The Ukrainian economy has been foundering for quite some time. The country has gone through two revolutions in a decade, and at the heart of both of them are two issues: government corruption, and the struggling economy. Last summer, before the Euromaidan protests began, Russia began to wage a trade war against Ukraine to force it to stay away from the European Union. After the Yanukovych government was ousted, the interim government quickly discovered that the situation was worse than they had feared. The military was in shambles, and significant amounts of money had been stolen. The government coffers were empty.

Then Russia annexed Crimea and invaded eastern Ukraine.

The IMF loan which has propped up the country has also meant that the Ukrainian government has had to simultaneously reform a government, fight a war, and cut spending. Austerity may mean that in the long-run Ukraine’s debt-to-GPD ratio will improve, but many are asking what good that will do if the country collapses.

And there are red flags. The Economist recently took a detailed look at the problems which Ukraine is facing. First up, the numbers:

A year of revolution and war has taken a grim toll on Ukraine’s economy. GDP could fall by 10% this year. The currency, the hryvnia, has plunged nearly 50% against the dollar in 2014. Inflation has hit 19%; at the beginning of the year, prices were stable. The central bank raised rates this week, for the third time this year, to 14%. Consumer spending rose by 5% in the second quarter compared to the year before, but that probably reflects panic buying; it is likely to slump soon too.

But The Economist also sees that the conditions of the IMF loan have not met the demands of reality in Ukraine:

On the surface, Ukraine’s public finances, at least, seem reasonably sound. Public debt has risen in the past decade but it is no Greece. According to the IMF, the debt-to-GDP ratio will be around 70% by the end of the year (though this calculation includes the separatist regions). This year Ukraine’s interest payments will amount to 3% of GDP, which is low by international standards. But Ukraine is running out of the money to service these debts. Few people, least of all the IMF’s technocrats, predicted that the fighting would be so fierce. As investors pull money out of Ukraine, the central bank has spent billions of dollars in a desperate attempt to prop up the tumbling hryvnia: foreign-exchange reserves are now at their lowest level in a decade. The central bank’s efforts have done little: this week alone the hryvnia fell 14% (see chart).

Things might improve in Ukraine, but the war is expensive. Journalist Maxim Eristavi recently analyzed Ukraine’s economy and concludes that the war “breaks the spine” of the economy:

On July 31, in a last-minute vote, Ukraine’s parliament authorized an additional $743 million for the army, which otherwise would be left without a cent starting August 1. Lawmakers decided to finance these military expenditures with additional tax hikes, including a mandatory “war-tax” of 1.5 percent for all Ukrainians. That won’t come close to covering all of the war’s costs, however. To repair the war devastation in Eastern Ukraine, the country needs at least $600 million, according to the Finance Ministry. Kyiv has, at most, half of that, and the fierce fighting in the region continues.

Why Is The Hryvnia Falling?

There is a problem with some of the analysis which has been done on Ukraine. At various times throughout the last 9 months, the Ukrainian economy looked as if it were stabilizing, or even slowly recovering. The hryvnia has stabilized multiple times. So while there were always going to be problems, a problem is not necessarily a crisis. What is really causing the hryvnia to sink and investors to flee?

First, let’s look at the three year history of the hryvnia versus the dollar. What this shows is that there is a slow devaluation that has been going on for years. This underscores the point that there are fundamental weaknesses in Ukraine’s economy (remember, on this chart up is bad for the Ukrainian economy).

Now let’s zoom in. Obviously, the collapse of any government is not going to do wonders for the economy. But a more careful analysis shows that there are some surprising results. As things in Maidan Square turned violent the currency lost value. When Yanukovych fled the country on February 22, the currency lost value. But after the interim government took control and chaos did not erupt, the spike ended…

But the top of that first spike is February 26th, the day Russian forces began to position themselves in strategic areas across Crimea. In early March, after it was clear that Russian forces were taking over the peninsula, the currency began to plummet. As Russian interference became more readily apparent in eastern Ukraine, the currency appeared to be in free-fall. It was during this period in time that separatists began taking over government buildings all across eastern Ukraine.

But the currency improves between April 11 and April 16th? What happened during that period in time? On April 10th the Ukrainian government offered amnesty to those militants who were willing to leave government buildings, and on April 12 Acting Ukrainian President Oleksandr Turchynov announced the beginning of the “Anti-Terror Offensive,” or ATO. After the Easter Sunday truce ended in violence, the hryvnia continued to dive.

In other words, during this period of time when the Ukrainian government showed strength the hryvnia improved. When it showed weakness or when Russia showed aggression, things got worse.

But then there is a period of time where the hryvnia moved little, and the conflict moved even less. The interim government was hesitant to confront the separatists directly. The hryvnia slowly got worse. After Petro Poroshenko was elected and took office in June, the Ukrainian government was more aggressive toward the separatists. The hryvnia slowly got better.

Until late July. After MH17 was shot down, and with more signs of Russian intervention in eastern Ukraine, and with Ukrainian aircraft regularly being shot down by Russian-supplied anti-aircraft missiles, the value of the currency declines significantly, spoking during the “Russian invasion” in August, and only stabilizing after a ceasefire was signed at the start of September.

When the ceasefire did not look like it was going to be permanent, and when the European Bank for Reconstruction and Development revised Ukraine’s GDP downward, the hryvnia fell to record lows in mid-September. But with fighting in eastern Ukraine only simmering, the hryvnia stayed relatively stable until November 3rd. Immediately after the Russian-backed militants held their elections, which Russia alone considered valid, Russian troops once again started to cross the border, fighting began to increase, and the world once again started to warn of a significant Russian escalation in eastern Ukraine.

So while Ukraine would have faced significant economic problems regardless, they may not have amounted to a crisis if Russia had not directly interfered by first annexing Crimea and then militarily supporting the militants in eastern Ukraine, culminating in several rounds of invasion.

— James Miller