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Andelsblatt: Why Ukraine’s finances may be in dangerous disarray

Next week it will be that time again: politicians from a wide range of countries will meet in Conference on the Recovery of Ukraine in Lugano, Switzerland, to discuss what kind of country Ukraine should be in the future, Handelsblatt reports.

But talking alone is unlikely to help. The country, shaken by the Russian invasion, today needs a lot of money to survive as a functioning state. Just to pay salaries and pensions and provide basic services, the government there needs to raise $5 billion a month. At the same time, tax revenues are expected to shrink, while the war increases government spending.

In fact, international financial assistance to the country is making slow progress. And so another problem emerges for Ukraine. Meanwhile, the central bank of Ukraine (NBU) stepped into the funding gap by buying government securities. However, as she warns, this is a risky venture.

Ukrainian state statistics do not yet reflect the problem of declining tax revenues. The year is still too early for that. Inevitably, however, the state will suffer from reduced revenue because economic activity has been partially halted by the war.

In March and April, Ukraine exported only about half as many goods as in the same months of 2021. Compared to the pre-war period, companies’ potential was utilized by only 60%, according to the NBU.

As a result, Ukrainians suffer wage losses at the same time. “Many companies are no longer able to pay the same wages as before Russia’s new attack in February,” says Olga Pindyuk, an economist at the Vienna Institute for International Economic Studies.

In contrast to revenues, the expenditure side already shows the difficult situation Ukraine is in. In the first quarter, government spending increased by 36% compared to the previous year, mainly because defense spending quadrupled. Moreover, due to the war, Ukraine is currently unable to borrow from the capital market.

The NBU is now partially covering this gap by buying government bonds – reluctantly and out of necessity. As recently as June 23, the Financial Stability Board of Ukraine, which includes representatives of the NBU, warned that financing the state by the central bank carries high risks.

The expansion of the money supply threatens inflation and the collapse of the domestic currency, the hryvnia. On the black market, the hryvnia is already worth less against the dollar than the official exchange rate set by the National Bank.

To keep inflation under control and defend the value of the hryvnia, the NBU raised the key interest rate from ten to 25% in early June. Previously, Ukraine had issued bonds with an interest rate of nine to ten percent. At the same time, the NBU is pouring foreign currency into the market to defend the hryvnia exchange rate. At times it has sold up to a billion foreign currencies per week.

However, such transactions should be carried out only to a limited extent, warns the NBU. This is because Ukraine needs the foreign currencies to pay for imports.

The central bank has a good reputation

The words of central bankers carry weight. NBU has a good reputation in Ukraine and abroad. It is seen as an institution that meets Western standards and differs in this from the judiciary, whose reputation remains tarnished. Economists say it is even more important that the government listens to the central bank’s messages.

Therefore, to maintain its economic situation, Ukraine also needs foreign financial assistance. But this takes time, the NBU cautioned in a document. In reality, purely financial support of the country is making slow progress.

For example, when the finance ministers of the G-7 countries met in May, it proved difficult to raise the sum of US$9.5 billion for Ukraine. “We are approaching the political question of what Ukraine is worth to us at all,” says Gunter Deuber, head of research at Wiener Raiffeisenbank International (RBI), which has a retail bank in the country.

In this context, Ukraine should receive mainly grants and not loans from these countries. “Loans are not financially sustainable for Ukraine,” Swiss economist Beatrice Weder di Mauro found at a conference two months ago. Eventually, the country’s debt will increase rapidly. RBI’s Deuber estimates it will reach 100 percent of economic output (GDP) next year. “For an emerging market, that’s too much.”

Russia, on the other hand, surprisingly appears to be in better economic shape than Ukraine – even as Western states have piled one package of sanctions after another against the aggressor. In early June, for example, the Russian central bank cut the key interest rate to 9.5%. This brings her back to the same level as before the war.

At the same time, the country generates high revenues from the export of raw materials and has only low debt. Russia will feel the pain of Western sanctions probably only when specialized components for industrial and military goods become scarce.

The relatively stable situation for now can be used by Russia for propaganda purposes, says RBI’s Deuber. Putin could claim that the Russians are doing better economically than the Ukrainians. “I’m afraid he will play that card,” says the economist.

Much will depend on how much financial aid Ukraine receives in the coming months. If anything, it will make it even harder for the country’s government to be heard abroad. In Western industrialized countries, the economic situation is rapidly deteriorating – and this will hardly increase the willingness to help.

Source: Capital

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