Ever since Ukraine liberated the Kharkhiv region last weekend after Russian occupation, western observers have wondered how Moscow might respond. Now they partly know.
“Russia has answered Ukraine’s counter offensive by destroying civil infrastructure,” Ukrainian prime minister Denys Shmyhal told the Financial Times on Thursday, noting that Russian missiles have knocked out electricity plants and seriously damaged the gigantic Kryvyi Rih dam.
This creates big humanitarian and military challenges. But it also invites a key economic question: can Kyiv contend with the immediate, spiralling financial costs of destruction without tipping into fiscal crisis and/or hyperinflation?
The problem for Ukraine is not just how to fund the costs of future peacetime reconstruction, estimated to be in the region of $350bn. It also faces an immediate budgetary crisis as it tries to keep its economy (and its people) alive, and power on. Unless it receives rapid assistance from the IMF, among others, it risks losing this economic battle — whatever happens on the military side.
Kyrylo Shevchenko, central bank governor, forcefully outlined the problem earlier this week. Since the invasion, Ukraine’s economy has shrunk by more than a third, inflation jumped above 20 per cent — and an estimated $97bn in infrastructure was destroyed, just by June.
This is alarming. But it could soon get worse. Shmyhal says the government currently has a $5bn hole in its monthly budget since tax revenues have collapsed, while military spending has soared.
Sympathetic western creditors have “reprofiled” existing foreign debt, saving Kyiv around $6bn, bankers tell me. Shmyhal says the finance ministry has also sold $14.5bn of domestic war bonds and plans to sell more.
But the central bank is wary of too much war bond issuance because it fears this will lead to hyperinflation. It is entirely correct to worry: war often sparks disastrous inflationary spirals.
And though Kyiv has received an estimated $17bn of international loans and grants this year, this does not entirely plug the fiscal hole. And Shmyhal reckons that Ukraine will face monthly deficits of around $3.5bn in 2023, assuming the war drags on.
So what should the west do next to shore up Ukraine’s financial defences? Probably the most important move would be to urge the IMF to provide meaningful support.
The fund has already implemented one structural adjustment programme in Ukraine, in 2015. It has also given two small(ish) dollops of $1.4bn emergency aid since the invasion. The second emerged this week after Kristalina Georgieva, IMF head, spoke to President Volodymyr Zelenskyy by phone, as he headed to the eastern front lines.
However, Kyiv is now asking the fund to offer a fully fledged programme, ideally of at least $15bn. Such numbers are not unprecedented in IMF history: Greece and Argentina received more to battle their respective crises. But what would make any Ukraine package controversial is that the IMF has never implemented a significant structural adjustment programme in a country engulfed in full-blown war before.
Moreover, Ukraine’s relations with the IMF have been prickly in recent years. Economists at the fund have fretted about the country’s “poor governance” (the polite phrase for corruption) and Zelenkskyy’s erratic commitment to economic reform in the past.
On Ukraine’s part, there has been widespread resentment of western financiers and IMF austerity plans — and opposition to the idea of foreign investors grabbing Ukrainian assets. So much so, that when Zelenksyy was “just” a TV actor playing the fictional president in the popular show Servant of the People (before becoming the actual president in 2019), he enthusiastically kicked the IMF out of Ukraine. You could not make this up.
But war is now resetting Ukraine’s political economy, ushering in once-unimaginable levels of unity and innovation — and undermining the power of previously dominant oligarchs. This creates more openings for reform. And Zelenksyy’s government is trying to show that it will be as fiscally responsible as the IMF needs.
Last week, Rustem Umerov, an official who is running peace negotiations, was appointed as head of a putative sovereign wealth fund. Umerov tells me he has a mandate to sweat state assets, or sell them to global investors, to raise cash.
So I, for one, hope that the IMF finds the courage to offer meaningful support soon, not least because this could prompt more aid from the US and Europe as well. An IMF reform programme could pull in more private sector investment if (or when) war ends, or even sooner if western governments start offering war insurance to private investors.
Georgieva, for her part, has hinted she is getting ready to be creative: after speaking to Zelenskyy, she told staff that “we are going to modify somewhat our engagement capacity” and “there is a build-up toward a fully fledged program.”
This is good news but she cannot act without the support of the IMF board. So all eyes are now on what the US and European governments do at next month’s IMF autumn meeting. There is much at stake — for both Kyiv and the west.
