The Ukrainian economy is facing its most difficult challenge since the transition period of the 1990s. The annexation of Crimea and the occupation of industrialized Eastern Ukraine by Russian troops and local terrorists have reshaped economic ties within the country. We estimate it will take up to one year for the full economic adjustment to take place. The current war zone is likely to remain out of Kyiv's control for some time to come, in our view, meaning part of the economy will effectively come to a complete stop, which will weigh on overall economic performance. We now see Ukraine's GDP continuing to contract through 1H15. The decline in exports from eastern industrial companies will keep Ukraine's C/A balance in negative territory even though a strong adjustment in imports is also taking place on the back of the hryvnia depreciation. The currency will remain under pressure, but the current shadow market exchange rate of UAH 14.0-14.5/USD looks somewhat high. NBU reserves are likely to remain largely flat thanks to generous IMF funding. The state budget deficit will widen to 4.8% of GDP in 2014 and will be covered mainly with IFI money.

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