Ukraine’s economy to contract by 35% in 2022 – IIF

Ukraine’s economy to contract by 35% in 2022 – IIF
The Institute of International Finance estimates Ukraine’s economy will contract by 35% this year, joining the World Bank’s forecast for a 45% contraction and the official Ukrainian government estimate of 40%. / bne IntelliNews
By bne IntelliNews April 15, 2022

Ukraine’s economy will contract by 35% this year as a result of the war with Russia, the Institute of International Finance (IIF) said in a note released on April 13.

“We expect Ukrainian real GDP to contract by more than 35% in 2022 under the assumption that the conflict will largely remain contained to the east of the country in 2022H2,” said Elina Ribakova, deputy chief economist with IIF, and economist Benjamin Hilgenstock in a paper. “As a result of the severe drop in economic activity as well as war-related tax cuts and additional expenditures for the military campaign, we expect government revenue to fall by roughly 50%, resulting in a fiscal gap of $3-10bn per month. Thus the international community’s commitments of $6bn to date will certainly fall short.”

IIF’s estimates differ slightly from the recently released World Bank estimate that Ukraine’s economy will shrink by 45% this year as a result of the conflict, while Russia’s economy will contract by 11.2%. The estimate of the amount of funding Kyiv has received is also slightly different from the other reports that the total promised is some $25bn, but $7bn has actually arrived so far.

Ukraine’s GDP could collapse to one third of what it was pre-war, International Monetary Fund (IMF) managing director Kristalina Georgieva said on March 22. Ukraine’s Ministry of Finance currently anticipates GDP to contract by as much as 40%.

The impact of the ongoing military confrontation gets worse by the day. The cost of the war is now $600bn, according to an updated estimate by Kyiv School of Economics (KSE) released on April 12, up from its previous estimate of $565bn at the end of March. The damage being done to Ukraine is rising by approximately $6bn a week, according to these estimates. To put that in context, Ukraine’s previous standby agreement (SBA) with the IMF was for $5bn to be released over 18 months to pay for the necessary reforms.

While donor money is probably enough to keep Ukraine’s wartime economy functioning for the meantime, there will be problems with Ukraine’s external financing picture, which had been relatively benign in the recent past, warns IIF.

“Reserves of the National Bank of Ukraine (NBU) have remained broadly stable since late February; however, we worry that exports may stay subdued for a considerable amount of time as ports are closed and railroad/road infrastructure is used for other purposes while imports pick up,” Ribakova and Hilgenstock say.

Russia has destroyed Mariupol, one of Ukraine’s major ports. In addition, Russia controls the Kerch Strait, which prevents any Ukrainian shipping from leaving the Sea of Azov, where Mariupol is. In addition, the Black Sea port of Odesa remains in government hands, but all shipping in and out of it is blockaded. As a result, Ukraine’s exports of grain, coal and metal have collapsed.

In March, exports fell by 50% month on month to $2.7bn (from $5.3bn in February) and imports by 70% to $1.8bn (from $5.9bn in February), according to the Ministry of Economy. Exports are likely to remain significantly subdued, while imports may pick up again in the coming months.

“The economic impact of the war will be dramatic, even though the magnitude is set to remain unclear for some time,” Ribakova and Hilgenstock say. “The destruction of physical capital plays an important role; the Kyiv School of Economics estimates that such damage has already reached at least $80bn in only six weeks of war (and overall losses of $564-600bn).”

IIF points out that the displacement of labour will also weigh on the economic recovery. Some 7.1mn people have been internally displaced and another 4.5mn have left the country, with half going to Poland, according to the latest UN reports. That comes on top of the exodus of workers in recent years, driven abroad by much higher wages in neighbouring countries. Ukraine was already suffering a labour shortage before the war broke out, with an estimated 20% of its entire workforce working overseas, mostly in Poland.

To estimate the war’s impact on real GDP, IIF has developed scenarios by distinguishing between three types of regions within the country:

(1) regions with isolated attacks;

(2) regions that were part of the initial invasion but have since been reclaimed; and

(3) regions that will be experiencing prolonged conflict.

“In our baseline scenario, we assume that output will decline by 20%, 40% and 80% respectively, resulting in a more than 35% drop for the country in 2022,” Ribakova and Hilgenstock say. “While we find this scenario appealing due to its simplicity, we also present a range of alternative scenarios. The risk is likely to rise, as the war may escalate further.”

The key near-term challenge is budget financing. As bne IntelliNews has reported, the government has seen tax collection collapse as an estimated 30% of companies have stopped working altogether and another 45% have reduced their output, according to a survey by the NBU in March.

“Authorities currently estimate a monthly financing gap of at least $3bn, with the higher end of the range of possible outcomes at $10bn. The key driver is lower revenues, which could fall by at least 50% in 2022 due to the sharp GDP contraction and a number of war-related measures,” Ribakova and Hilgenstock say.

Ukraine will see an increase in the state budget deficit of Ukraine from $2.7bn in March to $5-7bn in April and May per month, Finance Minister Serhiy Marchenko predicted on 12 April, the Financial Times reported.

"We are in a state of great stress, in the worst condition. This is a matter of our country's survival," the minister said. "If you want us to continue to fight in this war, to win this war... so help us," Marchenko added. The minister has urged the international community to come to Ukraine’s financial aid.

The government has also reduced its income by offering wartime tax breaks to allow companies to continue to function. Among them are tax breaks recently introduced in the Rada, including a temporary removal of VAT and other duties on imports as well as corporate income taxes for SMEs. The suspension of VAT in particular will dramatically reduce the tax take, as it accounts for a third of tax revenues by itself. In addition, the parliament is considering suspending the excise tax and reducing the VAT on fuel, IIF reports.

“Should the war continue for months, which is more likely than not at this point, tough choices will need to be made on fiscal spending. Even under the most optimistic assumption of a $3bn financing gap per month, currently committed external funding would only last until the end of April,” Ribakova and Hilgenstock say, reinforcing Marchanko’s prediction that the deficit could double in the coming months.

As Ukraine went into the war with some $28bn in reserves, or over four months of import cover, a comfortable level, it has been able to service its debt obligations so far. There is another $4bn to pay on principal sovereign borrowing in the rest of this year, which the state should be able to cover without too much difficulty.

“Nonetheless, we are worried about a growing external financing gap. Financial account outflows accelerated sharply in February, to $1.9bn, partly due to refugees’ withdrawals abroad,” Ribakova and Hilgenstock say. “Since then, the NBU has introduced restrictions, but they may not be sufficient… With ongoing financial account outflows, this would result in an increasing financing gap.”

IIF also highlighted the impact the war in Ukraine will have on global food security. Food prices have already soared, as bne IntelliNews reported in a deep dive into the global grain trade.

Ukraine remains one of the key exporters of important staple foods, including barley, maize, vegetable oils and wheat. The war poses an immediate risk to the 2022 harvest, as the country could miss the sowing season, which should already have started, IIF reports.

In addition, seaports, which account for around 80% of total cargo, will likely remain closed in the coming months (and naval mines could present a threat even after the war), and railways are largely used for other purposes.

Finally, authorities have restricted exports of critical items such as barley, beef, buckwheat, rye, salt and sugar, while many other products now require licensing, IIF reports.

“The Ukraine crisis’ geopolitical ripple effects also weigh on Russian exports, and we expect the situation to be most challenging for countries in MENA and Sub-Saharan Africa,” Ribakova and Hilgenstock say. “Non-food commodities, among them energy and metals, have seen significant price increases in recent months as well. These appear to be somewhat correlated with the role that Belarus, Russia and Ukraine play in total world imports.”


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