Loading

EBA: Ukrainian economy during the war. What is next?


To maintain macroeconomic stability and win this war, all of us need to work together.

Ukraine’s economy is suffering colossal losses from russian armed aggression that are very difficult to estimate now because the war is ongoing. However, we all understand that the army wins the battle, and the economy wins the war. So, on August 4, 2022, the EBA Southern Ukrainian Office organized the online discussion “Ukrainian economy during the war. What is next?”. There, the experts and guest speakers analyzed the state of the economy of Ukraine and made their forecasts regarding the future state of the business climate. The discussion was moderated by Arthur NitsevychHead of the EBA Odesa Legal Committee, Interlegal Partner, and Mykola Melnikov, Interlegal Partner.

Ukraine is a very big player in the world food market. Before the war, we exported more than 15% of the world’s food corn and about 10% of cereals. That is, we were one of the largest global exporters in one and another segment. However, now the Ukrainian food market is in a state of crisis due to many factors that have already taken place for a long enough period. First, in the past years, the weather conditions were quite unfavorable for the global harvest of agricultural products (and we in Ukraine did not feel this because last year we had a record harvest). Secondly, the increase in energy prices, primarily gas, leads to the increased prices of fertilizers. And fertilizers, surely, are an important component of the cost of grain and other agricultural products. Thirdly, russia’s invasion of Ukraine and the start of the war also significantly affected the world food market. After all, many companies did not want to cooperate with the aggressor country. Fourthly, the lack of grain exports from Ukraine also prompted a change in food prices in the world. And the prices of meat and other food products began to rise due to grain prices. Also, there is a factor that has significantly affected the economy, and it will still have a long-term effect on the food market. This is a prerequisite for domestic consumption in China. There are more and more people consume protein and switch to beef. And this, in turn, increases the need not only for meat but also for grain, which is fodder for livestock. All these factors in general led to the fact that food prices in the world increased by 60% in the last two years. This is an aggregated index calculated by the Food and Agriculture Organization of the United Nations (FAO). Their study shows that now the level of food prices in the world is the highest in the last decades. And it is even higher than the prices during times of other social disturbances (for example, the “Arab Spring”).

The discussion was started by Sergiy Nikolaychuk, Deputy Governor at the National Bank of Ukraine, who shared how the monetary and currency system works in the war conditions and talked about the prospects of the Ukrainian economy.

The NBU’s actions at the beginning of the war were aimed primarily at maintaining the stability of the banking system and uninterrupted payments. This was necessary for the adaptation of the economy, business, and population to new conditions. To do this, the National Bank fixed the official exchange rate, introduced currency restrictions, “frozen” the discount rate at 10%, and introduced additional instruments to support the liquidity of the banking system. Thanks to these steps at the beginning of the war, as well as a considerable margin of safety, the financial system has stood the test of these extremely difficult conditions.

Gradually, businesses and people began to adapt to the current conditions, and the market logic of decision-making began to play an increasingly important role in their behavior. Maintaining a low cost of hryvnia loans now with significant inflation created significant pressure on the foreign exchange market. To counteract this, the NBU adapted its tools to the new reality.

Mr. Nikolaychuk reminded us that in June the NBU raised the discount rate to 25%. This is a rather drastic step, but it is necessary to increase the attractiveness of hryvnia assets and reduce pressure on the foreign exchange market and international reserves. He also said that on July 28, the National Bank of Ukraine published its Inflation Report with a macroeconomic forecast – the first one since the start of the war. The report was skipped in April 2022 for the first time in 7 years given the uncertainty. Its level remains extremely high even now, however, if we compare it with the situation that was in April, then forecasts can already be made with a sufficient level of reliability. 

“Our basic scenario is, in fact, programmatic, as it foresees the effects of a range of necessary measures in the sphere of economic policy implementation. We also included in this scenario the full restoration of the activities in the Black Sea ports of Ukraine from 2023 and a significant reduction of security risks thanks to the successful actions of the Ukrainian army. Compared to the pre-war level, the risks will remain quite high,” – said Mr. Nikolaychuk.

If these assumptions are implemented, inflation, according to the NBU’s forecasts, will accelerate slightly above 30% this year and will decrease to about 20% next year, and to a single-digit level in 2024. Inflation is expected to return to the 5% target only in 2025. Such a moderate decrease in inflation in the following years is due to the need for the government to adjust several administrative tariffs to market levels, considering the significant cost of energy carriers on world markets.

The NBU forecast also predicts a slow recovery of the economy from current levels. “In general, we expect that this year the GDP of Ukraine will decrease by a third and will only partially offset these losses during 2023-2024. Such losses this year are caused by the effects of war: direct losses of infrastructure, destruction of enterprises, blockade of seaports, low demand in most sectors, significant migration, and significant loss of human potential. We expect that the impact of these factors will be quite significant by the end of this year and the recovery in the following years will be determined primarily by the reduction of security risks. At the same time, considering the significant losses of production and human potential and still high security risks, the rate of recovery in 2023-2024 will be about 5-6% per year,” – Mr. Nikolaychuk emphasized.

He specified that the basic forecast of the NBU has certain “upside” risks, i.e., those risks, which implementation will lead to better development of macroeconomic indicators than the NBU expects. The forecast did not consider the opening of Ukrainian ports this year, as well as the implementation of the Marshall Plan (European Recovery Program), that is, the receipt of significant amounts of international aid from both official creditors and the inflow of private capital.

“Our basic forecast, on the one hand, lays down rather optimistic assumptions regarding security risks and the introduction of economic policy measures. But still, we hope that the positive risks associated with international aid and with the functioning of seaports and other infrastructure restoration will be realized first,” – noted Mr. Nikolaychuk.

Regarding the start of grain exports from Ukrainian ports, Mr. Melnikov expressed his fears as to whether all the money would go to Ukraine. After all, there is a probability that most of this grain has already been sold and belongs to foreign traders. Here, Mr. Nikolaychuk commented that if the volume of grain exports is expanded due to the normal functioning of the Black Sea ports, the effects will be quite significant and positive in the current conditions. “In any case, the Ukrainian economy will receive an additional resource if the ports work properly. This will also free up the elevators, which will make it possible to collect a new crop in larger volumes and to carry out normal sowing in the following year. There are many aspects to this issue, and they are quite positive,” – emphasized Sergiy Nikolaychuk.

Next, Svitlana Mykhailovska, EBA Deputy Director for Advocacy, spoke about changes in the dynamics of business and investment opportunities and the search for potential partners, both in Ukraine and abroad within the framework of the EBA Committee for Reconstruction of Ukraine and the EBA Business Security and Protection Committee.

“Today it is very difficult to talk about investments. According to various estimates by experts, investment risks reach 40%. Therefore, direct investments are impossible to attract in the absence of military risk insurance and guarantees. Nevertheless, we are working on this, in the EBA Committee for Reconstruction of Ukraine, and in the European Business Association, we are setting up external communication, and restoration of B2B matching, already with foreign partner companies. Business performed quite well, and this was shown by our EBA Second Bank Chance platform, which we introduced before the full-scale invasion of the russian federation to implement the ideas of sustainable development. It was completely readapted in the format of supporting the army, ground defense, volunteers, business, and B2B. It is extremely important that we do this within the EBA, within the country, and involving external partners. We need to rebuild this vector. We have already held several meetings with Embassies, and we plan to intensify this work already in the fall, involving business associations from European countries and establishing contacts. We see in this a great potential for rebuilding and establishing business relations. Thus, business actively supports our army and the budget of Ukraine. One of the impetuses for this recovery was the lifting of restrictions on critical imports. However, on the other hand, we see the potential introduction of a 10% import fee as a new risk. We understand why this is being done and fears about the outflow of currency are well justified. At the same time, we receive quite a lot of negative appeals regarding the idea of introducing an additional import fee. After all, business has only just begun to recover and this can become a rather painful signal. And today we talked about this at a meeting with Mr. Hetmantsev and representatives of the National Council for the Recovery of Ukraine. For our part, we suggest that the authorities continue to actively cooperate with the Ministry of Finance, the National Bank of Ukraine, and the Office of the President of Ukraine. It is extremely important, and we need to think about more flexible safeguards for those risks that they consider necessary to solve with additional import fees. Therefore, it is impossible to “tighten the belts” even more. Therefore, deregulation and predictable, reasonable fiscal policy are quite important for the stability and reconstruction of business processes. Among the main risks that we see, today is the adoption of populist decisions because the election is coming in the next years. And we cooperate with the authorities and work for businesses that continue to work, provide jobs, and pay taxes,” – noted Ms. Mykhailovska.

Another direction that EBA is working on is the complete reset of labor relations. After all, today this is a very sensitive topic since the personnel resources of the business are significantly limited. At the same time, the business faces the question of mobilization, which will become even more acute already in September. Because a certain reservation of employees, made in the spring of this year, ends and a new wave of reservations will begin in the fall. The EBA has repeatedly encountered many requests from companies regarding the lack of a single, unified, clear procedure because each department interpreted it differently. Therefore, the active work of the Association is conducted in this direction as well.

Olena Bilan, Chief Economist, Head of Research Department “Dragon Capital”, spoke about the situation in the world food markets and trends in the foreign exchange market.  

Ms. Bilan noted that the situation improved significantly after the NBU weakened the official rate and fixed it at a new level, and the Government together with the Parliament restored import taxation. The most important task for all authorities during the war is to maintain macroeconomic and financial stability. Therefore, the introduction of an additional import fee, which is currently being discussed, is unlikely to be avoided, despite some negative effects on business. “Business is faced with a choice — a 10% increase in import prices now, or another devaluation of 20% or more in the future,” – Ms. Bilan emphasized.

“The rise in global food prices is not only a problem of hunger in individual countries. This is also a geopolitical problem because the risk of social protests, a change of power, and local conflicts increases significantly. In this context, the agreement on the restoration of grain exports from Ukraine has positive consequences for grain importers, the world economy, and also for the economy of Ukraine. Provided that the capacities of the ‘’Odesa’’, ‘’Chornomorsk’’ and ‘’Pivdenny’’ ports, which were fixed in the agreement, are used at least at the pre-war level, grain exports can more than double compared to the current volumes of transshipment by land routes, reaching almost 5Mt per month – close to the pre-war level. This will allow increasing the export revenue by 800 million dollars per month or by 25% compared to the current volume, which will positively affect the foreign exchange market and reduce the pressure on the reserves of the NBU. Although the positive effect will gradually be offset by the increase in imports”.

Another important factor for the economy is next year’s harvest. Long-term export through ports will help unload elevators for grain storage from the upcoming harvest. This, together with the increase in income from exports, will allow farmers to expand the sown areas at the expense of the northern regions, which were mined during the sowing season this year. Thus, next year’s grain harvest can increase by 15%. By comparison, before the ports were unblocked, we expected a 10% y/y drop in harvest due to a lack of seeding funds and storage capacity.

Thus, provided the agreement is fulfilled, we estimate its overall impact on economic growth at the level of 5.0 percentage points. At the same time, we expect an acceleration of inflation by 3% percentage points, because the revival of grain exports will contribute to the recovery of domestic prices, which will eventually be reflected in the prices of flour and bread. Also, the risks of implementing the agreement remain high, because it is valid for 120 days with the possibility of extension, which russia may not agree to. There may also be delays of ships during inspection or violations of security guarantees.”

In this context, Mr. Nitsevych noted that the situation in the food market, as well as energy resources, is highly dependent on logistics. The situation with the ports showed risks that were “almost unexpected.” So, the question arose: what changes in the new circumstances should be expected in the policy of global investors in the transport industry? In this context, Ms. Bilan noted that investments in Ukraine remain risky and investors are unlikely to invest until there is insurance against war risks or a significant improvement in the security situation of the economy. Mr. Nitsevych added that it is necessary to look at what world leaders are doing by investing in logistics and do the same. Ukraine is a hostage of the war situation, but this is not a unique case in history. In turn, Mr. Melnikov noted that the war will end with the victory of Ukraine, but we have different ideas of how it will be. After all, for example, victory can be interpreted from the point of view of the logistics industry with safe and uninterrupted shipping in the entire Black Sea water area. He agreed that “global” security throughout Ukraine will be an indicator for the start of the recovery in Ukraine. Ms. Bilan added that the biggest risk to the economy right now related to war is the risk of missile attacks that could happen anywhere in the country. This can be an obstacle to the renewal of investment activities, and the return of our children from other countries. If we can reduce these risks to a minimum or, with the help of our partners, strengthen the anti-missile defense, it will already be a partial victory for the economy.

Serhiy Yakubovskyi, Economist, Doctor of Economic Sciences, Professor of Odesa I.I. Mechnikov National University, focused mainly on the economy of Southern Ukraine and the Odesa region in particular.

Thus, according to Mr. Yakubovskyi, the unemployment rate in Odesa increased by 88% from January to July. If we talk about Ukraine as a whole, unemployment has increased by 83%. So in Odesa, it is even 5% more than the average for Ukraine. Regarding the socio-economic consequences of the war on the Odesa region, we can see that the prices of certain types of goods have increased significantly (vegetables +85%, fuel and oil +57%, fruits +52%, sewage +27%, transport +26%, fish +25%, pasta +22%). And this also affects the development of the economy and the well-being of the Odesa population. As for exports and imports of the Odesa region, the dynamics were bad until July, until the grain corridor began to work, so now the situation has a chance to improve. If everything develops in this direction, it will improve the situation with imports and exports in the Odesa region. But interestingly, our region has a positive trade balance, even considering the blocking of ports. After all, in the first 5 months, we exported more than we imported. In January and February, the region’s exports increased by 225%. As for imports, they were growing at the beginning of the year, but then there was a significant drop of 72% compared to May 2021.

Mr. Yakubovskyi also made proposals regarding the further actions of business and people in wartime Odesa. Thus, possible scenarios may include the preparation of investment projects for the Odesa region and appeal to international economic organizations for their direct support, proposals for regulating the departure of conscripts abroad, namely sailors, proposals for expanding recreational business activities on the Odesa coast, continuing cooperation with European partners and establishing new ties with companies in Turkey, Israel, and China, etc.

Mr. Yakubovskyi commented on the actions of the authorities of Ukraine during the war, namely, the return from July 1 of most import tariffs, restrictions on trade and recreational activities, non-transparent redistribution of all financial aid and external loans through the government, limited information, closure of many information agencies, unfavorable conditions admission to universities (especially for refugees from outside Ukraine), lack of a transparent system, regulation of border crossing for conscripts, which on the one hand reduces labor mobility, on the other – stimulates rampant corruption. So, in his opinion, the first three days were the most effective. But then the situation changed. “We have to discuss what victory can be. We must look deeper into possible victory. The leadership of Ukraine is discussing the “Vietnam scenario”, that is, the scenario of absolute victory. The second scenario that is being discussed is the “Korean” scenario since many in Europe believe that there will be no peace and no war, but there will be some agreement mentioned above. The “Georgian” and “Transnistrian” scenarios are also possible. And most importantly, we need to discuss all these scenarios, not just a complete victory. It is possible to rebuild the economic potential very quickly if the war ends, but if it continues for a long time, unfortunately, several million Ukrainians will remain in Europe, and we will lose them. Moreover, the Europeans are doing everything possible to keep them there,” – highlighted Mr. Yakubovskyi.

The European Business Association is grateful to all the experts for the productive discussion and exchange of relevant information, experience, and expertise.

Together we will win! Glory to Ukraine!