Hard-hit Eastern Europe pushes toughest response in Ukraine

ORUSSIA HEN invaded Ukraine, many Eastern European countries responded with hawkish resolve, fearing they were next. Their governments have pushed for EU to cripple Russia’s economy and dug deep into their own pockets (some deeper than their Western counterparts) to send arms and aid to Ukraine. Country in the EU‘s East hosted most of the 5.6 million refugees who fled the war. But doing the right thing doesn’t come cheap, and the economic fallout from being frontline states is starting to kick in.

Listen to this story.
Enjoy more audio and podcasts on iOS or Android.

Your browser does not support the item

Save time by listening to our audio articles while you multitask

Trade was the first victim. Russia has been a major export market for some economies in the region. Trade with Russia represented 6% of GDP in Latvia and Lithuania in 2021 and 1.5% in Poland and Slovakia. In 2021, Russia received about a tenth of non- EU exports from Poland and the Baltic States. Most of those ties are probably broken for good, but they see it as a price to pay. “It is Poland’s key political interest that the West does not start doing business with Russia again,” said Piotr Arak, director of the Polish Economic Institute, a government think tank in Warsaw.

Direct trading is only part of the story. East EU states have integrated into Western supply chains. Their economies, notably those of the Czech Republic, Hungary and Slovakia, are strongly oriented towards exports to Germany. Thus, a blow to German industry, such as a cut in Russian gas, would seriously harm its suppliers in the East.

Energy imports are particularly challenging. Slovakia and Hungary, which got 96% and 58% of their oil from Russia last year, say EU the oil embargo should be implemented gradually. Other countries are better prepared. The Baltic states ended imports of Russian gas in April and now rely on liquefied natural gas (LNG) imported by ship. Poland imposed an embargo on Russian coal and, like most countries, rejected Russia’s demand to pay for the gas in rubles. In response, Gazprom, which supplies 40% of the country’s gas, halted deliveries to Poland (and Bulgaria) last week. But Poland also has an alternative gas import plan through its own LNG terminal and new gas pipelines to the gas networks of Norway and Lithuania.

Fleeing Russian energy means higher prices. It will be particularly painful in the poorest east of Europe. Inflation was already higher in Eastern Europe before the war; in April, it reached double digits in many countries. In some, consumers’ energy bills are set by regulation, delaying the pain. In Slovakia, for example, prices will only be updated in January. But “the prospect of a 100% increase in gas prices for households has yet to materialize,” said Michal Horvath, the central bank’s chief economist.

In Poland, inflation reached 12.3% in April, a headache for the ruling party, which faces elections next year. Government largesse is partly to blame for the rising cost of living, and Mr Arak thinks voters will blame him: “During communist times, the government would introduce higher prices, often triggering mass protests . For the majority of Poles, it remains clear that the state is responsible for maintaining price levels. To cushion the blow, the government reduced the value added tax on food, gas, fuel and fertilizers. He calls an upcoming economic package an “anti-Putin shield.”

Central banks will also have to act, in particular by raising interest rates. But this will have unpleasant consequences. In Poland, where approximately 90% of loans to households and businesses are at variable rates, mortgage holders are highly exposed. Banks have already significantly tightened credit standards. With inflation, soaring house prices and declining business confidence, this could mean a “perfect storm”, says Adam Czerniak, head of research at Polityka Insight, a think tank in Warsaw. Rising interest rates and weakening economies mean that rising public debt will become more expensive to repay, especially in countries like Hungary where debt is already high.

Spending on refugees will further boost inflation. Take housing. In Warsaw, rents have jumped by more than 30% since the end of February. The constraints on public services are similar. Refugees have increased Poland’s population by almost 8% since the start of the war in Ukraine in late February. This puts pressure on health care and education, which were already in poor shape. However, this will be partially compensated by the arrival of new arrivals on the local labor market. In Slovakia and Hungary, the dedication of NGOs and individuals made up for the lack of public services for refugees.

The economic costs of the war for Eastern Europe seem enormous. But that doesn’t seem to have softened the countries’ resolve. The economic blow is considered manageable. Poland’s economy, which remains strong, had not experienced a recession for nearly three decades until the covid-19 pandemic, notes Wojciech Kopczuk of Columbia University. The Baltic countries have suffered much more from the financial crisis, adds Morten Hansen of the Stockholm School of Economics in Riga. Citizens absorbed this suffering because it was necessary to join the euro, as part of the countries’ strategic effort to integrate with the West. As in the current crisis, they were prepared to suffer economic hardship to safeguard their independence.

The war and its consequences will have economic benefits for Eastern Europe. Bulgaria aims to become a regional energy hub. Poland, in particular, stands to gain from Ukraine’s post-war reconstruction and its growing integration into the EU. “No Western country has such close intergovernmental ties with Ukraine as Poland,” says Oktawian Zajac of the Boston Consulting Group’s Warsaw office. The bonds that Ukrainian migrants and refugees forge will also bring economic benefits, says Kopczuk.

The responses of central and eastern European states to the Ukraine crisis “will define the region for decades to come”, says Sona Muzikarova of Globsec, a think tank in Bratislava. Undeterred by the economic pain of war, they show by example that Russian aggression must be firmly resisted.

Read more about our recent coverage of the Ukraine crisis

Mary I. Bruner