Ukraine’s war economy urgently needs more international support
The writer is governor of the National Bank of Ukraine
Six months ago, Ukraine woke up to the reality of a full-scale war being waged against it. We were forced to fight the enemy on two fronts at once – in combat areas and in finances – so that we could get the resources to fight until we won.
To survive and win, Ukraine must have a strong economic backbone and a reliable financial system. Thanks to considerable efforts, we managed to ensure the stable functioning of the banking system. Customer payments are made without interruption. We have prevented deposit outflows. In fact, retail hryvnia deposits have increased by 31.7%, or nearly $3.7 billion, since the outbreak of hostilities. Lending to strategically important sectors continues. The portfolio of business loans in hryvnia increased by 6.5%, or almost 1 billion dollars.
Moreover, we avoided monetary destabilization. In August, year-on-year inflation in Ukraine stood at 23.8%. Other countries have experienced much worse inflation during or immediately after a war. Think of Germany after World War I, South Korea in the early 1950s, or Serbia in the early 1990s. Given the global trend of accelerating inflation, the growth rate prices in Ukraine can be considered a feat.
Still, it’s too early to relax. Ukraine benefited from a margin of safety accumulated before the war. However, international reserves have fallen by almost 18% since the start of the year. These have allowed us to sustain the economy, but they won’t last long if we keep burning them.
With winter approaching, it is time for the state’s economic policy priorities to change in a way that can accommodate a prolonged war effort. This requires effective redistribution of domestic resources and strong financial support from abroad.
After years of pursuing a balanced fiscal policy and implementing monetary and financial policy reforms, Ukraine faces a huge wartime budget deficit. This is inevitable for a country that is waging a defensive war. To cover the gap, the government needs at least $5 billion in funding per month, according to the Ministry of Finance. By the end of 2022, the deficit could reach 25% of gross domestic product, excluding international donations. History suggests that there are limited ways to fund state expenditures in times of war. National economic stability depends on the authorities’ ability to combine these limited methods.
A simple solution would be for the central bank to issue money. But it would erode household savings, deepen crisis tendencies in the economy, fuel inflation and undermine social stability. Modern European history is full of lessons about the disastrous political consequences that can follow.
As a candidate for EU membership, Ukraine knows that such action would hamper its prospects. The founding treaty of the EU expressly prohibits national central banks from financing their governments. Ukraine needs other sources of financial support for its economy.
What are they? First, Ukraine should revitalize domestic borrowing by issuing public debt on market terms. The objective is to shift the burden of financing the deficit to the post-war period. However, this process should be structured in such a way as to prevent the public debt from continuing to increase in times of peace. Second, Ukraine should reduce the deficit by reducing non-priority spending and raising taxes. And third, international financial support for Ukraine should increase.
Russia’s strategic goal is to undermine Ukraine’s economic resilience. Financial assistance from our partners is therefore almost as important as military support. They have already provided Ukraine with over $17 billion in aid. We expect an additional $12 billion by the end of the year.
The launch of a new cooperation program with the IMF will send an important signal to creditors. The IMF has always stood by Ukraine in times of crisis. A four-year program worth $17.5 billion was set up in 2015 after the Russian occupation of part of Ukraine. This IMF support was part of a package of around $40 billion in international financial assistance to Ukraine.
Coupled with powerful sanctions against Russia, a similar assistance package will help Ukraine endure and thwart the aggressor’s ability to finance its war machine. Moreover, we believe that the free world’s weak response to Russia’s annexation of Crimea and military aggression against Ukraine in 2014-2015 encouraged this year’s full-scale invasion.
If the world community had introduced an adequate set of sanctions in 2015, this war might never have broken out and our current and future losses would not have been so huge.