How to Fix Ukraine’s Economy

by August 2022
Ukraine Economy, Illustration.

The Ukrainian economy is in dire straits after Russia’s attack on the country on February 24, with current forecasts of a 35% drop in gross domestic product (GDP) in 2022. The primary challenge is to stop Russia’s aggression, which is costly, but the next issue is to rebuild Ukraine and complete its post-communist reforms, which will be even more expensive. A third process is EU accession. These three processes should be combined as the West looks at Ukraine’s financing needs.

The West, having frozen Russian central bank accounts, controls large Russian state assets. These assets (following international legal steps to attach them), US and European financing pledges, and program support by the International Monetary Fund, which is conditioned on Ukrainian structural reforms, should together help salvage Ukraine’s future.

Reconstruction and EU membership will require Ukraine to implement long overdue economic reforms. It is also vital that an independent international authority be set up immediately to manage the large inflow of funds in a transparent fashion because Ukraine’s foremost structural problems are corruption and insecure private property rights.

The Current State of the Ukrainian Economy

Currently, the Ukrainian economy continues to function surprisingly well. Gas, electricity, phone, internet, and other services continue to work. The shops are full of goods and no rationing is needed. The vast majority of enterprises continue to operate, although the Russians have devastated some parts of the country.

Still, Ukraine has suffered enormously from unprovoked Russian aggression. In 2014, Russia seized 7% of Ukraine’s territory and caused a loss of 17% of its GDP, since it occupied part of the highly industrialized eastern Donbass region.

At present, Russia occupies 20% of Ukraine’s territory, in the south and the east (Crimea, the whole of Luhansk oblast, half of Donetsk oblast, much of Zaporizhia oblast, the whole of Kherson oblast, and parts of Kharkiv oblast). Currently, Russia is trying to conquer more of the Donetsk, while Ukraine attempts to take back Kherson, and both are fighting outside of the city of Kharkiv. Intermittently, Russia sends missiles from Russian and Belarusian territory and from submarines in the Black Sea, against all parts of Ukraine, primarily directed against civilian targets.

The Costs of Russia’s War on Ukraine

The material and human losses from the Russian aggression are quite substantial. Both the Ukrainian government and the private Kyiv School of Economics maintain databases of the country’s material losses. They have recorded losses of more than $100 billion. But this is based on the original cost. Realistic assessments of the reconstruction cost to Ukraine place the damage to date at nearly double, at about $200 billion.

Concretely, the cities of Mariupol and Chernihiv have been devastated. In Mariupol, the two big steelworks belonging to Rinat Akhmetov’s Metinvest were demolished. Akhmetov has declared that he will ask for $17 billion in compensation for the destruction of his giant steelworks Azovstal and MMK Ilicha in the European Court of Human Rights in Strasbourg.

The Russians have killed tens of thousands of Ukrainian civilians. If we assume that the losses amount to 50,000 civilians and that each should be compensated by $1 million, the total Ukrainian claim on Russia would be $50 billion, but this amount is highly debatable. The agreed payment from Libya for its government’s role in the terrorist bombing over Lockerbie in Scotland was much higher, $10 million per victim.

To this should be added the current Russian devastation of the Ukrainian economy. The IMF forecasts that Ukraine’s GDP will fall by 35% in 2022. Since Ukraine’s 2021 GDP was $200 billion, that would mean a loss of $70 billion this year. Nobody is predicting a fast recovery of the Ukrainian economy and we don’t know yet how large a share of it that Russia is likely to keep, making it impossible to predict Ukraine’s total losses.

On July 4–5, the Swiss government organized a Ukraine Recovery Conference in Lugano. The Ukrainian government presented a rather detailed and very ambitious reconstruction plan for 2022–2032, asking for about $750 billion for a decade, an enormous amount of financing. The Ukrainian government has divided this period into three phases. The first phase is the emergency funding for 2022, which it assesses at $60–65 billion. The second reconstruction phase covers the three years 2023–2025 and the Ukrainian request is $300 billion. The third development phase of the years 2026–2032 is accompanied with a request of $400 billion.

The Ukrainian government has repeatedly stated that it needs about $5 billion a month in government financing since the start of the war. This amount does not include military support. At the Lugano conference, the government declared that it had received pledges of about $30 billion, but on July 22, Kyrylo Shevchenko, the governor of the National Bank of Ukraine, stated that so far it had only received $12.7 billion in actual disbursement. Meanwhile, Ukraine has declared default on government debt service.

Ukraine faces many horrendous economic problems. The most immediate concern is to receive sufficient military support as well as government financing. The big long-term problem is to secure financing for reconstruction and future development. The great opportunity for Ukraine is that in late June the EU granted it the status of a candidate country. To achieve EU membership, Ukraine will be required to enact substantial reforms of its government and economy.

How Can Ukraine Be Financed?

So far, Ukraine has benefited from substantial Western financing, most of all from the US, but the financing demands are enormous and the pledges to date are not sufficient. Strategic thinking is required. There are many possible sources of financing, but Ukraine needs vast amounts, and few such sources are available. The big possible sources are essentially only Russian war reparations and US and EU financing, while the international financial institutions are also important.

Russia has caused Ukraine all these costs for no legitimate reason. The Russian official statements are so convoluted with lies that they may be safely ignored. The fundamental point is that Russia should be liable to pay war reparations for the damage it has caused Ukraine.

The Putin regime will not agree to pay any reparations, but the beauty of the current situation is that the West already controls large Russian state assets. Immediately after Russia invaded Ukraine, the G-7 decided to freeze the international currency reserves of the Central Bank of Russia held in Western countries. These funds are very large. According to the public statistics of the Central Bank of Russia, on January 1, 2022 they amounted to $316 billion. Germany held $96 billion, France $61 billion, Japan $57 billion, the US $39 billion, the UK $31 billion, Canada $17 billion, and Austria $15 billion. The central bank reserves have many advantages. Their owner is clearly identified. They are indisputable property of the Russian Federation, which is directly responsible. These funds are highly liquid, and they involve a minimum of administrative and legal work.

The countries that hold and have frozen these funds should confiscate them through national legislation because of Putin’s unprovoked war of aggression against Ukraine and his many human rights violations. They could do so on their own, or they could support such decisions with international law.

The UN Security Council relies on two prime sources of international law, although Russia, as a permanent member of the UN Security Council, can veto any decision of that body. While the UN General Assembly has less power, it has demanded that Russia “immediately, completely and unconditionally withdraw all of its military forces from the territory of Ukraine within its internationally recognized borders” in a vote of 141 for and five against. Russia vetoed a corresponding resolution in the UN Security Council. Ukraine is likely to introduce another resolution to support its reparations claims on Russia.

On March 16, the highest UN court, the International Court of Justice in The Hague, ruled by a vote of thirteen to two (the Russian and Chinese justices), that Russia “shall immediately suspend the military operations that it commenced on 24 February.” Russia did not comply. The ultimate verdict of the International Court of Justice that is yet to come should provide a sufficient basis in international law for any Western country to confiscate Russian funds.

For the short-term budget financing—$5 billion a month in 2022—there are only two serious sources, the US and the EU. So far, the US has allocated $54 billion of both humanitarian and military funding to Ukraine for this year, and the US is essentially fulfilling its part of the bargain. The problem lies with the EU. It has committed more than $10 billion, but it has only disbursed slightly more than $1 billion in nonmilitary assistance. The EU needs to speed up its financing to Ukraine.

So far, the IMF has stayed on the sidelines, but in July Ukraine asked for a three-year program of $15–20 billion. While this will not resolve Ukraine’s financial needs, an IMF program is highly helpful for macroeconomic stability, other fundraising, and reforms.

Reforming Ukraine Through EU Accession

Most important for a country’s future development is its institutional transformation, the development of a free democratic society with free information and a strong rule of law that can guarantee private property rights. In 1990, Ukraine and Poland were at a similar economic level, but now Poland is about three times wealthier because of a far better policy. It is time for Ukraine to catch up, and a strong public consensus argues that that should be done.

The independent nongovernmental organization Transparency International produces an annual corruption perception index. Currently, it ranks Ukraine 122 among 180 countries, with the thoroughly corrupt Russia at 136. All international institutions engaged in Ukraine focus on these problems.

Ukraine has carried out substantial reforms after Euromaidan in 2014. In particular, it has established strong macroeconomic institutions—a solid central bank, a well-functioning ministry of finance, a computerized tax system, and a sound banking system—in good cooperation with the IMF and the World Bank.

In June 2022, the European Commission recommended that Ukraine should be granted candidate status, on the understanding that the following seven steps were to be taken:

  1. Enact and implement legislation on a selection procedure for judges of the Constitutional Court of Ukraine;
  2. Finalize the integrity vetting of the candidates for the High Council of Justice members by the Ethics Council and the selection of candidate to establish the High Qualification Commission of Judges of Ukraine;
  3. Further strengthen the fight against corruption and complete the appointment of a new head of the Specialized Anti-Corruption Prosecutor’s Office;
  4. Ensure that anti-money laundering legislation is in compliance with the standards of the Financial Action Task Force (FATF); adopt an overarching strategic plan for the reform of the entire law enforcement sector as part of Ukraine’s security environment;
  5. Implement the Anti-Oligarch law to limit the excessive influence of oligarchs in economic, political, and public life;
  6. Tackle the influence of vested interests by adopting a media law that aligns Ukraine’s legislation with the EU audio-visual media services directive and empowers the independent media regulator;
  7. Finalize the reform of the legal framework for national minorities currently under preparation as recommended by the Venice Commission.

This is an excellent, concrete list. The Commission will monitor Ukraine’s progress in fulfilling these steps and report on them, together with a detailed assessment of the country, by the end of 2022. Illustratively, the four first EU conditions focus on judicial reforms while the other three relate to democratic principles. An important political issue that is missing from this Commission list is reform of the Ukrainian central government apparatus, although decentralization has been quite successful.

Ukraine also needs several large economic reforms to become competitive. First of all, most of the 3,500 state companies should be auctioned off as fast as possible, while the biggest remaining ones should become subject to proper corporate governance. Second, the Ukrainian market needs to be opened up for domestic and foreign competition and become regulated by a proper competition policy, a traditional strength of the EU.

At present, the Ukrainian government does not have any clear economic ideology. All too often, it lapses into Soviet state-oriented thinking. Yet, First Deputy Prime Minister and Minister of Economy Yuliya Svyrydenko recently published a liberal creed for “the philosophy of the free step.” She called for 7% growth a year for the next decade by cutting the tax burden from 45% of GDP to 30%, by radically liberalizing the economy, and by imposing the rule of law. It remains to be seen which economic policy will prevail.

Anders Åslund
Anders Åslund is an adjunct professor at Georgetown University. His most recent book was Russia’s Crony Capitalism: The Path from Market Economy to Kleptocracy.
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