Financial and Economic Policy of Ukraine in the Conditions of War with Russia: current...

Svitlana Dombrovska

National University of Civil Defence of Ukraine

Kharkiv

s.dombrovska@nuczu.edu.ua

ORCID: 0000-0002-8627-0057

Viktoriia Shvedun

National University of Civil Defence of Ukraine

Kharkiv

v.shvedun@nuczu.edu.ua

ORCID: 0000-0002-5170-4222

FINANCIAL AND ECONOMIC POLICY OF UKRAINE

IN THE CONDITIONS OF WAR WITH RUSSIA: CURRENT

PROBLEMS AND PROSPECTS FOR DEVELOPMENT

POLITYKA FINANSOWA I GOSPODARCZA UKRAINY

W WARUNKACH WOJNY Z ROSJĄ: AKTUALNE

PROBLEMY I PERSPEKTYWY ROZWOJU

Abstract: The article is focused on the examination of the current problems of nancial and

economic policy of Ukraine in the conditions of war with Russia. The authors highlight

that logistical challenges related to the war continue to put strain on the economy, particularly

those related to the operation of ports, transport networks and energy infrastructure. The war

has also caused an imbalance in the foreign exchange market and an unprecedented increase in

the budget decit. Tax revenues were limited due to declining economic activity. The authors

suggest ideas for the further development of the nancial and economic policy of Ukraine.

In particular, the import of luxury goods can be a good alternative to direct conversion of

funds into foreign currency. It is already noticeable that there are various restrictions on the

import and purchase of foreign exchange assets. These measures are already beginning to

be applied, but they need to be expanded and deepened. It is also necessary to limit peo-

ple’s desire for savings, because in conditions of instability, savings will inevitably ow

into the currency.

Zarys treści: Artykuł koncentruje się na analizie bieżących problemów polityki nansowej

i gospodarczej Ukrainy w warunkach wojny z Rosją. Autorki podkreślają, że wyzwania lo-

gistyczne związane z wojną nadal obciążają gospodarkę, szczególnie te związane z funkc-

jonowaniem portów, sieci transportowych i infrastruktury energetycznej. Wojna zaburzyła

równowagę na rynku walutowym i bezprecedensowy wzrost decytu budżetowego.

Dochody podatkowe były ograniczone z powodu malejącej aktywności gospodarczej.

95gl;;

Nr 7 ss. 95–104 2022

ISSN 2543–7321 Przyjęto: 03.10.2022

Oryginalna praca badawcza DOI: 10.34858/SNB.7.2022.008

STUDIA NAD BEZPIECZEŃSTWEM

96 Svitlana Dombrovska, Viktoriia Shvedun

Autorki proponują perspektywy dalszego rozwoju polityki nansowej i gospodarczej Ukrainy,

w szczególności import towarów luksusowych może być dobrą alternatywą dla bezpośredniej

konwersji środków na walutę obcą. Już teraz zauważalne jest wprowadzenie różnych

ograniczeń dotyczących importu i zakupu aktywów walutowych. Środki te już zaczynają być

stosowane, ale należy je rozszerzyć i pogłębić. Konieczne jest również ograniczenie chęci lud-

zi do oszczędzania, ponieważ w warunkach niestabilności oszczędności nieuchronnie wpłyną

do waluty.

Keywords: nancial and economic policy of Ukraine, war, currency exchange rate, export,

import, unemployment

Słowa kluczowe: polityka nansowa i gospodarcza Ukrainy, wojna, kurs wymiany walut, ek-

sport, import, bezrobocie

Introduction

Russia’s invasion of Ukraine, which began a year ago, has led to great loss of life,

mass displacement and signicant damage to infrastructure. The impact on economic

activity has also been huge: real GDP has fallen sharply, ination has risen sharply,

trade has been seriously disrupted and the budget decit has risen to unprecedented

levels.

Immediately after the invasion, the authorities quickly adapted monetary policy to

maintain nancial and exchange rate stability. More recently, in order to compensate

for the signicant loss of international reserves, an exchange rate devaluation was

carried out, which helped to stabilize foreign exchange reserves and maintain overall

macroeconomic and nancial stability.

Fiscal policy focuses on priority defence spending, welfare payments, humanitar-

ian needs and, where possible, some rebuilding of critical infrastructure.

Uncertainty about the size of funding needs remains extremely high and depends

on the duration of the war and its intensity, and economic risks loom large, including

related to potential additional damage to critical infrastructure or new disruptions in

the agricultural and energy sectors.

More than 7 million Ukrainians, about a fth of the population, have left

the country or become internal immigrants, which puts pressure on the social protection

system.

There are also problems in the labour market due to changes in the size and com-

position of the labour force because of the large external migration and mobilization.

The number of registered unemployed people per vacancy has jumped from 6 to 12

since the beginning of the war, and research data indicates that the unemployment rate

has risen to 40%. Real wages have dropped signicantly.

Financial and Economic Policy of Ukraine in the Conditions of War with Russia: current...

The state budget of Ukraine

Rapid estimates show that GDP growth declined by 37.2% year-on-year in

the second quarter of 2022.1

However, the IMF notes, along with the fact that active hostilities have moved

to the eastern and southern regions, activity in non-combat zones has stabilized

and the economy is adapting to the conditions of war.

However, private consumption and investment remain weak due to declining pur-

chasing power, nancial constraints and large-scale migration abroad.

The IMF still predicted that Ukraine’s GDP would shrink by about 35% over

the year. Ination would reach 30% by the end of 2022.2

Logistical challenges related to the war continue to put strain on the economy,

particularly those related to the operation of ports, transport networks and energy

infrastructure3.

The war also caused an imbalance in the foreign exchange market, but after

the National Bank devalued the exchange rate peg by 25%, the pressure eased.

The war is causing an unprecedented increase in the budget decit. Tax revenues

are limited due to declining economic activity. Meanwhile, despite the reduction in

secondary spending, the decit has continued to rise, mainly due to defence spending.

As a result, the budget decit excluding external grants is estimated to have reached

13.9% of 2022 GDP at the end of August. Thanks to a signicant increase in non-tax

income, which is provided by external grants, the total budget decit at the end of

August was lower and amounted to about 8% of GDP.

Among the payments charged by tax and customs authorities, the main revenues

were received from: value added tax on goods imported into the customs territory

of Ukraine, UAH 26.8 billion; corporate income tax, UAH 23.6 billion; personal in-

come tax and military duty, UAH 13.7 billion; value added tax on goods produced

in Ukraine, UAH 12.0 billion (collected – 25.6 billion, reimbursed – 13.6 billion

UAH); rent for subsoil use, 5.8 billion UAH; excise tax, 5.5 billion UAH; and import

and export duty, 2.7 billion UAH (Table 1).

Table 1. The main revenues to the State Budget of Ukraine in 2022

Source of revenues Amount, billion UAH

value added tax on goods imported into the customs territory

of Ukraine

26.8

corporate income tax 23.6

personal income tax and military duty 13.7

value added tax on goods produced in Ukraine 12.0

1 https://www.weforum.org/reports/global-risks-report-2023, [accessed: 07.02.2022].

2 https://www.imf.org, [accessed: 17.02.2022].

3 Strulik, H., Capital Tax Reform, Corporate Finance, and Economic Growth and Welfare, “Jour-

nal of Economic Dynamics and Control” 2003, vol. 28(3), pp. 595–615.

98 Svitlana Dombrovska, Viktoriia Shvedun

Source of revenues Amount, billion UAH

rent for subsoil use 5.8

excise tax 5.5

import and export duty 2.7

Source: https://index.minn.com.ua/ua/nance/budget/gov/income.

At the same time, given that the war has become protracted, the IMF called

the prospects for 2023 low-key and extremely uncertain.

The problems of the currency exchange rate

Judging by the number and radical nature of the economic changes made, we can

say that at the moment the government of Ukraine is mostly struggling with two things:

1. Exchange rate growth (devaluation) of the hryvnia. At rst a law was passed

on critical imports (banning the import of goods except those on a permitted list)

and along with this all customs duties were abolished. This law was subsequently

repealed and customs duties reinstated. Serious currency restrictions were imposed.

Also, to maintain the exchange rate, the National Bank of Ukraine was forced to sell

almost $14 billion from reserves (this is almost 40%). However, recently it was still

forced to raise the hryvnia exchange rate by 25%. The measures that indirectly put pres-

sure on the currency exchange rate included raising the key rate to 25%. It is also now

planned to introduce a 10% fee for foreign exchange transactions, i.e. for any purchase

of goods from abroad.

2. Labour rights. Back in March, law 2136 was passed, which allows employment

and collective bargaining agreements to be suspended due to hostilities, essentially

leaving workers without pay indenitely. This seemed little and the following draft

laws were accepted:

– draft law 2352, leaving mobilized workers without salary;

– draft law 5161, which allows concluding employment contracts that do not

guarantee the permanent provision of work;

– draft law 5371, which essentially abolishes the Labour Code for small

and medium enterprises (fewer than 250 people).4

Ukraine has a huge import dependence even in its main export industries, for ex-

ample, food. Therefore, the devaluation of the hryvnia itself is neither bad nor good.

In a war, it is just a necessity.

Moreover, even before the Russian invasion, it was obvious that the Ukrainian

currency was too overvalued. The invasion destroyed the usual logistics, blocking

4 https://rev.org.ua/nansovo-ekonomichna-politika-ukra%D1%97ni-pid-chas-vijni, [accessed:

15.02.2022].

Financial and Economic Policy of Ukraine in the Conditions of War with Russia: current...

seaports, destroyed many production chains – exports fell signicantly, while imports

recovered very quickly. Exports of goods decreased by 35% in 2022 and imports

decreased by 19.6% (Fig. 1, 2).

Fig. 1. Dynamics of changes in the export of goods from Ukraine during 2011-2022, $ billion

Source: https://www.ukrstat.gov.ua.

Fig. 2. Dynamics of changes in the import of goods into Ukraine during 2011–2022, $ billion

Source: https://www.ukrstat.gov.ua.

Devaluation makes things worse for importing enterprises as prices for all im-

ports increase, but it creates better conditions for exporting enterprises. For the same

amount of foreign currency they receive a larger amount of hryvnia, and salaries,

taxes and other expenses are paid in hryvnia. Additionally, a 10% tax on the purchase

17,69 17,93 17,04

19,25

26,11

29,36

35,75

40,22 40,91 40,93

55,62

41,71

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

19,48 20,88 20,14 20,85

27,1

33,08

40,47

47,87 48,69

42,04

57,15

46,52

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

100 Svitlana Dombrovska, Viktoriia Shvedun

of currency for imports is already being worked out, which will make the situation of

all importers even worse.5

Businesses have, for many years, become accustomed to cheap imports

and the lack of necessity to produce many important components within the country.

This behaviour is called the “entrepreneurs strike” when, in response to the incon-

venient demands of society, entrepreneurs respond with public disobedience. If we do

not want to further imbalance the economy of Ukraine, the deterioration of conditions

for importers of consumer goods is necessary, since almost all military products are

supplied from abroad and are almost impossible to import, unlike many consumer

goods. Every imported consumer good bought reduces the amount of military items

we could buy.6

If we want to steadily reduce imports we will have to move in one form or another

to deploy a full import substitution which will result, in many cases, in a deterioration

of the quality of the nished product, this being normal for any import substitution in

the initial stages. The war is for a long time. Accordingly, we will be in a situation of

foreign currency decit for a long time. Drastically reducing imports and replacing

them with domestic goods or, alternatively, changing consumer habits, is an uncon-

tested policy for us for many years to come.

Unfortunately the correct, albeit belated, steps to reduce imports are combined in

the current policy with an extremely high key rate of 25%, which will make any large-

scale changes in the structure of the economy impossible.

The key rate is, in fact, the interest rate that aects bank loan interest. If the state

raises the rate, credit becomes more expensive, aggregate demand and investment

slows, it is more expensive for businesses to take credit for enterprise development

and it is more expensive for people to take loans for purchases.

The rate increase reduces aggregate costs in the economy, which reduces de-

mand and slows price growth. Of course, this comes at the cost of economic growth;

enterprises reduce investment and people reduce purchases. Businesses either do not

launch new projects and do not hire people, or even reduce employee numbers and cut

back on existing projects.

Obviously, import substitution still requires a fairly large-scale investment.

That is, in order to pay the loan taken for new production, it is necessary that it shows

a yield of 25%, and it is unlikely that in wartime many entrepreneurs can boast

of such results.

5 Cloyne, J., Hürtgen, P., The Macroeconomic Eects of Monetary Policy: A New Measure

for the United Kingdom, “American Economic Journal: Macroeconomics” 2016, vol. 8(4),

pp. 75–102.

6 Le Manh Vu, Suruga Terukazu, Foreign Direct Investment, Public Expenditure and Economic

Growth: The Empirical Evidence for the Period 1970–2001, “Applied Economics Letters”

2005, vol. 12(1), pp. 45–49.

101

Financial and Economic Policy of Ukraine in the Conditions of War with Russia: current...

The possibilities of economic restructuring

The need for a large-scale structural change is obvious to everyone. The ocial

justication is the ght against ination. The logic is the following: to reduce demand,

prices for goods will also be reduced. However, two forces participate in the forma-

tion of the price, supply and demand, and therefore ination is divided into demand

ination and supply ination.7

Supply ination is caused by supply-side constraints such as the cost of logistics,

administration, raw materials and credit. Changes in demand do not directly aect

this ination.

For example, some product costs 100 units, including 10 units which were

the cost of its delivery to the place of sale. If tomorrow due to some kind of shock

(for example, restrictions at borders, as during COVID; blockades of ports, as now we

have) the cost of delivery increases by 5 times, it will become 50 units and the price

of the product will increase to 140 units. At the same time, even a drop in demand is

unlikely to make the price fall as, after all, this will not make the costs less, but rather

the contrary (larger lots can be protable).

Is it possible to blame the side of demand, not supply, for rising prices? Of course,

the rst reaction of sellers to the increase in demand is to increase prices. But then

new sellers come in, or the old ones expand production, supply catches up with de-

mand and price growth stops. Of course, such a production rise is not rapid and then

the increase in demand may chronically outpace the growth of supply. In this case,

prices will not rise until they destroy most of the demand.

This mechanism allows not only the eno.ichment of sellers of scarce goods,

but also prevents the appearance of a commodity decit, replacing it with a reduction in

the number of those who want to buy the goods.8

In what situation can demand growth denitely not be satised with the growth

of supply in any near term, because of which ination will grow continuously?

In the most general form, this is a situation of lack of resources and production capac-

ity. When all people are fully engaged, all production facilities are at full capacity

and raw materials are used as eciently as possible.

The current situation is not at all like this as unemployment, despite the outow of

the population, is breaking records. If a high rate does not help reduce price growth,

then why is it needed? Most likely, the main reason is an attempt to reduce the demand

for imported goods and foreign currency in general. The logic is simple: a high rate

reduces the amount of money in the private sector. After all, if there is a lot of money,

then it will inevitably be converted into currency either directly bypassing various

currency restrictions or in the form of imports. All the talk about the need to return

“condence in the hryvnia” is absurd – while there is a war, no one will consider any

7 Blasselle, A., Poissonnier, A., The Taylor Principle Is Valid Under Wage Stickiness, “Journal of

Macroeconomics”, vol. 16(2), pp. 581–596.

8 Barakchian, S., Crowe, C., Monetary Policy Matters: Evidence from New Shocks Data, “Jour-

nal of Monetary Economics” 2013, vol. 60(8), pp. 950–966.

102 Svitlana Dombrovska, Viktoriia Shvedun

assets in hryvnia as a reliable investment. The more money people have on hand,

the more they will try to convert into foreign currency.

Moreover, the import of luxury goods can be a good alternative to direct con-

version of funds into foreign currency. You cannot transfer more than 200 thousand

hryvnias per month to a foreign account, but you can safely buy, for example, a car

worth several hundred thousand dollars and use it as an investment.

It is already noticeable that raising the rate is too indiscriminate a weapon to com-

bat the ow of funds into the currency. More eective would be to use the point

constraints. For example, various restrictions on the import and purchase of foreign

exchange assets. These measures are already beginning to be applied, but they need to

be expanded and deepened.

It is also necessary to limit people’s desire for savings, because in conditions of

instability, savings will inevitably ow into the currency. The most interesting point

arises here: the tendency to save in dierent groups of the population is dierent,

so a more selective approach is also needed.9

Instead of such continuous measures as raising the rate, it is recommended to use

more selective measures, for example, to introduce progressive taxes, i.e. those in

which the percentage of tax increases at higher levels of income. So that tax growth

does not interfere with investments, tax deductions for investments in production

should also be introduced. This system, when money is spent on investment in pro-

duction, can be oset from taxes paid earlier. Such a system operates in the United

States for projects in the eld of renewable energy.

Raising taxes in this way will help to do the same as raising the key rate, in that

they reduce the amount of money in the private sector, thereby reducing the demand

for foreign currency. This measure will be selective, reducing funds from those who

are more inclined to buy expensive imports and foreign currency. It would also

be possible to introduce luxury taxes on expensive cars, real estate and jewellery etc.

Conclusions

In general, everything can be used as an investment to save funds from ination.

If we want to not only make rich people a little poorer, but also make poor people a lit-

tle richer, we can directly inuence the value of salaries by introducing, for example,

community service for unemployed people.

In this case, the amount of wages will determine the minimum wage in the country.

Such programmes are already planned, but the level of payment for them is extremely

low, corresponding to the minimum salary of 6700 hryvnia. By increasing this thresh-

old, the private sector could be forced to compete for an employee and, accordingly,

raise salaries.

In order for such programmes to be successful, it is better to move the de-

cision-making centre on the implementation of such work to the local level of

9 Le Manh Vu, Suruga Terukazu, Foreign Direct Investment..., op. cit., pp. 45–49.

103

Financial and Economic Policy of Ukraine in the Conditions of War with Russia: current...

the municipality. As a result, various local initiatives, including volunteer ones, could

apply for the need for labour and do useful things for society, such as weaving camou-

age nets, delivering humanitarian aid and helping in refugee centres etc. As long as

we have tasks that need to be completed to improve our defence capability, we cannot

allow the situation of unemployment.

After these measures, it is possible to reduce the key rate and introduce additional

programmes of preferential lending and nancing for investments in production. Such

grant and loan programmes are already being prepared, but so far, they do not exceed

several billion hryvnias per year, which, of course, is very small. After that, the state

should help with all the necessary resources (nances, administration, etc.) in areas

that become a greater priority for us, such as import substitution of basic consumer

goods and dual-use goods etc.

First, if we believe that the new reality associated with shock is with us for a long

time (several years at least), then it is necessary to completely rebuild the economy:

– close one production and create new ones;

– retrain employees;

– completely change the structure of import and export;

– change the ratio of dierent industries, geographical location of labour

and production capacities.

Obviously, such actions require the mobilization of all possible resources. After

all, in such a situation we cannot aord:

– a large amount of free nances (savings) in the private sector;

– unspecied means of production;

– and even more so, unused labour.

The second option, if we believe that the external shock is temporary and every-

thing will end soon, then our task is the opposite:

– to preserve the former structure of the economy by all forces; to do this, it is

necessary to reduce investment and allow many enterprises and employees to

idle to reduce costs;

– it is necessary to encourage those who try their best to preserve production as

it existed, for example, by subsidizing them. Such a “subsidy” of imports can

be considered a long support of the hryvnia exchange rate by NBU due to

reserves in the rst months of the invasion.

Of course, we will not win without Western support, and we must fully promote

the need to help Ukraine at all levels. However, we ourselves are obliged to do eve-

rything possible to successfully withstand the long war of attrition. Instead of half-

hearted and late steps, we need to recognize the need for changes in our economic

model and start using all possible resources to rebuild it.

104 Svitlana Dombrovska, Viktoriia Shvedun

Bibliography

Barakchian, S., Crowe, C., Monetary Policy Matters: Evidence from New Shocks Data,

“Journal of Monetary Economics” 2013, vol. 60(8).

Blasselle, A., Poissonnier, A., The Taylor Principle Is Valid Under Wage Stickiness, “Journal of

Macroeconomics”, vol. 16(2).

Cloyne, J., Hürtgen, P., The Macroeconomic Eects of Monetary Policy: A New Measure for

the United Kingdom, “American Economic Journal: Macroeconomics” 2016, vol. 8(4).

Strulik, H., Capital Tax Reform. Corporate Finance and Economic Growth and Welfare,

“Journal of Economic Dynamics and Control” 2003, vol. 28(3).

LeManh Vu, Suruga Terukazu, Foreign Direct Investment Public Expenditure and Economic

Growth: The Empirical Evidence for the Period 1970–2001, “Applied Economics Letters”

2005, vol. 12(1).

Mamatzakis, E.C., The Dynamic Responses of Growth to Tax Structure for Greece, “Applied

Economics Letters” 2005, vol. 12(3).

Varoufakis, Y., Creditors uninterested in getting their money back: dissolving the eurozone

paradox. “Journal of Australian Political Economy” 2016, vol. 77.

https://index.minn.com.ua/ua/nance/budget/gov/income, [accessed: 17.02.2022].

https://www.imf.org, [accessed: 17.02.2022].

https://rev.org.ua/nansovo-ekonomichna-politika-ukra%D1%97ni-pid-chas-vijni, [accessed:

15.02.2022].

https://www.ukrstat.gov.ua, [accessed: 10.02.2022].

https://www.weforum.org/reports/global-risks-report-2022, [accessed: 07.02.2022].

Summary

Uncertainty about the amount of funding needs remains extremely high and depends on

the duration of the war and its intensity, and economic risks loom large, including related to

potential additional damage to critical infrastructure or new disruptions in the agricultural and

energy sectors. Various local initiatives, including volunteer ones, could apply for the need for

labour and do useful things for society, such as weaving camouage nets, delivering humani-

tarian aid and helping in refugee centres etc. As long as we have tasks that need to be completed

to improve our defence capability, we cannot allow the situation of unemployment.