Wien Next week it will be that time again: At the Ukraine Recovery Conference in Lugano, Switzerland, politicians from different countries will discuss what kind of country Ukraine should be in the future.
But just talking about it won’t help. The country, which was hit by the Russian attack, currently needs a lot of money to survive as a functioning state. The government there has to raise five billion dollars a month just to pay wages and pensions and provide basic services. At the same time, tax revenues are expected to shrink while the war drives up government spending.
In fact, international financial aid to the country is progressing slowly. And so another problem arises for Ukraine. The central bank NBU, meanwhile, has jumped into the financial gap by buying state securities. However, as she warns herself, this is a dangerous undertaking.
The problem of declining tax revenues is not yet reflected in the statistics of the Ukrainian state. The year is still too young for that. Inevitably, however, the state will suffer from falling incomes because economic activities have come to a partial standstill due to the war.
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In March and April, Ukraine exported only about half as many goods as in the same months of 2021. According to the NBU, compared to the pre-war period, the companies’ capacities were only used at 60 percent.
As a result, Ukrainians are also suffering wage losses. “Many companies are no longer able to pay the same salaries as before Russia attacked again in February,” says Olga Pindyuk, an economist at the Vienna Institute for International Economic Studies.
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In contrast to revenue, the expenditure side already shows the difficult situation Ukraine has gotten into. In the first quarter, government spending rose 36 percent year-on-year, largely as defense spending quadrupled. In addition, because of the war, Ukraine is currently unable to issue bonds on the capital market.
The NBU is now partly filling this gap by – reluctantly and out of necessity – buying government bonds. As recently as June 23, Ukraine’s Financial Stability Council, which includes representatives of the NBU, warned that state financing by the central bank entails high risks.
The expansion of the money supply threatened inflation and the collapse of the local currency, the hryvnia. On the black market, it is already worth less than the official exchange ratio determined by the NBU compared to the dollar.
To keep inflation in check and defend the value of the hryvnia, the NBU raised interest rates from 10 to 25 percent in early June. Previously, Ukraine had issued bonds with an interest rate of nine to ten percent. At the same time, the NBU is throwing foreign currency into the market to defend the hryvnia exchange rate. At times, it sold up to a billion foreign currencies a week.
However, such transactions should be limited, the NBU warns. Because Ukraine needs foreign currencies to pay for imports.
Central bank enjoys a good reputation
Central bankers’ words carry weight. The NBU enjoys a good reputation in Ukraine and abroad. It is regarded as an institution that meets Western standards and differs in this from the judiciary, whose reputation continues to be tarnished. It is all the more important, say economists, that the government listen to the central bank’s signals.
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Therefore, in order to protect its financial condition, Ukraine also needs foreign financial aid. But that takes time, the NBU complains cautiously in a paper. In fact, purely financial support for the country is progressing slowly.
For example, when the finance ministers of the G-7 countries met in May, raising the $9.5 billion for Ukraine proved difficult. “We are approaching the political question of what Ukraine is worth to us at all,” says Gunter Deuber, Head of Research at Wiener Raiffeisenbank International (RBI), which owns a retail bank in the country.
Ukraine should primarily receive grants and not loans from the countries. “Loans are not financially sustainable for Ukraine,” said Swiss economist Beatrice Weder di Mauro at a conference two months ago. After all, the country’s debt will increase rapidly. RBI’s Deuber estimates that it will reach 100 percent of economic output (GDP) next year. “For an emerging country, that’s too much.”
Paradoxically, however, Russia seems to be doing better economically than Ukraine – even though the western states have put together one sanctions package after another against the aggressor. At the beginning of June, for example, the Russian central bank lowered the key interest rate to 9.5 percent. This puts it back where it was before the war.
At the same time, the country generates high revenues from raw material exports and has only a low level of debt. Western sanctions will probably only feel the pain in Russia when specialized components for industrial and military goods become scarce.
Russia may use the relatively solid constitution for the time being for propaganda purposes, says Deuber from the RBI. Putin could claim that the Russians are better off economically than the Ukrainians. “I fear that he will play this card,” says the economist.
Much will depend on how much financial aid Ukraine will receive in the coming months. For the country’s government, it is likely to become even more difficult to make itself heard abroad. In western industrialized countries, the economic situation is deteriorating rapidly – and that will hardly promote the willingness to help.
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