- Hubert Walas
Ukrainian Economy Report.
Ukraine is in the middle of a defensive war, a war for independence. This means that its economy is also at war. Critical infrastructure is being destroyed, millions of people are leaving the country, and GDP is falling by a third.
Nevertheless, the nation holds on and fights for the future. A future that is better than the reality of today's war, but even the pre-war period. And much of that depends on the Ukrainians themselves.
What can be the financial health of a country waging a defensive war on its territory against a country whose economy, in the year the war began, was almost ten times larger than that of the invaded country? This is a rhetorical question.
At moments when the fate of the state is at stake, as it is now for Kyiv, the economy takes a back seat. Nevertheless, it remains the foundation of the functioning of the state. After all, if soldiers do not receive their salaries, pensioners do not receive their pensions, or the public sector does not receive payments from the state, no matter how small, the question may arise: is it all worth it?
With the majority of the population still not directly involved in the war, maintaining a functioning economy is a vital task for a country in conflict.
And it is an extremely difficult task.
Ukraine's gross domestic product shrank by around 30% last year, according to various estimates. Unemployment rose by 20 percentage points, while inflation was close to 27%. According to the World Bank, the proportion of the population living below the poverty line rose from 18% to 60% in one year.
Then there are the material and infrastructural losses. These are estimated at USD 140 billion, while the cost of reconstruction, according to the World Bank, is a staggering USD 410 billion. This is twice Ukraine's pre-war GDP.
But the greatest loss remains the loss of people. The flower of the nation, overwhelmingly male, bleeds at the front. Millions fled the war-torn country as soon as it broke out. The Ukrainian Ministry of Economy estimates that 6.2 million of Ukraine's pre-war citizens are outside its borders.
Ukraine loses around $2 billion a month from this fact alone, estimates Serhii Marchenko - Minister of Economy.
The demographic collapse of the country is even more devastating than the infrastructural and economic destruction. Before the invasion, Ukraine's population was estimated at around 41 million. Today, excluding migrants and people under Russian occupation, that figure may be 7 to 13 million lower. Demographer Ella Libanova estimates Ukraine's current population at between 28 and 34 million. Considering that in 1991, at the time of the collapse of the USSR, Ukraine had a population of 51 million, we are talking about the disappearance of half the population in 30 years. But let us leave aside the demographic aspect for a moment. We will come back to it later.
So, how did Ukraine manage to defend itself? Also, in the economic space?
If Ukraine had fought this war in isolation, it would have lost it long ago. But just as Ukraine's economy is 1/10th of that of the Russian Federation, Russia's economy is an even smaller fraction - closer to 1/20th - of the economic power of the countries that, in one way or another, have declared their support for Ukraine and are supporting it.
It is external support, both military and economic, that keeps Kyiv alive. Based on the Kiel Institute's Ukraine Support Tracker, the Bruegel report estimates total support for Ukraine in 2022 at almost €169 billion. Of course, these are 'commitments', that is, promises. The actual amount delivered may differ from the pledges, but the fact that we are talking about an amount exceeding Ukraine's current total GDP speaks volumes. Strictly, financial assistance is valued at EUR 84 billion in this statement.
Thanks to this, according to many economic indicators, Kyiv's financial situation is relatively good, and in some aspects even excellent. According to the National Bank of Ukraine, foreign exchange reserves have reached a ceiling of nearly $39 billion, the highest in history. This helps keep the currency stable. After a slump in 2022, economic growth is expected to stabilise in 2023. Estimates point to a minimal decline of -1% and even +3% year-on-year growth. By comparison, the IMF forecasts that Russia's economy will contract in nominal terms by the size of Ukraine's entire economy, or about $160 billion, over the same period.
External aid allows Kyiv to keep up the fight and maintain a semblance of normality. Moreover, given the circumstances, the assessment of the state of the Ukrainian economy by various recognised actors is decent.
The European Commission recognises that the Ukrainian economy has "shown remarkable resilience" despite a contraction of almost 30% in 2022. The International Monetary Fund uses a similar phrase to acknowledge the resilience of the Ukrainian economy while raising its GDP growth forecast in 2023 from -1% to 3%.
And now, here are a few words of summary from the aforementioned Breugel report:
“In the first months of the war, Ukraine had to rely mainly on its own military and economic resources. On the macroeconomic front, this caused severe tensions and challenges. The ballooning fiscal deficit had to be financed primarily by the NBU, causing inflationary pressures and creating the risk of a balance-of-payments crisis. Fortunately, since the second half of 2022, the flow of foreign financial aid has intensified and become more regular and predictable (similar to military assistance). It has allowed gross international reserves to be increased, the FX market to be calmed, the exchange rate and budget to be stabilised, and some FX and banking restrictions to be relaxed.”
In one word - Ukraine's economy reflects the circumstances in which it finds itself. Nevertheless, it shows positive signs and delivers hope for the future.
Yet, one variable remains key to its fate - when and how the war will end.
This variable was the starting point for the authors of the report by the Ukrainian Institute for the Future, who presented two scenarios - positive and negative - for the Ukrainian economy in the coming year.
Starting with the negative. It assumes that hostilities will continue but their active phase will end in early 2024. It assumes that a ceasefire will be established and later broken by attacks on critical infrastructure or civilians.
The lifting of martial law, which according to the scenario under discussion would occur in such a situation, will lead to a mass emigration of young men. The labour market will experience a drastic demand for skilled labour, which it will not be able to meet. Industry will focus on manufacturing for the military, while other sectors will suffer chronic shortages of finance, labour or investment. Foreign investor confidence will remain very low due to further terrorist attacks by the Kremlin. On the other hand, if there is no territorial change, Ukraine will remain severely cut off from the sea, and maritime transport will remain very expensive and risky due to mined ports.
In the negative scenario, the authors also assume that Western aid will gradually disappear. As a result, the economy will sink into increasing misery, which, together with the stalemate on the frontline, will contribute to social discontent and even protests.
If an economic crisis was to hit the world at the same time, Ukraine would be even more vulnerable to its effects.
The positive scenario, on the other hand, involves the liberation of the occupied territories.
Naturally, this would lead to the recovery of lost growth in these areas and the development of maritime export opportunities. The scenario assumes that significant foreign financial assistance would continue to be provided, more than $30 billion per year. Significant investment related to the Ukraine reconstruction project would also contribute to growth. This in turn would create hundreds of thousands of jobs and encourage the return of millions of migrants.
In this scenario, the economy would grow at a rate of up to 10-15% of GDP per year, quickly closing the post-war gap. It should be noted, however, that the report's authors consider the probability of this scenario to be low.
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Assuming all this, however, it is essential to take a few steps back and look at the issue from a broader perspective.
A loss of 30% of GDP in one year is a dramatic result, but in nominal terms, it is only $50 billion. This is relatively small for a country the size of Ukraine in a state of total war. More serious are the infrastructural losses, but even these can be restored considering an optimistic end to the war.
Ukraine's pre-war GDP was estimated at around $200 billion; now, after a 30% loss, it is closer to $140-150 billion and will remain at a similar level later this year.
These are huge figures but well below Ukraine's demographic and geographic potential. Even considering the pre-war result of 2021 (the best in recent history!), we get a GDP value that is 40% lower than that of the Czech Republic and comparable to that of Hungary. These are countries with about ¼ of Ukraine's pre-war demographic potential and ⅙ of its territorial potential.
This brings us to the heart of the matter. The system inherited from the Soviet Union in 1991, the continuation of informal vassalage to Moscow and, worst of all, the perpetuation of a social model riddled with corruption. All this has led to a years-long process of squandering Ukraine's demographic and territorial potential. How big a waste? A comparison with Czechia and Hungary illustrates this quite well. Theoretically, Ukraine could be four times wealthier if it had followed a different model over the past 30 years.
The Ukrainian people have tried many times to break out of this toxic arrangement - think of the Orange Revolution or the events in Maidan. But the resistance of the core - i.e. Moscow - was so strong that a full-scale war was needed. That is how we can judge it today.
So, given that we are talking about economics in this episode - Ukraine is fighting to compare itself economically with countries with similar demographic and territorial potential. Poland, although territorially half the size, is the closest example. The IMF estimates Poland's GDP at $750 billion in 2023.
If we compare Ukraine’s loss of $50 billion in GDP to this amount, and even add the loss of infrastructure, we get between 6-20% of the annual (!) GDP that Ukraine, given its potential, is striving for and, indirectly, fighting to achieve.
The conclusion to be drawn from this somewhat twisted argument is that, in economic terms, Ukrainians are fighting for a much more prosperous future than they would have had if they had remained under the umbrella of the Russian Federation. A more prosperous future to the extent that, in nominal terms, the current losses - losses in GDP or even infrastructure - can easily be made up. Especially given the preferential loans or even subsidies for reconstruction, the reparations from Moscow and, above all, the decades of functioning under a much more efficient system than the one inherited from the Soviets.
Still for this future, for which Ukrainians are fighting in the trenches today, two criteria must be met to become a reality. First, and most obviously, it requires an undisputed victory on the front - recovering lost territory and compensation from the aggressor.
Yet just as significant is a change in the mindset of Ukrainian society - to weed out the pervasive corruption, nepotism and oligarchy - after all the very characteristics of the nation that Ukraine is fighting with, and instead betting on transparency and meritocracy. Of course, this is an incredibly difficult task and will take decades of work.
Zelensky's government is slowly progressing in this direction, which is one of the criteria for the country's future admission to the European Union. The European Commission's report notes progress in the judiciary and the independence of the media. However, the anti-oligarchy law, for example, remains a problem.
While the creation of legal norms that severely punish corruption, for example, is crucial, the foundation for creating this new system needs be a monumental change in society itself.
This is what will ultimately determine the outcome of the ongoing war. Even if Ukraine wins the war on the frontlines but does not undergo a dramatic internal transformation, millions of Ukrainians who have tasted life in the West will be reluctant to return to a system, which is riddled with corruption.
However, if the country makes a successful transition or moves in the right direction, then, assuming a positive outcome on the front, it has the chance to undergo a complete reconstruction - infrastructural-economic-social. The reconstruction project, reparations and cheap credit will boost GDP growth and create hundreds of thousands of jobs. And this, together with socio-legal reform, will convince millions of migrants to return and rebuild their motherland. That is the true definition of victory. At the same time, it's the most difficult task imaginable, but young Ukrainians today are fighting for nothing less for their children.
The war is, therefore, the greatest tragedy in Ukraine's history, but it is also its most significant opportunity for a better tomorrow.
