Mark Adomanis in Washington -

Russia’s intervention in the Donbass has been growing steadily more intense and public. Over the past week, numerous Russian servicemen were captured after “accidentally” wandering into Ukrainian territory. As this column is being written, it appears possible that an outright Russian invasion is underway though, as is always the case in these situations, the initial information is contradictory and inconclusive. Responding to this pressure, the government in Kyiv has released ever more stirring public statements about its intention to prosecute the “anti-terror operation” to a successful conclusion.

These are not just rhetorical commitments. As reported by the AP, recently elected President Petro Poroshenko announced he would raise military spending by $3bn through 2017. Now $3bn might not sound like much when it comes to defence budgets - at one point the Pentagon was spending roughly seven times as much only on air conditioning in Iraq and Afghanistan - but it is actually a roughly 50% increase from the most recent budget targets. Justifying his decision, Poroshenko noted that, “in the foreseeable future there will always, unfortunately, be the threat of war," and that Ukrainians “must always be prepared to defend our independence."

At first glance this sounds perfectly understandable. Ukraine doesn’t just face the threat of war, it is clearly already fighting a war on its own territory. Several thousand people have been killed in the violence in eastern Ukraine, and enough heavy weaponry, including tanks and artillery, has been deployed that calling what is happening anything other than a war feels like a cheap dodge. And wars, obviously, cost money. It’s hard to fault Poroshenko for wanting to dedicate serious resources to the military in such a desperate situation.

The problem is that Ukraine is broke.

Economic slump

In what is surely one of the least surprising developments ever, the performance of Ukraine's economy has been disastrous, even worse than already poor consensus estimates. Throughout the first half of 2014, Ukraine’s GDP contracted by at least 4.7% (the expectation was for "only" a 3.1% decline) and is projected to decline by more than 6% by the end of the year. It turns out that having a shooting war in the heart of the country's most economically significant region has a deleterious economic and financial impact.

Ukraine's economy has now contracted for seven of the past eight quarters. Its stocks are flirting with all-time lows. The currency has collapsed, losing more than 40% of its value against the dollar since the start of 2014. This means that the country's (already highly constrained!) ability to pay its bills has been getting smaller at exactly the same time that those bills have been growing rapidly. This situation of shrinking available resources and growing claims on those resources is, quite obviously, completely unsustainable. In the very near future something will have to give.  Either Ukraine's economy will get back on track, gradually restoring the country's ability to service its debts and meet its payment obligations, or the country will face financial collapse.

Unfortunately for Ukraine, the first scenario is far less likely than the second. Looking at the country’s already significant level of sovereign debt, its vanishing currency reserves, its growing budget deficit and its shrinking economy, there is simply no way to make the numbers add up. The aid already promised by the IMF, US, and EU was insufficient to meet Ukraine’s pre-existing problems (even the head of the IMF has admitted as much). The growing chaos in the eastern Donbass region and the ever-more rapid deterioration of the Ukrainian economy means that the country’s financing needs have grown much larger.  

The expectation among most Westerners, and even among some officials in the Ukrainian government, has been that someone would magically ride to the rescue. Carl Bildt, Sweden’s hawkish and high-profile foreign minister who was one of the leading figures behind the attempt to integrate Ukraine into the EU, has been one of those chiefly responsible for sparking these hopes, occasionally