A financial crisis has begun in Ukraine. The currency is in freefall to the point that the national bank has just ordered exchange kiosks to stop displaying the exchange rate. The government has a deficit it cannot cover and major public companies have started to default on their debt. And the economy is on track to contract by more than a third by the end of this year – a catastrophic crash, worse than any multiple crises seen since the collapse of the Soviet Union.
The war with Russia is the main cause, but the lack of financial aid from the West is aggravating the collapse of the Ukrainian economy. As bne IntelliNews reported, Ukraine lacks money. In a phone call on August 1, President Volodymyr Zelenskiy asked his French counterpart Emmanuel Macron to help release the second tranche of EU macro-financial assistance to Ukraine amounting to €8 billion. euros. Earlier, European Commission spokeswoman Arianna Podesta said there were currently not enough funds to provide Ukraine with the second tranche. The government has to cover huge military expenses, the budget deficit amounts to about 5 billion dollars per month, and without external aid, which Ukraine does not receive, it cannot sustain these expenses.
According to IER expert estimates, real GDP fell by around 46% year-on-year in March 2022, and over the following three months, the rate of GDP contraction stabilized at the 39- 40% year-over-year. At the worst of the Euromaidan revolution in 2014, the economy contracted by 17% in the second quarter of that year, but then started to rebound and was back in the black by the start of the following year.
In June, the contraction in real gross value added in the agricultural sector accelerated. This is mainly due to the temporary occupation of Kherson Oblast and part of Zaporizhia Oblast, which substantially contributed to agricultural production (cereals, vegetables and fruits) in June 2021. However, in the second half of this year, the IER predicts a gradual improvement in the economic situation, depending on the course of the war. As a result, real GDP is expected to decline by around 30% year-on-year in 2022.
However, the GDP contraction could be much steeper if inflation accelerates further, logistics do not improve and hostilities escalate.
The physical economy bears the brunt of the war and has shown some resilience, but the financial system is beginning to collapse. The central bank raised its key rate to 25% June 2 and intends to keep it there for two years. The National Bank of Ukraine (NBU) also devalued the currency on July 21 from around 28 UAH per dollar to 36 UAH, a decrease of 25%, to bring the official rate in line with the exchange rate on the street. But the currency immediately fell to UAH41 and will continue to slide. (chart)
The government runs a deficit of about $5 billion a month, which is funded almost entirely by NBU printing presses. It’s not sustainable. Western donors have sent a total of $12.3 billion since the war began five months ago – about $2.75 billion a month – but that is insufficient to cover the funding gap. The EU and US have pledged another $16 billion, but the distribution of that money has been slowed by bureaucratic delays, and in the meantime the economy is slowly collapsing.
The shortfall is already impacting the NBU’s reserves, which have fallen by around $5 billion over the past two months, further undermining the value of the hryvnia. And the government has ordered all public companies to delay paying their debt to “preserve cash”. As a result, Naftogaz defaulted on a $335 million bond, despite having the cash on hand and management willing to pay to preserve the company’s credit history.
Grain exports resumed on August 1, which will bring much-needed revenue, but with grain shipments only expected to bring in about $1 billion a month, the numbers still don’t add up. Kyiv got some relief as the Paris Club of sovereign creditors agreed to delay all sovereign debt payments for at least a year, but private investors are less enthusiastic. Naftogaz bondholders were advised to reject the company’s request to delay redemptions and coupon payments because the company was “still in business” and had cash to pay on its balance sheet.
The government is currently in a very difficult situation. With much of its manufacturing industry and infrastructure damaged or destroyed and with insufficient revenue to cover the budget, it is in a bad position to sustain what looks increasingly like a long fight. Kyiv is now entirely dependent on supplies from the West, including equipment, but the West is depleting its stockpiles of ammunition and its manufacturing sector is unable to produce any more quickly. The United States in particular compensated by sending more powerful weapons, such as the M142 High Mobility Artillery Rocket Systems (HIMARS), which had a devastating effect on the Russian forces, but this does not change the situation, because the machine Russian military continues grinding on.
In two ominous signs in July, the Kremlin canceled the second Russia-Africa summit, which was to be held in November, and in late July Kyiv ordered the evacuation of parts of the Donetsk region it still controls, nominally to avoid problems in the winter. Both suggest that the fighting will continue into November and possibly beyond and that Russia continues to make steady, albeit very slow, progress in its campaign to take control of the whole of the greater Donbass region. .
The government has a limited ability to mobilize resources to cover its financing gap through taxes (economy is weak) or debt (international capital markets are closed for Ukraine; on the internal market for capital, the Ministry of Finance is not willing to sell the debt at new higher rates). interest rates that distort monetary transmission).
This situation is not tenable. Although the NBU can provide direct support to the government, this comes at the cost of a rapid burn of foreign exchange reserves. In June alone, the central bank sold about $4 billion of its reserves to support the hryvnia and the NBU predicted a decrease in international reserves in the second half of 2022 by 8.6% – from $22.8 billion to $20.8 billion by the end of the year.
With limited resources and instruments, the central bank is caught in a dilemma, but cannot simultaneously defend the exchange rate, print money (225 billion UAH, or 6.1 billion dollars, since the beginning of war) to cover budget deficits and support the stability of the financial system. Something will have to give – and the value of the currency is probably the first thing that will go. Over the past few days, the NBU has banned currency exchange kiosks from communicating the exchange rate, in an effort to “protect” the population from the rapid collapse of the currency.
A financial crisis is already upon us. Projected funding from the international community for the second half of 2022 is approximately $18 billion. With monthly foreign exchange interventions of about $4 billion and external debt payments (principal and interest) of $3 billion for the remainder of 2022, more defaults are to be expected, otherwise foreign exchange reserves could fall to a dangerously low level of $12-15 billion, experts say — well below the level needed to sustain the value of the hryvnia.
Some of this pressure was lifted after the Paris Club of sovereign creditors granted Ukraine a one-year default in July, but private creditors were not so lenient and, on July 26 , state-owned gas company Naftogaz defaulted on a $335 million bond buyback, despite having the cash to meet its obligation. The government has ordered public banks to delay their payments to “preserve liquidity”.
In addition to the debt, another big draw on the budget will be the need to buy more gasoline for the winter. Ukraine currently has the lowest level of gas storage in all of Europe, with tanks only 22% full last week in July. Naftogaz says it needs to purchase an additional 5 billion cubic meters of gas in an extremely tight market at an estimated cost of $7.8 billion. It is unclear where companies will find the gas or the money to buy it.
But there is good news. Economic activity has started to recover in Ukraine after a significant decline at the start of the large-scale invasion, according to National Bank Vice President Serhii Nikolaychuk. This does not mean that GDP is increasing but that the depth of the fall is decreasing, he said in July.
The recovery of the economy is reflected in the following indicators: revitalization of commercial networks, increase in restaurant turnover and reduction in the number of inactive businesses. Moreover, exports are also gradually recovering and the end of the blockade of Ukrainian ports should make a very big difference in Ukraine’s balance of payments.
Nevertheless, NBU forecasts a decline in GDP by more than a third in 2022 and an increase in inflation to more than 30%. The national bank estimates that the economy will decline by 40% in the first half of this year and end the year down 30-35%. At the same time, the regulator’s analysts estimate that the Ukrainian economy will show a recovery of 5-6% in 2023-2024. This will become possible if the active phase of the war ends and the Black Sea ports are unlocked.
The regulator expects inflation to return to the 5% target in 2025. According to the NBU’s forecast, inflation will decline to 20.7% in 2023 and 9.4% in 2024.