With the Crimean referendum on Sunday, and most people expecting the region to vote for secession from Ukraine, attention is turning to how the split will impact the rest of Ukraine. Even if tensions don’t escalate toward war, deteriorating relations with Russia could drive the rest of eastern Ukraine toward a split as well, seriously undermining the Ukrainian economy.
Ukraine divides evenly by political, linguistic identity
As a first step to understanding what a breakup might loop like, Nomura research analysts Dmitri Petrov and Peter Attard Montalto divide the country according to political affiliation and first-language (Russian mother tongue, support of the ‘Party of the Regions’ in the east; Ukrainian mother tongue, support of the ‘Fatherland’ party in the west) and found that either method paints the same picture.
Marathon Partners Equity Management, the equity long/short hedge fund founded in 1997, added 8.03% in the second quarter of 2021. Q2 2021 hedge fund letters, conferences and more According to a copy of the hedge fund's second-quarter investor update, which ValueWalk has been able to review, the firm returned 3.24% net in April, 0.12% in Read More
This divide splits the country’s GDP almost exactly down the middle, but the east has more manufacturing than the west (57% – 43%), while the west has a slightly larger population. Crimea itself is relatively small, but Donetsk and Luhansk, which also border Russia, are important economic hubs and their annexation would be a huge blow to Ukraine.
Eastern manufacturing geared towards Russian sales
Even if Russia doesn’t move troops into eastern Ukraine (which some experts have warned it might do), falling trade with Russia could push the east into its arms.
“It is a matter of debate whether Europe could absorb some of the processed foods and base metals,” write Petrov and Montalto. “However, it is quite clear that very specific industrial goods such as train carriages, turbo engines and locomotive parts are heavily oriented towards the Russian market and supply chain, and re-orienting these industries to Europe would be nearly impossible without very heavy investment.”
The EU has signaled that it will sign the EU Free Trade treaty with Ukraine by the end of the year, but if eastern Ukraine is tooled to manufacturing goods that Europe doesn’t want then it doesn’t really matter. It’s unlikely that all of the companies that need capital to modernize and change production would get it. Even if they do, it won’t happen overnight and unemployment will rise in the short-term anyways. Petrov and Montalto estimate that this could push unemployment levels from around 7.6% in the east to more than 14%. Ukraine is already expected to implement new austerity measures; doubling the unemployment rate on top of that and the underlying national tension could be enough to drive a wedge between east and west without direct Russian involvement.