Ukraine’s war economy is doing remarkably well as it weathers storm

Kept afloat by enormous external assistance, Kyiv is pursuing reforms more diligently than at any other time

Acountry facing invasion and fighting for survival must divert everything possible to military purpose — even exports are discouraged in favour of imports, ideally paid for with long-term loans and grants. The authorities must work to stabilise major macroeconomic disequilibriums. Ukraine’s wartime economic management is pulling this off, just. It is a real-time economic experiment like nothing seen since Britain during World War 2 in 1939-46.

Extraordinary measures have been employed by the Ukrainian authorities to stabilise the economy, involving a mix of fiscal and monetary policy. Output stabilised at 30% below its pre-war level by the end of the first year of war in 2022, and grew about 4.5% in 2023. It is forecast to rise again by 3%-4% in 2024, according to the IMF.

This is quite an accomplishment. But good data hides a precarious position. Collapse has been averted, but Ukraine’s economy is being kept afloat by enormous external assistance from the IMF, EU and other Western donors.

Not all of this assistance is assured going forward. If the EU’s current, but stalled, four-year €50bn aid package for Ukraine is not unfrozen by March, the authorities may need to monetise the fiscal deficit and potentially open an inflationary spiral. Already, foreign exchange reserves narrowed sharply in December. If large-scale Western assistance is not resumed, a balance of payments and currency crunch could follow.

Even in recovery, Ukraine’s new normal is a much disrupted, shrunken economy. More than a third of the population depend on humanitarian assistance to some degree, or are employed in public works programmes. Huge resources have been put into the hands of the state. Government spending has nearly doubled from the pre-war level and accounts for about 66% of GDP. State banks and parastatal corporations previously slated for privatisation are now key economic drivers.

Meanwhile, Russia holds significant economic advantages in an attritional war of the kind the conflict is now becoming — its economy is eight times larger in terms of purchasing power parity and 15 times larger in nominal terms. Defence spending at 6.5% of GDP in Russia is easily affordable; Ukraine by contrast is having to mobilise total production in a war economy and a national battle for survival.

Under these threatening circumstances Ukrainian policymakers are bracing for a long war in which they must maintain macroeconomic stability, finance huge social spending, expand the military-industrial sector to arm the country selfsufficiently, and grow the economy.

WELL HANDLED

How is this going? The first two are more or less assured. Macroeconomic policy has been well handled and foreign financing of $37bn is being sought for 2024. Despite delays, EU partners insist the means will be found to deliver promised financing to Ukraine — with or without a spoiler veto from pro-Russia Hungary. Better-thanexpected revenue collection and domestic financing should cover the rest.

The latter are a work in progress. Growing an economy in wartime is a difficult enough task, but the authorities are attempting the rare feat of attracting foreign direct investment too.

Remarkably, this is happening — in a war zone. Joint ventures and other investment by Western companies in the defence sector are being set up as part of efforts to ramp up production of military material, as well as investment in energy and infrastructure.

Political risk insurance (PRI) is a prerequisite and is being underwritten by bilateral investment guarantees and through the World Bank’s Multilaterial Investment Guarantee Agency, which has extended $185m in PRI coverage in Ukraine since the war began. Trade missions to Ukraine continue. More lucrative is the prospect of foreign participation in postconflict reconstruction. Already foreign companies are positioning themselves for this, setting up representative offices and donating to humanitarian and other local causes in the meantime. Two US states — Ohio and Arizona — are establishing such projects, with business associations and private sector companies from the US and Ukraine.

So what is growing? Outside the defence sector, industrial output has recovered slowly. Consumer spending has stabilised at a new, lower level, but is being slowly squeezed by a rundown in personal savings and a wave of bankruptcies. Emigration — 6-million Ukrainians have left since the war began — continues as people seek better opportunities abroad.

The export-orientated IT sector has stabilised, though the once-promising cluster at Kharkiv, employing 20,000 people, has largely migrated offshore — the city is 20km from the front lines and under near daily attack — but it continues to employ locals on remote work and disbursed teams. Other companies in towns in or near the front lines have physically moved plant to the relative safety of western Ukraine. Most business, across all sectors, are focused on survival more than growth.

GOVERNANCE REFORMS

For the longer term, a dynamic and competitive Ukraine economy needs structural and governance reforms for which payback is also longer term. Such reforms — a traditional area of weakness in Ukraine — are being pursued more seriously than at any time in the past decade. IMF country reviews, which are generally written in dry language, note that the Ukrainian authorities have met, or exceeded, nearly all reform benchmarks. In many IMF country programmes, particularly African ones, half of agreed measures being achieved is considered good progress.

Anticorruption measures are central to these reforms. That includes anti-money-laundering laws being tightened, asset declarations for public officials, cleaning up the courts and making the anticorruption prosecutor independent of the prosecutor general. De-oligarcant laws — a key demand of the EU as part of entry requirements for Ukraine agreed on December 14 — are being implemented as President Volodymyr Zelensky uses political capital to move against the powerful business families that have traditionally exerted undue economic and political influence.

Ukraine’s record of economic resilience is a remarkable achievement. A country experiencing invasion and risking economic collapse has weathered the onslaught and is growing again. But even that is not enough — Ukraine must still mobilise its economy and society to hold back and outlast a far larger and more powerful adversary. How that will play out is the great unanswered question.