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Ukraine economy at risk, may need another bailout

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By JUERGEN BAETZ
Associated Press

BRUSSELS (AP) - While Ukraine's leaders are trying to win the war against Russian-backed separatists in the east, they appear to be losing the battle to resurrect the country's battered economy.

Ukraine might need billions in additional support if the fighting between the military and the separatists in the country's east persists through next year, the International Monetary Fund warned Tuesday. Only covering the shortfall in the central bank's reserves would require an additional $19 billion by the end of 2015, the fund said.

If the fighting eases over the coming months, the country's economy would still be shrinking by a sharp 6.5 percent this year, with meager growth on the horizon next year, according to the IMF. Analysts, however, say the damage to Ukraine's economy is likely to be more severe.

"There is no end in sight to the conflict, so it's almost impossible to make growth forecasts," said Timothy Ash, the head of emerging markets research at Standard Bank in London. "The recession this year will be deeper - maybe minus 8 percent - and there will be no recovery next year."

Just as with the military stand-off, the country's economic future will depend largely on Russia's actions.

"Risks loom large" because of the fighting and the unresolved dispute with Russia over prices on gas imports and arrears, the IMF acknowledged in its first in-depth assessment since granting the country a $17 billion bailout program in March.

In return for the emergency loans, Ukraine must slash spending and push through painful reforms - a difficult task for any government even when not fighting a war.

The IMF's bailout program depends on the conflict in Ukraine easing in the coming months. If that doesn't happen, "a new program strategy will be needed" that would involve significant more financial aid, the IMF said.

The fund said Ukraine's increased spending on defense, banks and state energy company Naftogaz will lead to a higher budget deficit this year than forecast in March, forcing the government to slash spending even more in the coming two years.

The current bailout program already faces a financing shortfall of $3.5 billion through 2015 even under the current - rather optimistic - outlook, the IMF said. More money will also be needed to rebuild destroyed infrastructure and houses in the east once fighting stops.

"Clearly, the risks are on the downside," Nikolay Gueorguiev, the IMF's Ukraine mission chief, said in a conference call.

In addition to the IMF bailout, the 28-nation European Union has pledged a support package of loans and grants worth $15 billion. The EU is mediating in Ukraine's gas dispute with Russia and has signaled it is ready to grant further aid if needed. The United States has lent Ukraine $1 billion.

Ukraine's eastern region, where the fighting rages, used to account for about a quarter of the country's industrial production and exports, and 16 percent of overall economic output. Due to the conflict, however, the economy of the region, called Donbass, is projected to shrink dramatically, by up to 20 percent, the IMF estimates.

"Ukraine is not really sustainable (as a state) without the Donbass," Ash said. "The region is a railway hub, it has the coal mines, steel plants and chemical plants, that's also why Russia is focusing on the Donbass."

Even before the fighting escalated, Kiev was facing an uphill struggle to lead the country of 46 million to a more prosperous future after years of economic woes caused by under-investment in its aging industries, inefficient state monopolies and widespread corruption.

Russia in December promised Ukraine a $15-billion bailout but withdrew that offer after the ouster of President Viktor Yanukovych in February. His demise was triggered by months of protests following the decision to back away from closer relations with the EU and turn toward Russia instead.

Moscow annexed Ukraine's Crimean Peninsula in March and has since been accused of fomenting unrest in eastern Ukraine. NATO says about 1,000 Russian troops are already on Ukrainian soil there. Russia denies direct involvement in the fighting.

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Follow Juergen Baetz on Twitter at http://www.twitter.com/jbaetz

Copyright 2014 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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