Losses are building up far faster than Kyiv can manage.
AUGUST 4, 2022,
By Maria Repko, the deputy executive director of the Centre for Economic Strategy in Ukraine.
During the last several weeks, international and Ukrainian economists’ and policymakers’ discussions have been largely focused on a “Marshall Plan” for Ukraine focusing on the technical issues around reconstruction, from conditionalities on anti-corruption to the green agenda.
But, as a European friend of mine, close to policymaking circles, noted, “Talking about Ukraine’s reconstruction is important to build confidence and give Ukrainians hope. But it is also cheap.”
The West is making generous promises, but the actual delivery is disappointingly slow. In total, Ukraine has now been promised more than 31 billion euros in budgetary support by the most important donors, according to calculations of the Kiel Institute for the World Economy, which tracks pledged financial assistance to Ukraine.
But only about 7.6 billion euros have actually been disbursed between February and June 28. Only in late June-early July did the inflows start to catch up. By now, total aid provision is about 11 billion dollars, still an order of magnitude less than payments to Russia for its hydrocarbons over the same period.
Meanwhile, the country’s foreign currency reserves are bleeding, and on July 20 Ukraine asked Eurobond holders for a standstill, because the commercial debt servicing becomes too much of a burden for the budget, as well as from the balance of payments prospective.
The National Bank of Ukraine (NBU) was selling up to $1 billion per week to keep up with the pace of foreign currency demand and to defend the exchange rate peg. On July 20, the decision was made to shift the peg upwards, to 36.60 hryvnias to a dollar from 29.25 hryvnias to a dollar.
Ukraine’s foreign currency reserves stood at $23 billion as of the end of June. The current pace of losses means that Ukraine will be shortly on the verge of financial collapse if aid inflows are not sped up. There are several reasons for quickly falling foreign exchange reserves, all of which are out of Ukraine’s hands.
Russia’s invasion has wrecked the economy, and foreign aid is not enough to cover the gap. War-related expenditures have skyrocketed, and all other spending is being kept at a bare minimum.
Scarce foreign funding is forcing the National Bank of Ukraine to buy government bonds (effectively printing hryvnia) to cover the enormous budget deficit, which reached $4 billion in May and almost $6 billion in June.
In March to May 2022, the government’s own revenues covered just about 40 percent of the expenditures needed to run the country and pay the bills. Another 40 percent was covered by the NBU. The rest is funded by grants (about 7 percent of expenditures during three months of the full-scale war), foreign loans, and local bond issues. These funds, once on the market, might be channeled for foreign exchange purchases.
Russia has also stripped Ukraine of resources, and blocked most of its exports. Ukraine’s pre-war exports reached 40 percent of GDP, with the two largest categories grain and metallurgical products. Two of Ukraine’s most important metallurgical plants were destroyed in now-occupied Mariupol, and the grain in the occupied parts of southern Ukraine is being stolen by Russia. The remaining exports desperately lack shipping capacities. Goods were mainly shipped via marine transport, and the Black Sea ports are now under a blockade by Russian warships.
As the Ukrainian army forced Russians to back down from Snake Island, a partial solution to this problem is possible. The recent negotiations moderated by Turkey and the United Nations have opened the way to export Ukrainian grain from Odessa. But the outcome is uncertain: Russia, after the contract signing, sent missiles to Odessa, and on general did not yet drop its “Novorossia” idea with capturing the region and cutting Ukraine off the Black Sea. Meanwhile, imports are growing, fueled by the fixed exchange rate regime, consumer demand recovery from the first shock of the war, and rising energy prices.
Ukraine has done its best to counter this. While on the first day of the Russian invasion, to support hryvnia, the NBU introduced restrictions on payments abroad, with a list of allowed “critical imports,” which was later expanded. In early April, to prevent goods shortages, VAT and customs fees were lifted for most of the imports.
On July 1, the pre-war VAT and customs duties rules were reinstated. This will ease the pressure on public finances, make Ukrainian goods more competitive, and improve the trade balance.
The country’s refugees, meanwhile, are spending money from Ukrainian accounts worldwide. The number of people who left Ukraine is estimated to be over 5 million as of June. Not all of them are poor, living on social assistance, or in shelters. Many continue to work remotely for Ukrainian organizations, and Ukrainian women and children receive financial support from husbands and fathers who remain in Ukraine. In total, Ukrainians abroad spend nearly $1.5 billion per month via card payments from their hryvnia bank cards. This money supports the economies of the receiving countries but also depletes NBU reserves.
So far, the NBU and the Finance Ministry of Ukraine have done an excellent job maintaining the country’s economy and financial sector resilience. The banks are functional, pensions and welfare payments are being made, and salaries are being paid. But there is a limit to what institutions of a country at war can do to combat the effects of a severe economic downturn and continuing destruction of infrastructure, housing, and productive assets.
If Ukraine loses its economic and financial stability, the frontline will also shatter. The rear should function so that the soldiers do their job, which will not be the case if promises of weapons remain on paper and financial assistance is not turned into real money. A group of Ukrainian economists has formulated the following principles for Western support of Ukraine to safeguard its economic stability:
Act quickly to ensure Ukraine does not lose the war economically. Timing is crucial here. The room for either tax increases or expenditure cuts in Ukraine is severely limited. Quick and stable financial inflows are needed. The amount should cover the budget gap, including the needs for fast recovery in deoccupied areas. There is no need to wait for the war to end to launch the reconstruction effort. People in towns and villages damaged by the Russian military need a place to live, infrastructure must be repaired before winter comes, kids must go to school, and the elderly and ill need access to medical services.
Beyond infrastructure and physical assets, Ukraine needs reconstruction (or creation) of strong institutions right away. The mechanisms for transparency and accountability of foreign support may lay the ground for some of these institutions. These mechanisms must be implemented at all stages, ensuring public access to data on financing agreements, possible public-private partnerships and concessions, public procurement and use of funds, and accessible grievance mechanisms and stakeholder monitoring mechanisms. Whenever physical or institutional infrastructure is rebuilt, it must take into account Ukraine’s increased EU integration in terms of social, ecological and governance standards.
Grants are preferable to loans. When attracting even long-term and concessional loans, the Ukrainian government is building up a debt burden, which will be devastating for the post-war economy. Under current terms, the debt/GDP ratio could rise from a pre-war level of 50 percent to 100 percent. Yet only 18 percent of the aid comes in the form of grants, with long-term loans making up the rest.
The aggressor should pay. While the voluntary contributions of the international community and the government of Ukraine will play a part, the reconstruction should be primarily financed by assets of the Russian state and complicit oligarchs. This requires some legislative work of the states where Russians keep their assets. However, the choice between their own taxpayers and the aggressor state must be obvious for legislators of those countries.
Finally, financial support and reconstruction efforts should be inclusive and nondiscriminatory both in the participation of civil society, victim representatives, and affected stakeholders, and in the determination of beneficiaries, preferencing decision-making and implementation closest to the affected populations at the community and regional level.
Military, humanitarian and financial aid to Ukraine is laudable. But right now, there is still a lack of a sense of urgency, lulled by the talks of the long-term recovery and an EU future for Ukraine. But the war is yet to be won, and Ukraine needs support now.
— Maria Repko is the deputy executive director of the Centre for Economic Strategy in Ukraine.