Pushing off the bottom: What will 2023 be like for the Ukrainian economy

15 January, 01:28 PM

The state and prospects of the Ukrainian economy will depend on two key factors: the course of the war and the amount of international financial support

Events on the front give hope that with sufficient military support from its partners, Ukraine will continue to liberate its territories from the Russian invaders and will be able to end the hot phase of the war on acceptable terms in 2023.

Unfortunately, the improvement of military prospects in the medium-term horizon is accompanied by increased risks. The purposeful destruction of Ukraine’s energy infrastructure by the enemy has already led to restrictions on electricity consumption by the population and businesses. So far, the impact of power outages on economic activity has been moderate. The rate of decline in real GDP deepened to -39% year-on-year in October from – 35% year-on-year in September. However, attacks on critical infrastructure are likely to continue, even as the enemy's missile stockpile is depleting, and cold winter weather will further limit consumption. In terms of GDP dynamics, the first quarter of next year could be the worst since the beginning of the war.

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Therefore, the 2023 economy is unlikely to show positive growth rates after a dramatic contraction of almost a third in 2022.

But the readiness of Ukraine’s international partners to provide the country with direct financial assistance is a clearly positive factor. The latest statements from our partners allow us to expect an increase in the amount of international support next year to $42 billion — from $32 billion in 2022. Moreover, a large share of aid (more than 40%) will be provided in the form of grants that do not need to be repaid.

Funds from our international partners will fully finance the budget deficit, which will reach an unprecedented 27% of GDP for the second year in a row. After all, monthly budget expenditures on security and defense have increased more than four times compared to the pre-war level, and tax revenues have decreased due to the decline of the economy. As a result, the government's financing needs have reached almost $5 billion per month, even though it reduced non-critical spending and agreed with private creditors to postpone all payments for two years.

In addition, external revenues will help keep gold and foreign exchange reserves at an acceptable level and avoid another adjustment in the hryvnia exchange rate. The National Bank maintained a fixed the rate since the beginning of the war, and has introduced strict restrictions on payments abroad. However, it was forced to weaken the exchange rate by 20% in July, to 36.6 hryvnias/dollar as the demand for foreign currency was constantly growing, and foreign aid was coming in insufficient amounts and with a delay, which led to a sharp reduction in gold and foreign exchange reserves.

The adjustment of the hryvnia exchange rate, together with the resumption of the export of Ukrainian grain through individual Black Sea ports after the signing of the multilateral grain deal, helped to stabilize the situation on the foreign exchange market.

The NBU will likely try to avoid another such move, as the fixed exchange rate is an important stabilizing factor for the economy in the current uncertain environment. In addition, further weakening of the hryvnia will push up inflation, which has already reached 27% year-on-year despite fixed tariffs for utility services, but will not help significantly reduce the foreign trade deficit due to the specific structure of trade flows and limited opportunities for export.

Overall, the fact that Ukrainian authorities, with the support of international partners, were able to maintain macroeconomic and financial stability and ensure the almost uninterrupted operation of the banking system despite the unprecedented challenges associated with the war is outstanding and decisive. Thanks to this, Ukraine will recover much faster from the consequences of the war and return to the path of rapid economic growth, despite the shocking loss of assets.

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