Crisis Adds to Ukraine’s Economic Woes

Amid the looming threat of invasion, structural problems in the country’s economy need close attention.

Crisis Adds to Ukraine’s Economic Woes

Amid the looming threat of invasion, structural problems in the country’s economy need close attention.

Hryvna is the national currency of Ukraine.
Hryvna is the national currency of Ukraine. © Roman/Freepik
Tuesday, 15 February, 2022

The Ukraine crisis dominates international headlines at a level not seen since 2014. Back then, Russian forces invaded and de-facto annexed a sizable and economically viable part of Ukraine's territory, including the Crimea peninsula and parts of Donbas, the country’s industrial heartland. Eight years on, the threat of a large-scale invasion looms over the entire country.

The economic consequences are plain to see. The hryvnia has dropped by four per cent against the dollar since the beginning of 2022, becoming one of the world's worst performing currencies, even as the central bank has spent more than a billion dollars supporting it. Foreign citizens have been urged to leave the country; investors have frozen their funding and suspended expansion.

Recently, leading economic commentators have suggested that Ukraine has been an “economic failure”, which heightens its vulnerability to interference from Russia.

Many of Ukraine’s policymakers will disagree with this analysis. Thanks to their work over past eight years, the country’s economy today is considered healthier than it was in 2014. In 2021, Ukraine’s economy recorded a real GDP growth rate of about three per cent compared to the previous year. This is about three per cent below its pre-Covid-19 trend – similar to many western countries. For example, the US economy was just 1.4 per cent short of the pre-Covid-19 trend by the end of 2021, while some of Eurozone member countries had shortfalls in the two to six per cent range as of end of the third quarter of 2021.

However, the longer-term picture is far more sobering. When measured against its economy before the global financial crisis of 2007-08, Ukraine’s economic performance has been outstandingly sluggish, with a shortfall deep in the double digits. Compared to the early 1990s, when Ukraine gained independence, the shortfall is even greater.

"Austerity-focused policies dominate in Ukraine’s economy."

Ukrainian officials have pushed through a number of market-based reforms since 2014. For example, markets for land, labour, banking and non-banking financial services were either established or re-established. The parliament adopted a series of laws that gave the central bank independence. The ministry of finance de-politicised its debt management and fine-tuned itself to supply attractive debt instruments to the investment global community. A fiscal rule capped the total budget deficit at three per cent of GDP. Reforms to the judiciary, pension and health-care systems are priorities for the future.

However, that focus excludes other problems. Ukraine’s economy has a high degree of dollarisation, meaning that private and state-owned business units create debt denominated in foreign money. This practice breeds future financial fragility across different sectors of the economy, which some economists regard as a low degree of “monetary sovereignty”. This subjects Ukraine’s economy to the swings inherent in international private finance (IPF) and requires a foreign lender of last resort – such as the IMF and the EBRD – to help out when needed. Without a standby lender, domestic debts—and external ones such Ukraine sovereign eurobonds—in foreign money could not be validated and would deflate. Such assistance comes with strings attached, hence the reason why austerity-focused policies dominate in Ukraine’s economy.

The central bank focus is on fighting inflation, and it raises rates whenever wage growth accelerates. Meanwhile, it tolerates an unemployment rate of nine per cent, just above what the central bank sees as the country’s natural unemployment rate of 8.5 per cent.

Yet wages have been falling as a share of GDP while profits have been rising. At the end of the third quarter of 2021 the wage share in GDP declined to 41 per cent from 44 per cent a year earlier. More dramatically, wage share dropped from a peak of 55 per cent in the middle of 2013 to all-time low of 37 per cent in early 2017. In contrast, the profit share of GDP has been on the rise, reaching 44 per cent in the third quarter of 2021 compared to 42 per cent a year before. Meanwhile, Ukrainians prefer to work abroad, frequently taking low-paid jobs.

One view is that, while Ukraine’s politicians have been too hesitant in pushing through reforms for several decades, the current crisis also offers an opportunity. Noah Smith, a Bloomberg opinion columnist, recently noted that “external military threat has been a catalyst for development for countries throughout the ages, most notably Japan and South Korea. Hopefully it will do the same for Ukraine now”. At the same time, the highest echelon of Ukrainian reformers stated that “a common enemy might help to consolidate reforms”.

While they may have a point, Ukraine’s reform programme needs to focus more on wage and employment growth. Indeed, this is something that ordinary Ukrainians have in common with their neighbours, as the Russian government is hiding its own economic failure to deliver prosperity to its citizens. Instead, the attention of ordinary people is turned away from their daily economic hardships towards the grand geopolitical battles waged by the country’s leadership. From that point of view, the Ukraine crisis is a useful invention.

Alexander Valchyshen is a research fellow at the Global Institute for Sustainable Prosperity.

This publication was prepared under the "Amplify, Verify, Engage (AVE) Project" implemented with the financial support of the Ministry of Foreign Affairs, Norway.

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