WARSAW—The escalating confrontation between Ukraine and Russia is inflicting severe pain on both economies and risks derailing the recovery in Eastern Europe and parts of the former Soviet Union this year, the region's leading development bank said Wednesday.
The European Bank for Reconstruction and Development, a multilateral development lender established in 1991 to help ex-communist countries transition from central planning to market economies, more than halved its 2014 growth forecast for the nations of the former Soviet Union, Eastern Europe and Turkey to 1.3%, from 2.8% in January.
The forecasts, unveiled at the beginning of the lender's annual two-day meeting in Warsaw, come as the spiraling crisis in Ukraine has triggered the most charged East-West standoff since the Cold War and underscores the renewed challenges for former Eastern bloc nations 25 years after communism's collapse.
"The uncertainty is tremendous. Capital outflows from Ukraine are turning seriously negative," said Erik Berglof, the EBRD's chief economist. "We have to be honest about the challenges that many of our countries face," added EBRD President Suma Chakrabarti.
The bank's forecasts are the most comprehensive attempt yet to assess the spread and scale of the damage to short-term economic growth prospects caused by recent uncertainty about Ukraine's future and rising tensions between the West and Russia.
Bankers said those challenges have spurred the EBRD to refocus on its core countries of operation after several years of expanding its reach to include Mongolia, Turkey and economies affected by the 2011 Arab Spring, such as Morocco and Egypt and Jordan.
"This situation is a surprise to us all, causing a major rethink in approach. We were accustomed to such situations in other regions of the world, but not under our very nose," said Piotr Czarnecki, chief executive of the Polish unit of the Austrian bank Raiffeisen, RBI.VI +1.66% which is one of the largest lenders in former communist economies.
The most immediate victims of the crisis are Ukraine and Russia. The economy of the former is now expected to contract by 7% this year after the EBRD forecast it to grow 1.5% as recently as January. For Russia, —the region's biggest economy—the EBRD said the best achievable outcome would be a year of stagnation, compared with the 2.5% expansion projected in January. Worse, the economy could fall into recession if the West imposes broader sanctions against Moscow—a step that could also drag down global growth.
"We wouldn't be surprised if Russian growth goes below zero.…We're worried about the potential escalation of sanctions," Mr. Berglof said.
The wider cost could be another year of slowing growth across a number of regions that have already been hit by setbacks, primarily the 2008 global financial crisis and the euro zone's subsequent debt troubles. In January, the EBRD forecast that 2014 would mark a year of accelerating growth in many of its 17 countries of operation. It now expects growth to slow from 2013 levels in two of the three Baltic States, four economies in Eastern Europe and the Caucasus, and five economies in Central Asia.
The EU on Monday placed sanctions on a senior Kremlin aide, a top Russian military commander and a number of Crimean and separatist Ukrainian leaders as it modestly ratcheted up its response to the crisis.
Before Monday's decision, the EU had placed sanctions on nearly 50 Russian and other individuals connected to the takeover of Crimea and the separatist push in eastern Ukraine. It said it would consider further action, including a possible new stage of broad economic sanctions.
The EBRD said there are a range of channels through which events in Russia and Ukraine will negatively affect other countries.
A number of countries in Eastern Europe and Central Asia have close trade links with Russia and Ukraine and will likely experience a decline in exports, as well as remittances from emigrant workers, the development bank said. Tajikistan, the Kyrgyz Republic, Moldova and Armenia are particularly vulnerable to a slowdown in payments from citizens working in Russia, the EBRD said.
In central and southeastern Europe, the impact is more likely to be felt through higher borrowing costs for governments and companies as investors seek compensation for increased levels of political and economic uncertainty, including threats to their energy supplies. But Bulgaria and Montenegro may also suffer from a drop in the number of Russian tourists, and the EBRD noted that Serbia retains strong trade links with Russia.
The development bank said that even without broader sanctions against Russia, growth in many economies will be weaker than forecast.
"Escalation of the crisis or a disorderly adjustment of Ukraine's economy could have a significant negative impact on investor confidence, growth, trade and possibly energy and food security in the region," it said.
The crisis doesn't spell the end of the recovery hopes of all economies that share borders with Russia and Ukraine. The EBRD raised its 2014 growth forecast for Poland to 2.8% from 2.7%, and raised its forecasts for Romania and Bulgaria, largely reflecting an increase in demand from the recovering euro zone.
—Alexander Kolyandr and Patryk Wasilewski contributed to this article.
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