Ukraine could need a further $19bn in emergency international funding by the end of next year if there is no resolution to the escalating conflict in the east of the country, the International Monetary Fund (IMF) has warned.

Peace talks are scheduled to resume this week in Minsk as the humanitarian disaster deepens and the outlook for Ukraine's economy darkens. Factories are shutting down, the country's industrial heartlands are under attack and the currency has been in freefall, contributing to a sharp increase in prices.

The IMF last week approved a $1.4bn (£840m) loan to Ukraine, the second tranche of its $17bn bailout programme agreed in April to stave off default.

Ukraine urgently needs IMF loans to support its budget and prop up its faltering currency as its debts come up for repayment. Almost $4bn must be repaid before the end of the year, with $9bn due in 2015.

In exchange for IMF aid, Ukraine's government has agreed on sweeping economic reforms, including curbing public-sector wage increases, increasing energy prices to bring them more in line with market values, overhauling banking and currency regulations and tackling chronic graft that has made the country one of the most corrupt in the world.

The IMF praised Ukraine's progress, but said risks to the programme had increased. Since mid-July, the conflict has escalated, while Naftogaz, Ukraine's national gas company, and Gazprom, Russia's state energy group, have been locked in a standoff over the price of gas, which until recently the Russians supplied at a hefty discount. The dispute is likely to further increase Ukraine's debts.

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Despite highlighting military and political turmoil, the IMF left unchanged its forecast that Ukraine's economy would shrink by 6.5% in 2014 – an estimate based on the assumption that fighting will abate in the coming months.

But it said that if fighting continued through next year, Ukraine would slide deeper into recession and its economy would shrink by up to 7.25%. With many independent economists pencilling in a 7.5%-8% slump and an extension to the bailout, the fund was accused of being too optimistic.

"The IMF are living in cloud cuckoo land," said Timothy Ash, of Standard Bank. The main question being asked by investors, he said, was "when, not if" Ukraine would be forced to restructure its debts.

The IMF has agreed to soften some of the bailout programme demands. Ukraine will be allowed to run a larger budget deficit this year, to reflect the drain on its finances from fighting Russia-backed separatists.

Ukraine's prime minister, Arseniy Yatsenyuk, said last week that the country was incurring billions of dollars of losses as a result of the war, costs that far exceeded the lost production in Ukraine's industrial heartlands.

The Donetsk and Luhansk regions at the centre of the conflict are the bedrock of Ukraine's coal, steel and chemicals industries. Although home to less than 9% of the population, these regions contribute 16% of the country's economic output. Yatsenyuk has accused separatists of attacking railways, roads, power stations, bridges and mines as part of a Russia-backed plan to stifle the economy.

In July, industrial output in Donetsk was down 29% on last year, in Luhansk 56%. ZAZ, Ukraine's largest carmaker, announced recently it had virtually ceased production because of the conflict and the erosion of consumer spending power as the currency has plummeted.

The hryvnia has rebounded after hitting an all-time low last week, but it has still lost more than a third of its value against the dollar this year.

A weaker currency also hurts Ukraine's highly dollar-dependent economy by making loans denominated in foreign currencies more expensive to repay, which in turn increases defaults, putting the banking system under stress.

Currency was a sensitive issue for Ukraine's 'dollarised' economy, said Olena Bilan, chief economist at Dragon Capital investment bank in Kiev. Currency strength was a sign of wider economy stability, she said, and "a psychological issue" for a population that remembered "the long period of economic problems that Ukraine experienced after the collapse of the Soviet Union".

Bilan thinks the population will back the IMF-mandated reforms. "People here are ready to accept some pain. There is understanding that the country was mismanaged and is in a critical situation now. It is no longer possible to keep [domestic energy] tariffs unchanged while paying very high gas prices to Russia."

But Elena Sniezhko, of Ukraine's Capital newspaper, said prolonged wage freezes and cuts at a time of high inflation were proving unpopular. According to a survey of economists by the paper, inflation was running at almost 13% in July but was expected to spike at 20% towards the end of the year.

Vasyl Povoroznyk, senior economist at the International Centre for Policy Studies, a Kiev-based thinktank, said that as the country prepared for parliamentary elections in October, the economy would remain a secondary concern behind the war. But the "most anticipated economic reform" was the demand that took protesters to Kiev's Independence Square – an end to corruption.

The IMF, which has seen Ukraine fail to complete its two previous reform programmes, said success hinged on whether the authorities can make "a decisive break with a past riddled with weak governance, widespread corruption and abysmal business climate".

Povoroznyk said the government had the will to carry out these reforms, but most overcome opposition from special interests in the bureaucracy and business world that have profited from siphoning off state funds.

"Why did people go to Maidan last year. It was for political and economic reforms. Unfortunately they have not been achieved yet."