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Moscow: Russia is entering its first recession since 2009 as sanctions over the Ukraine conflict combine with plunging oil prices and the weakening ruble to hammer the economy and force the government to prop up banks.

Gross domestic product may shrink 0.8% next year, compared with an earlier estimate of 1.2% growth, deputy economy minister Alexei Vedev told reporters in Moscow on Tuesday. The government will spend 39.95 billion rubles ($760 million) to support OAO Gazprombank, at least the third lender to secure a capital injection since US and European Union sanctions curbed their ability to borrow.

The economy is succumbing to penalties imposed over Ukraine as the plummeting ruble stokes inflation and a 30% drop in oil prices erodes export revenue. As economic ties with the EU deteriorate, President Vladimir Putin on Monday said Russia scrapped a proposed $45 billion Black Sea pipeline to carry gas to Europe by bypassing Ukraine.

“The elements of instability" afflicting Russia’s economy range from structural to geopolitical, Vedev said. “One of the key factors is the lower price of oil."

Urals, Russia’s chief export oil blend, will probably average $99 a barrel in 2014, a downgrade from an earlier forecast for $104, he said. Its price is forecast to drop to an average of $80 next year, according to Vedev.

Looming recession

The revised outlook marks the first acknowledgment by the government in Moscow that the economy won’t grow amid Russia’s worst confrontation with the US and its allies since the Cold War. GDP will probably shrink or show zero growth this quarter and decline in the next three months on an annual basis, Vedev said.

A recession is usually defined as two consecutive quarters of contraction on a quarterly basis.

In the latest sign of the pressures facing the government, it agreed to channel aid to Gazprombank after already helping state-owned lenders VTB Group and Russian Agricultural Bank bolster their capital by allowing them to convert loans worth 239 billion rubles into preferred shares.

Profits have plunged as banks increase provisions for bad loans amid a slowing economy and the decline in the ruble. Russian banks “can survive," Sergey Dubinin, the former central bank governor who is now chairman of VTB, said at a conference in London on Tuesday, adding that he sees “some panic" in the country’s financial system.

The ruble has weakened more than 28% against the dollar in the past three months, the worst performer among more than 170 currencies tracked by Bloomberg. It extended declines on Tysesaand traded 2.3% weaker at 52.4 per dollar as of 1:59pm in Moscow.

Ukraine conflict

Russia has been targeted by US and EU sanctions, with the penalties curbing access to global capital markets and stoking outflows. Putin denies involvement in the unrest, which began after he annexed the Black Sea peninsula of Crimea in March.

Net capital outflows are set to surge to $125 billion in 2014, more than the $100 billion predicted earlier, before slowing to $90 billion next year, according to Vedev.

Russia needs Brent, the grade of oil traders look at for pricing Russia’s main export blend, to average about $100 this year to balance its budget, Deutsche Bank AG estimates. Brent for January settlement dropped as much as 70 cents, or 1%, to $71.84 a barrel on the London-based ICE Futures Europe exchange.

Inflation, devaluation

Inflation will end the year at 9% in 2014 and slow to 7.5% at end-2015, Vedev said. The ruble’s devaluation will contribute 2.4 percentage points to price growth this year and 3.2 percentage points in 2015, he said.

Consumer-price growth accelerated to 8.3% in October, the fastest since July 2011. Policy makers have raised their main rate four times by a cumulative 400 basis points since March to rein in inflation. The Bank of Russia increased its benchmark interest rate to 9.5% from 8% when it last reviewed borrowing costs on 31 October.

“Some very strong factors have already done the damage for GDP growth next year," Vladimir Miklashevsky, a strategist at Danske Bank A/S, said by phone. “Extremely tight monetary policy by the central bank, capital outflows, the weakening of the ruble, and sanctions are contributing to accelerated inflation and the cost of capital." Bloomberg

Lyubov Pronina in London, Jason Corcoran in Moscow and Milda Seputyte in Vilnius contributed to this story.

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