The writer is a former deputy governor of the National Bank of Ukraine
Vladimir Putin infamously predicted that Ukraine would be conquered in a matter of days. The west was equally sceptical about Ukraine’s chances of surviving a Russian onslaught. However, it has been more than 150 days since the start of the full-scale Russian invasion of Ukraine, and Putin is far short of achieving his original goal of Ukraine’s destruction as an independent state. Earlier forecasts of a short war have been thoroughly discredited, and commentators on all sides no longer rule out that it may continue for many more months, if not years.
A longer duration of the conflict alters not only the military strategy but the macroeconomic calculus. In the war’s early days, Ukraine’s macroeconomic policies aimed to control expectations and avoid panics. These policies were based on controlling prices — for example, the hryvnia-dollar exchange rate was fixed at the prewar level — and providing stop-gap measures to support businesses and households, such as suspending import duties. These responses were appropriate to address the initial shock. But as the war grinds on, they need to be adjusted or Ukraine will run into an economic catastrophe.
The National Bank of Ukraine, the country’s central bank, has a seemingly impossible job. First, the fixed exchange rate provides an important nominal anchor. Second, the NBU is in charge of the financial system’s health to ensure that the economy has access to liquidity and that the payment system functions smoothly. The central bank has some power over capital flows, but Ukrainian refugees in the EU and other countries must be allowed to use precious hard currency to support themselves. Third, the NBU has to cover the government’s vast fiscal needs to pay for the war effort.
In the short run, this policy mix can work. For instance, the central bank can burn foreign exchange reserves. But it is not compatible with the longer horizons of the war. If policies are not modified, the NBU faces the prospect of high inflation, dangerous depletion of foreign exchange reserves and the risk of a currency crisis, or a banking panic.
The government’s limited resources leave few pleasant options. Recently, the central bank had to devalue the hryvnia by 25 per cent. But this will probably provide only temporary relief as another devaluation may be necessary. Alternatively, the hryvnia could be allowed to float more freely, helping to address accumulating imbalances in the economy. But this risks coming at the cost of losing a nominal anchor. Prewar inflation targeting is less useful, given the uncertain monetary transmission mechanism of wartime.
The fiscal authorities could also try to raise more revenue and control spending. These options are difficult. It is hard to raise taxes when the economy is weak. But one possibility is to tax the shadow economy via non-direct taxes such as excise duty or increased import duties.
The finance ministry must finally accept reality and start borrowing on the local debt market at much higher rates, rather than relying constantly on monetary financing from the NBU to cover budget shortfalls. So far, attempts to borrow at deeply negative real interest rates have been rather unsuccessful. In any case, Ukraine’s task is clear: the fiscal stance has to be significantly improved to sustain the war effort over an extended period.
But Ukraine’s allies face macroeconomic tasks of their own. My country is defending security in Europe. Indeed, the global order is being decided in Ukraine. If Putin’s Russia wins, the law of the jungle will be the new regime in international relations.
But for Ukraine to keep fighting and win, it needs not only much more weaponry but also larger-scale economic support. Since the beginning of the war, Ukraine has received external support to the tune of $2.5bn-$3bn a month. The expected external funding for the second half of 2022 is $18bn — a significant sum, but well below the nation’s needs. To avert economic calamity in Ukraine and sustain its ability to fight, the allies must disburse much larger amounts of about $4bn-$5bn a month in the nearest future.
Every day of the war means more lives lost, children traumatised and homes destroyed. The economic cost of the war is no less staggering and it touches everybody — from ruined infrastructure in Ukraine to the spectre of hunger in Africa and elsewhere. Ukraine must win this war and win it quickly. But a long war increasingly looks like the baseline scenario. This requires recalibrating macroeconomic policies in Ukraine and allied countries to make sure that Ukraine’s economy can sustain the war effort as long as necessary.
