Graham Stack in Berlin -

The EBRD's latest economic forecast is glooming reading for Eastern  Europe. The bank predicts that Russia's economy will stagnate this year and will even contract next year.

The EBRD's new economic outlook confirmed a prediction from May that the Russian economy would stagnate in 2014, after a slightly better-than-expected first six months. However, the bank is revising down the 2015 growth forecast to a contraction of 0.2%. In May it forecast that the economy would grow by 0.6% in 2015.

The EBRD's vision for Ukraine is significantly worse, underscoring the damage done to Ukraine by Russia's support for East Ukraine rebels and the military incursion - and that Russia has in fact got off very lightly in economic terms. EBRD forecasts a near 12% drop in Ukrainian GDP 2014-2015, with a 9% drop in 2014 due to the war to be followed by a continued sharp decline of 3% in 2015, as the economy absorbs an austerity package required to put government finances back on track.

Gloomier still

The EBRD's predictions are significantly worse that those from the Russian government, which downgraded its growth target for this year to 1% from 2% earlier. However, the government believes Russia's economy will continue to grow next year albeit by only 1.5%. "The Russian economy will come under pressure both from Western sanctions and the sanctions that Moscow has imposed on the West in response," the EBRD said in its latest economic outlook.

The report pointed out that the last round of sanctions imposed in the middle of September are particularly painful, as they target both the main state-owned bank and the all-important oil sector. The state-owned oil major Rosneft has already asked the government for a $40bn bailout as it struggles to cover its financing costs after being cut off from the international capital markets by sanctions.

Sanctions are also affecting business confidence in Russia, which in turn has killed off investment as well as restricting the access of companies and banks to international capital markets and contributing to capital flight, the EBRD said. The economic pall now also seems to be affecting consumers as although nominal wages are still rising, retail turnover has slowed dramatically in the last quarter; consumption has been one of the few effective economic drivers in recent years.

This follows on from former finance minister Alexei Kudrin's prediction this week that $110bn of capital will flee Russia this year, almost double the capital flight of last year.

The report noted that Russian corporates needed to make repayments of around $190bn on foreign debt by the end of 2015. As they were unable to borrow externally, international reserves - standing at $465bn in September - may come under pressure and interest rates may have to rise further.

Russia's foreign trade was expected to suffer while existing trade and financial links are restructured in the wake of the sanctions. These links were likely to be gradually reoriented from the West to the East and to Latin America.

Russia's own ban on food imports from countries that have imposed sanctions could drive up inflation in Russia by 1-2 percentage points to around 8% this year, well ahead of the central bank's initial target of 4-5%. Inflation was already running at 7.5% in September on an annualised basis.

The Kremlin has threatened to expand its own set of bans on European and US businesses if the international sanctions regime is extended. Amongst the most worrying is Russia's threat to close its airspace to international flights. "The imposition of a flight ban over Russia would affect both Russia and western countries. The potential ban on transcontinental flights may cost Aeroflot an annual $300m in lost royalties while European airlines may face cost increases of several hundred million dollars as they would have to take longer routes," the EBRD said.