At the height of the crisis in Ukraine, President Obama insisted that financial pressure would ultimately check Russian President Vladimir Putin’s aggression.
It appears this strategy is working – but with an unintended consequence that could spell doom for Eastern Europe.
A new study from Vienna Institute for International Economic Studies predicts that foreign direct investment (FDI) in Russia will drop $41 billion – a decline of 50 percent from 2013. The institute found that uncertainty caused by Russia’s action in Ukraine and the subsequent lack of economic development is the primary reason for the drop.
“The region is exposed to two main factors that drive FDI into opposing directions,” Gabor Hunya, a researcher at the institute, noted in the report. “One is the acceleration of economic growth, which spurs FDI. The other is the Ukraine-Russia conflict, which depresses economic growth and increases investment risk in the affected countries.”
This is bad news for Russia: The country needs FDI to diversify its economy so that it is not completely reliant on gas revenues generated by state-owned energy companies. Putin knows that the Russian economy cannot survive on gas alone; he needs FDI to build up other sectors.
This is one of the reasons the crisis has deescalated so quickly. A month ago there were concerns that Putin might invade Ukraine – now, he’s in talks to end the crisis completely.
While Obama’s economic strategy, however, has checked Russia, it’s also hurt growth prospects in Eastern Europe. FDI across all of that region’s 23 countries is expected to drop to $98 billion this year from $131 billion in 2013, according to the institute, with the Czech Republic, Slovakia and Poland the hardest hit.
Bad News for Europe
This is not just bad news for Eastern Europe; it’s bad news for the entire eurozone. Aside from Germany, economic growth is all but nonexistent. Eastern European economies are still struggling to recover from the sovereign debt crisis.
Putin’s actions in Ukraine, combined with subsequent economic pressure applied by Obama and Western European leaders, has made it harder for Eastern Europe to grow. Last month, the European Banks for Reconstruction and Development dropped its 2014 growth forecast for the region to 1.4 percent, down from a 2.7 percent projection in January. The group cited the Ukraine crisis for the decrease.
“What we are worried about, really, is the potential escalation of the sanctions, particularly on the financial system," EBRD chief economist Erik Berglof said last month.
The projected drop in FDI across Eastern Europe shows that Berglof was right to worry. Now, the rest of Europe – still struggling to shrug off the debt crisis – has reason to worry too.
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