Fighting Ukraine’s Financial Fire by Anders Åslund

Russia’s war has inflicted huge costs on the Ukrainian economy, leaving the government without sufficient means to maintain its most basic functions. To continue its military achievements, Ukraine needs much greater financial support, in addition to a constant supply of weapons.

STOCKHOLM – Thanks to Western arms deliveries, Ukrainian forces are celebrating one victory after another on the battlefield. But Ukraine faces another serious threat: high inflation. Therefore, you need not only weapons, but also more financial support.

Russia’s war has inflicted enormous damage, with the Ukrainian government and the Kyiv School of Economics putting the current tally of recorded material losses at $120 billion. The country’s GDP is expected to fall by 35-40% this year, and government revenue even more. Earlier this year, the International Monetary Fund determined that the Ukrainian government would need $5 billion per month ($60 billion this year) in external support to finance government salaries, pensions, health care, schools and some social benefits.

These are basic expenses to keep the government running. Unfortunately, only half of the necessary funds have been made available. According to the Ukrainian brokerage Dragon Capital, as of September 30, $35 billion had been promised to Ukraine, but only $20 billion had been disbursed. The dominant donor is the United States, which has already contributed $8.5 billion, with commitments to contribute another $1.5 billion a month for the rest of 2022.

The biggest disappointment is Europe, which has contributed only about half the US level: $4.8 billion ($2.8 billion from the European Union and another $2 billion from individual member states). Although the EU committed €9bn ($8.8bn) in macro-financial assistance in May, only €1bn has been disbursed, a pace that is simply unacceptable for this time of crisis. Now, five months after its commitment, the EU is expected to release at least €5 billion more.

In the absence of external financing, the Ukrainian government has no choice but to resort to monetary financing (printing money) which inevitably increases inflation. Ukraine’s inflation rate reached 24.4% in September and will most likely continue to rise, because the government received only $2.5 billion, half of what it needed, in September. Obviously, this is not sustainable. As historian Niall Ferguson points out in a recent Bloomberg commentary, Ukraine’s military may be winning, but its economy is losing, largely because the EU has not provided enough financial support. Ferguson is concerned about hyperinflation, when inflation is at least 50% per month, and so am I.

To be sure, a recent report from the Center for Economic Policy Research recommends that Ukraine increase tax revenue and sell, rather than monetize, domestic debt. But I doubt that such measures will be feasible during the war. After all, Ukraine cannot cut military spending (for obvious reasons), and has already reduced most other public spending to the bare minimum.

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Hyperinflation is all too common during or after wars or other massive structural changes. At the end of the Cold War, most of the former communist countries were affected by hyperinflation, which cannot fail to undermine public confidence in the state. The result is often authoritarian rule, as is found throughout the former Soviet Union.

For his part, Russian President Vladimir Putin no longer claims to be waging a war against Ukraine alone. Instead, he now says that he is up against the “collective West.” We Westerners should take him at his word and recognize that we have a common duty to keep the Ukrainian state afloat during the war. In the short term, increased Western contributions to the Ukrainian budget are the only way to meet this goal. While it is reasonable to anticipate the need for other reforms and alternative financial mechanisms, that work will have to wait until after the war.

Furthermore, with Ukraine’s public debt skyrocketing from 50% of GDP at the end of 2020 to an estimated 85% of GDP at the end of this year, it is vital that Ukraine receives grants rather than credit. While the US appears to understand this, the EU clearly does not. Its macro-financial assistance comprises only credits (although bilateral assistance from most EU members has mainly taken the form of grants).

This must change. We cannot allow Ukraine to fail financially through no fault of its own, simply because the EU is too preoccupied with its own bureaucratic rules. The best solution, as I have argued above, is to seize the estimated $400 billion of Russian reserves frozen in seven Western countries and send them to Ukraine as reparations. Canada has already adopted a law allowing this, although it has not yet seized any Russian funds.

The EU offered substantial grants to support its members’ economies during the COVID-19 pandemic, and there’s no good reason why it can’t muster the much smaller sums needed to help Ukraine. If necessary, it should consider requiring mandatory subscriptions from its members, as it did in 2016 to fund its migration deal with Turkey. If there is a will, there are many ways to boost Ukraine’s finances.

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