BOFIT: The long-awaited new US aid package brings military support to Ukraine

BOFIT: The long-awaited new US aid package brings military support to Ukraine
The new $61bn US aid package for Ukraine will cover most of Ukraine’s needs for this year, but $14bn is still unassigned. However, the military package will stabilise the situation on the frontline for now. / bne IntelliNews
By Bank of Finland Institute for Economies in Transition (BOFIT) April 26, 2024

After a long wait, the US aid package for Ukraine of almost $61bn got the last seal with President Biden's signature on April 24, 2024. The sizeable package focuses especially on military material aid, which will bring relief to Ukraine's acute shortage of defence equipment, the Bank of Finland institute for Emerging Economies (BOFIT) reported in its weekly update.

The package allocates approximately $13bn to replenish the USA's own stocks, $14bn to Ukraine to purchase US defence material, $14bn to the purchase of high-tech weapon systems, and $11bn to increase the capabilities of the USA in Ukraine's neighbouring regions. About $8bn of the aid package is direct budget support, which Ukraine can use to cover pensions, social security and other mandatory government expenditures.

At the same time, the president signed the so-called REPO (Rebuilding Economic Prosperity and Opportunity for Ukrainians) Act package, which e.g. allows the president to seize frozen Russian government funds in the United States and use those funds to support Ukraine. In the EU, the discussion has mainly been about using the proceeds of the frozen funds to support Ukraine in some form. In the G7 countries, it is estimated that the assets of the Russian central bank are frozen, worth a total of about $300bn. Most of the assets are in Europe, in the United States the assets of the Russian central bank are estimated to be around $4–$6bn. 

Despite the increase in external support, covering the budget deficit in 2024 is still uncertain.

At the beginning of 2024, the direct budget and military support that Ukraine received from its foreign supporters almost stopped. In March-April, however, funding has started to flow again and by mid-April, $10.2bn have been received from foreign donors for budget expenditures, of which 4.9bn have come through the EU's Ukraine support instrument. Almost all support has come in the form of low-cost loans. An additional $3.5bn has been received from the domestic bond market.

Despite the increase in foreign aid, covering the entire 2024 state budget deficit is still uncertain. According to the Ministry of Finance of Ukraine, the need for external financing for the entire year 2024 is $36bn, of which $14bn is currently unsecured after the US aid package. Through the EU's support instrument for Ukraine and the Extended Fund Facility (EFF) of the International Monetary Fund (IMF), Ukraine will receive additional funding if it meets the criteria defined in these support instruments.

Through the IMF, it is possible for Ukraine to receive an affordable loan instalment of around 900mn dollars every quarter, as long as the criteria set for financing are met. The next review period for IMF financing is in the summer.

The EU's €50bn support instrument for Ukraine covering the years 2024–27 is likely to be the largest financier of Ukraine's budget deficit in 2024. According to the Prime Minister of Ukraine, Ukraine is still receiving more so-called bridge financing during April. According to the Prime Minister, the EU Commission and Ukraine have also reached an agreement on the criteria related to the further financing of the Ukraine support instrument in the so-called Ukraine plan.

The EU Council of Ministers still has to approve the prepared plan for Ukraine, after which Ukraine will have the opportunity to receive a pre-financing instalment of €1.9bn. In the future, the fulfilment of the criteria will be reviewed every quarter, and when they are fulfilled, a new tranche of the support instrument will be paid to Ukraine, as a rule, in the form of a low-cost loan. During 2024, two instalments will probably be paid through the support instrument. All in all, the share of funding directed directly to the budget in the Ukraine instrument is approximately €33bn in the years 2024–27.

There is more and more uncertainty about securing support funding for the coming years, even though it is currently estimated that the state budget's funding needs will decrease. In 2025, according to the estimate of the Central Bank of Ukraine, the need for foreign aid will decrease to $25bn and further to $12bn in 2026, but these estimates are very uncertain due to the war.

Economic growth in 2023 surprised positively, inflation slowed further

In 2023, Ukraine's GDP grew by 5.3% y/y after a deep 28.8% drop in the previous year. In addition to the low benchmark, the growth was helped by e.g. military industry and a good harvest season. Despite the difficulties, 2023 Ukrainian agricultural production volumes reached their record per hectare. In the last quarter of the year, economic growth was sustained by Ukraine's daring decision to reopen the Black Sea trade corridor after Russia withdrew from the Black Sea grain agreement negotiated with the UN and Turkey. However, the growth of agriculture was limited by the loss of agricultural land, mining and weak grain price trends on the world market.

In April 2024, the IMF published a forecast for Ukraine's economic development for the years 2024–29. According to the forecast, GDP growth will slow down to 3.2% this year, but will accelerate again in the coming years. Based on the forecast, however, Ukraine's GDP would still be around 2% lower in 2029 than before the start of the full-scale war of aggression and 8% lower than in 2013 before the illegal occupation of Crimea. Because of the war, even this forecast is subject to considerable uncertainty. 

The war has also changed the structure of Ukraine's GDP. On the supply side, the biggest change is, as expected, the increase in the share of public administration. The share was already 22% in 2023, while it was still 7% in 2021.

Other key production sectors were retail and wholesale trade (13%), agriculture (9%) and processing industry (8%). Agriculture has become slightly larger than processing industry during the war.

The background is especially the plight of the country's formerly large steel industry. In 2023, the production of the steel industry was only about a third of its level before the war of aggression, when two significant steel factories have been taken over by the Russians and the industry's export routes have been cut off. The multiplication of the defence industry's demand during 2023 partly compensated for the lost export demand. The changes in the Ukrainian economy since the start of the war of aggression have been examined in more detail in the recent BOFIT Policy Brief.

The effects of the war are also visible on the demand side. Public sector consumption increased to 41% of GDP in 2023 (19% in 2021), while household consumption decreased by 12 percentage points to 63% of GDP. Compared to 2021, fixed investments increased by 3 percentage points and accounted for 17% of GDP in 2023.

The slowdown in the growth of consumer prices has continued in Ukraine towards 2024 as well. In March 2024, the annual inflation of consumer prices slowed down to 3.2%, after it was at its highest point of almost 27% in October 2022. In March, the slowdown in inflation was primarily driven by the fall in the prices of unprocessed food products (-4.9% y/y). However, the Central Bank of Ukraine estimates that the decline is temporary. Food prices have been weighed down by a good harvest season and an increased supply in the domestic market due to European border protests that prevented food exports. A slower-than-expected rise in energy prices and a stable exchange rate development have also contributed to slowing down inflation.