bne IntelliNews – Ukrainian economy will contract by 35% in 2022 – IIF

Ukraine’s economy will shrink by 35% this year due to 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 assuming that the conflict remains largely contained in the east of the country in 2022H2,” said Elina Ribakova, deputy chief economist at the IIF, and economist Benjamin Hilgenstock in a paper. “Due to the sharp decline in economic activity as well as war-related tax cuts and additional spending for the military campaign, we expect government revenue to fall by around 50%, resulting in a budget gap of 3 to 10 billion dollars per month.Thus, the commitments of the international community of 6 billion dollars to date will certainly be insufficient.

The IIR estimates differ slightly from the recently released World Bank estimate that Ukraine’s economy will shrink by 45% this year following the conflict, while the Russian economy will contract by 11.2%. The estimate of the amount of funding Kyiv has received is also slightly different from other reports that the total pledged is around $25 billion, but $7 billion has actually arrived so far.

Ukraine’s GDP could collapse to a third of what it was before the war, International Monetary Fund (IMF) Managing Director Kristalina Georgieva said March 22. The Ukrainian Ministry of Finance currently forecasts that GDP will contract by up to 40%.

The impact of the ongoing military confrontation is worsening day by day. The cost of the war is now $600 billion, according to an updated estimate by the Kyiv School of Economics (KSE) released on April 12, up from its previous estimate of $565 billion at the end of March. Damage to Ukraine is increasing by around $6 billion a week, according to these estimates. To put this into context, Ukraine’s previous stand-by arrangement (SBA) with the IMF provided for the release of $5 billion over 18 months to pay for needed reforms.

Although donor money is likely to be enough to keep Ukraine’s economy functioning in wartime, there will be problems with Ukraine’s external funding, which had been relatively benign in the recent past, warns the ‘IIR.

“The reserves of the National Bank of Ukraine (NBU) have remained broadly stable since the end of February; however, we are concerned that exports will remain subdued for a considerable time as ports are closed and rail/road infrastructure is used for other purposes while imports pick up,” say Ribakova and Hilgenstock.

Russia destroyed Mariupol, one of the main Ukrainian ports. Additionally, Russia controls the Kerch Strait, which prevents any Ukrainian shipping from leaving the Sea of ​​Azov, where Mariupol is located. Additionally, the Black Sea port of Odessa remains in government hands, but all incoming and outgoing shipments are blocked. As a result, Ukrainian exports of grain, coal and metals collapsed.

In March, exports fell 50% month-on-month to $2.7 billion (from $5.3 billion in February) and imports fell 70% to $1.8 billion (from $5.9 billion). dollars in February), according to the Ministry of the Economy. Exports are expected to remain noticeably subdued, while imports may pick up in the coming months.

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

The IIR stresses that labor displacement will also weigh on economic recovery. Some 7.1 million people have been internally displaced and a further 4.5 million have left the country, half of them to Poland, according to the latest UN reports. This is on top of the exodus of workers in recent years, pushed abroad by much higher wages in neighboring countries. Ukraine was already suffering from a labor shortage before the war broke out, with around 20% of its entire workforce working abroad, mainly in Poland.

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

(1) regions with isolated attacks;

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

(3) regions that will experience protracted conflict.

“In our base case, we assume that production will decline by 20%, 40% and 80% respectively, leading to a drop of more than 35% for the country in 2022,” say Ribakova and Hilgenstock. “While we find this scenario appealing due to its simplicity, we are also presenting a range of alternative scenarios. The risk is likely to increase as the war could escalate further.

The main short-term challenge is financing the budget. Like bne IntelliNews reported, the government has seen tax collection slump as around 30% of businesses shut down completely and 45% cut production, according to an NBU survey in March.

“Authorities currently estimate a monthly funding gap of at least $3 billion, with the upper end of the range of possible outcomes at $10 billion. at least 50% in 2022 due to the sharp contraction in GDP and a number of war-related measures,” say Ribakova and Hilgenstock.

Ukraine will experience an increase in Ukrainian state budget deficit from $2.7 billion in March to $5-7 billion in April and May per monthpredicted Finance Minister Serhiy Marchenko on April 12, the Financial Times reported.

“We are in a state of great stress, in the worst conditions. It is a question of the survival of our country”, declared the minister. “If you want us to continue fighting this war, winning this war…then help us,” Marchenko added. The Minister urged the international community to provide financial assistance to Ukraine.

The government also slashed revenue by offering wartime tax breaks to allow businesses to continue operating. Among them are tax breaks recently introduced in the Rada, including a temporary abolition of VAT and other duties on imports as well as corporate taxes for SMEs. The suspension of VAT, in particular, will significantly reduce tax revenue, as it alone accounts for a third of tax revenue. In addition, parliament is considering suspending the excise tax and reducing VAT on fuel, reports the IIF.

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

While Ukraine entered the war with some $28 billion in reserves, more than four months of import cover, a comfortable level, it has so far been able to service its debts. There is still $4 billion to be paid on the main sovereign loan in the rest of this year, which the state should be able to cover without too much difficulty.

“Nevertheless, we are concerned about a growing external funding gap. Outflows from the financial account accelerated sharply in February to $1.9 billion, partly due to refugee withdrawals abroad,” say Ribakova and Hilgenstock. “Since then, the NBU has introduced restrictions, but they may not be sufficient… With continued outflows from the financial account, this would lead to a growing funding gap.”

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

Ukraine remains a major exporter of important food staples, including barley, corn, vegetable oils and wheat. The war poses an immediate risk to the 2022 harvest, as the country could miss the planting season, which should have already started, reports the IIR.

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

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

“The geopolitical ripple effects of the Ukraine crisis are also weighing on Russian exports, and we expect the situation to be more difficult for countries in the MENA region and sub-Saharan Africa,” say Ribakova and Hilgenstock. “Non-food commodities, including energy and metals, have also seen significant price increases in recent months. These appear to be somewhat correlated with the role that Belarus, Russia and Ukraine play in total world imports.

Christi C. Elwood