revenues to roughly recover to their pre-cap level. 

Russia’s extensive efforts to reorient its supply chains create an evolving challenge that requires western allies to be equally adaptive. This situation can be likened to a cat-and-mouse game, where it is crucial to continuously update and close loopholes to maintain pressure on the targeted country.

It is uncertain whether Trump will be willing to maintain an indefinite pursuit of matching circumvention with countermeasures, especially if doing so requires any diplomatic heavy lifting or new investment. Indeed, strengthening compliance with the oil price cap would require increasing personnel dedicated to sanctions enforcement; utilizing advanced technologies to detect anomalies in supply chains; and additional funding for departments implementing export controls. Trump is also likely to be wary of the inflationary risks tied to tightening sanctions on tankers carrying Russian oil. The restrictions on Russia’s state-owned shipping fleet, Sovcomflot, provide a useful case study in understanding the prevailing approach to sanctions. Sovcomflot is integral to the seaborne export of Russian crude oil, and yet only 20 of its 120 oil tankers have been sanctioned so far. This loophole has been left open due to concerns that Russia will seek revenge by holding back its oil supply with an adverse impact on prices. High oil prices featured heavily in Trump’s campaign alongside a vow to end inflation. It is likely that an overarching focus on the short-term performance of the US economy will see closing loopholes in the current sanctions regime sink even lower down the strategic agenda. 

Severe limitations

Trump’s approach to energy policy is likely to involve a combination of deregulating the US oil industry and encouraging higher production, as evidenced by his calls for the US to ‘drill, baby, drill’. By ramping up production, a Trump presidency could bring down prices. Although Russia’s fiscal deficits are currently small (-0.5 per cent of GDP in June) and thus easily financed through the domestic debt market, weaker oil revenues would put strain on Russia’s budget, which is being stretched by unprecedented military spending. The Kremlin already has been forced to impose a tax overhaul this year and the magnitude of defence spending will almost certainly compel further income tax hikes if oil prices fall below expectations. In this climate, China and India serve as Russia’s buyers, not its allies, and these countries will be more than willing to pull the rug out from under Russia if it does not continue to offer attractive pricing. 

Fundamental structural issues within Russia’s economy, including acute labour shortages, dependence on public investment and the crumbling national infrastructure, will continue to pose severe challenges that a shift in US policy cannot remedy. Russia’s national infrastructure has been rotting under Putin’s rule. In 2021, the Russian senator Andrei Shevchenko warned that the cost of necessary repairs to infrastructure had surpassed four trillion roubles (2.3 per cent of the 2023 GDP). 

Russia is now being pulled in multiple directions, seeking to concurrently manage the costs of military operations in Ukraine, the reconstruction of devastated occupied regions and the restoration of its own infrastructure. It is becoming clear that something must give way, and it seems that Moscow’s ageing power, wastewater and transport infrastructure, as well as the much-needed development of rural areas which could enhance quality of life and economic productivity, will bear the brunt.

There also is no foreseeable way out of Russia’s labour market crisis – with vacancy overhang touching almost every industry. The issue of Russia’s demographic decline falls into the often overlooked ‘opportunity costs’ of the war. The wave of people leaving Russia since February 2022 marked the most significant exodus in the past three decades and a recent study by The Bell found that 650,000 Russians still live abroad. This human capital challenge is paralleled by technological setback. Moscow currently circumvents sanctions designed to restrict technological access by importing unrestricted dual-use items and relying more heavily on its own production. However, these alternatives are frequently of poorer quality and will likely stifle productivity gains. 

On the war front, contracts with countries like North Korea and Iran have substituted domestic limitations in ammunition production. However, resource constraints will become more pronounced over time. Of course, the long-term erosion of Russia’s combat power will matter little if Ukrainian forces suffer greater degradation due to cutbacks in US aid. How does Ukraine stand to cope with a second Trump presidency? 

Challenges ahead for Ukraine

Trump’s ‘America First’ policy advocates for channelling spending towards domestic issues, such as the border crisis, over international engagements. This perspective has informed harsh criticism of spending on Ukraine, casting a long shadow over the future of US support. Trump’s personal relationship with Ukraine has also been highly contentious since the 2019 phone call with President Volodymyr Zelenskyy, which led to his first impeachment. Accused of pressuring Zelenskyy to investigate Joe Biden, Trump’s animosity towards Ukraine deepened. This was only made worse by Paul Manafort’s involvement with Ukrainian pro-Russian figures and the ‘Black Ledger’ of secret payments. Trump’s remarks about ending the war in Ukraine and conceding parts of the country to Moscow suggest a drastic shift in US policy that threatens to undermine Ukraine's defence and economic stability.

Ukraine’s 2025-27 budget declaration reveals the stress that it is already under. Ukraine is targeting fiscal consolidation, but deficits remain very large: equal to 18.2 percent of GDP in 2025, 10.3 per cent in 2026 and 6.7 per cent in 2027. Much of this burden will need to be covered by loans from allies. In August, Ukraine’s Ministry of Finance announced that it needs 35 billion dollars in external financing for 2025 alone. Defence will dominate the budget during this period, averaging 50 per cent of all expenditures – illustrative of the enormous cost of a long war. 

Social spending, including support for veterans, education, healthcare, youth and sports, and culture, will all be significantly cut. The government is also planning to fix the subsistence minimum and minimum wages. As social benefits and pensions will not rise in line with inflation, those who rely on these payments will experience a decline in their real income. This will unfold in a country where roughly 29 per cent of the population now live in poverty. 

European aid and the arrival of a 50 billion US dollar loan financed through interest generated on frozen Russian assets will help, but the impact of a US retreat would still be felt. From January 2022 to April 2024, the US provided 27 per cent of the financial aid Ukraine received. Even with the implementation of this harsh austerity programme, delays in the flow of US aid would force Ukraine to burn through the loans at its disposal, compelling yet another painful re-evaluation of spending. 

Since 2022, Ukraine has managed to avoid the severe inflation and dramatic currency depreciation typically experienced by wartime economies. Inflation peaked at 26.6 per cent in December 2022, which compares to 200 per cent in Syria in 2013 and 313,000,000 per cent in Serbia during the Yugoslav Wars. This has been achieved through various internationally funded strategies, including spending an average of US$2.4 billion per month in 2023 defending the hryvnia, Ukraine’s currency. 

In a worst-case scenario, compensating for the gap left in the budget could necessitate a return to the dangerous monetary financing used in 2022. Monetary financing carries the risk of hyperinflation because, if relied upon for too long, it can overload the economy with liquidity. Indeed, the national bank is already undertaking an unorthodox monetary policy to contain excess liquidity in the banking system. The needs of the army are intertwined with the state’s survival and thus will not be sacrificed. To avoid heavy dependence on monetary financing, Ukraine could be forced to delay or cut public wages and pensions. Concurrently, it is likely that the national bank would need to scale down its interventions in the FX market, resulting in currency depreciation that would further erode purchasing power. 

Ukraine’s European partners will try to avoid an extreme scenario like this, but the intensification of financial pressures on households will be very difficult to avoid. By exacerbating the ongoing humanitarian crisis, interruptions in the flow of US aid have the potential to amplify the refugee crisis as more Ukrainians seek safety and stability abroad. Past experiences have shown that delays in the flow of US aid increase the exposure of Ukrainian infrastructure and civilians to missile attacks, even far behind the frontlines. An analysis by the Wall Street Journal of daily data from the Ukrainian Air Force Command found that Ukraine intercepted only 46 per cent of Russian missiles during the six-month congressional deadlock, which ended in April 2024. In the previous six months, Ukraine had successfully intercepted 73 per cent of missiles.  

Room for optimism?

While a Trump administration will almost certainly initially pursue cutbacks in aid, Trump could be pushed to rethink his position on aiding Kyiv if the Ukrainian front started to collapse. Trump’s narrative has always hinged on the assertion that Russia would not have dared to invade Ukraine under his watch. Trump now appears to believe that by starving Ukraine of aid he can force Kyiv to the negotiating table and force a ceasefire deal. Paradoxically, by weakening Ukraine, Trump is likely to reinforce Russia’s long-held view that it can win the war by outlasting the West in a prolonged war of attrition. 

The continuation of the war and the potential for Russia to seize large parts of territory without adequate support for Ukraine would create a scenario too perilous for many to ignore. This pressure will come from various quarters, including hawkish Republicans, the opposition and a considerable portion of the electorate. Historical precedents also indicate Trump’s willingness to make compromises on Ukraine. Republicans in Congress were willing to approve aid to Ukraine after a six-month blockage put the Ukrainian frontline in a desperate position. This deal was reached when Trump himself proposed revising the package to structure economic support as forgivable loans rather than grants. 

Recent developments in the diplomatic sphere also suggest that Trump will, at the very least, be willing to continue a dialogue with Ukraine. In July, Trump and Zelenskyy had a phone conversation that both parties characterized as constructive. Ultimately, the optics of failing to contain Russian advances would undermine Trump’s argument of stronger deterrence under his leadership. Aid may come on worse terms, and there could very well be less of it, but historical flexibility suggests Trump’s position could shift on the need to uphold political narratives of the US as a strong, dominant power in the world. 

In sum, Russia’s war in Ukraine stands on the brink of a significant upheaval. Despite promises of a rapid resolution to the war, the path to peace is likely to remain elusive. A shift in US foreign policy is likely to worsen an already difficult economic and humanitarian situation in Ukraine. This is true even if there are grounds to believe that Trump could rethink his position further down the line. In any case, Moscow will, at least temporarily, have the military and economic upper hand.

This article was published by New Eastern Europe on 17 September, 2024, you find it here.