State Becomes Main Player in Ukrainian Economy
The war has pushed the national share in the GDP to a record 78 per cent, while excluding oligarchs.
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Russia’s invasion of Ukraine has left the country’s economy in tatters. The National Bank of Ukraine forecasts a 31.5 per cent drop in gross domestic product (GDP) by the end of the year, while unemployment reached 35 per cent in the second quarter and consumer prices are projected to rise by about a third. The poverty rate, which was 2.5 per cent in 2020, may approach 25 per cent by the end of December and twice that by the end of next year.
Ukraine’s economy has gone into wartime mode, with an increasingly higher state involvement. Forbes Ukraine estimated that the share of GDP redistribution through the budget increased from the traditional 40 per cent to a record 78 per cent. This was not just military spending and social assistance for the poor and internally displaced during the war. Today, the state is the country’s main employer with six million people, about 37 per cent of the working population, employed by state institutions.
On November 7, Ukrainian authorities announced the nationalisation of five strategic enterprises. The prime minister Denys Shmyhal, defence minister Oleksii Reznikov and security council secretary Oleksiy Danilov invoked wartime laws as the government seized stakes in a top engine-maker and four other strategic companies from some of the country's richest men.
The companies include Zaporizhzhia-based Motor Sich, one of the world’s largest aircraft turbine manufacturers. Its president, Vyacheslav Boguslayev, was arrested in late October on charges of treason under suspicion that he had colluded with Rostec, Russia’s state technology conglomerate. The other four are Zaporizhtransformator, a manufacturer of oil-immersed power transformers and electric reactors, truck and special-purpose vehicles producer AutoKrAZ, natural gas company Ukrnafta and refining factory Ukrtatnafta Ukrainian oil.
Media focused on the companies’ largest private shareholders whose influence on politics, economy and the media has been a defining element in Ukraine’s recent history.
Among them are Ukrainian and Russian oligarchs Igor Kolomoisky, Gennadiy Bogolyubov, Vyacheslav Boguslayev, Oleksandr Yaroslavskyi, Konstantin Grigorishin and Kostyantyn Zhevago.
Shareholders, however, also included small investors and former workers, who now find themselves without their securities.
Formally, the law foresees that shareholders should receive “compensation for the forced alienation of confiscation of property” within five years after the end of martial law.
Economists are split in their assessment of this decision. Sergey Fursa, investor at the Kyiv-based investment management company Dragon Capital, called it “war communism on the stock market” in a Facebook post.
POWERFUL STATE
As the state’s share grows, the power of oligarchs is shrinking. According to a study by the Centre for Economic Strategy, the war delayed the implementation of the anti-oligarch law, but has forced authorities to resort to more radical steps against unfriendly oligarchs and their assets. In addition, some major assets were destroyed or damaged as a result of the hostilities.
“The state becomes more powerful in wartime,” Hlib Vyshlinsky, executive director of the Centre for Economic Strategy, told IWPR. “Russian properties have been nationalised and transferred to the state, the government favours state-owned enterprises (SOEs) and state-owned banks (SOBs) for emergency programmes. After the war it will be hard to return to the pre-war status quo as interests of the SOE management and related stakeholders become entrenched.”
Companies can also be sanctioned or confiscated. Under this procedure, 17 real estate objects and shares in the capital of five companies in Ukraine belonging to Russian oligarch Vladimir Yevtushenkov were taken over. In addition, the assets of 3,500 persons against whom sanctions were imposed were frozen, but not transferred to the state. The confiscation of assets in a criminal case by a court decision has led to the loss of dozens of companies, including Kyiv’s large shopping Ocean Plaza centre.
This is, however, a fraction of the Russian and Belarusian companies and individuals who own assets in Ukraine. According to Russian Roots, a registry of Ukrainian companies related to the Russian Federation and the Republic of Belarus, as of October 2022 20,314 Ukrainian companies had Russian or Belarusian beneficiaries and founders.
Fursa said that this was concerning.
“The increasing role of the state, amid the corporate governance reform delay, is a disturbing signal that can fuel corruption, and I would like to be sure that this is a temporary phenomenon, and the trend will turn 180 degrees after the war ends,” he explained to IWPR.
The risks are also seen by Eugene Dubogryz, an associate expert of the CASE Ukraine think tank:
“The same people close to the authorities are appointed as the top managers and supervisors of many enterprises and banks,” he said. “Even if they are effective managers when there are many assets, they cannot manage effectively simply for the lack of time. The second risk is the creation of various state conglomerates, concerns, and groups – after the victory [of Ukraine in the war] these enterprises will be very difficult to sell through the legal structure.”
ARE PUBLIC MANAGERS EFFECTIVE?
In the first months of the war, private Ukrainian businesses stopped all operations because of uncertainty, while key state-owned companies continued to operate. Ukrzaliznytsia, the railway company, became a critical asset as it evacuated millions of Ukrainians, bringing them to safety for free. Similarly, Ukrposhta, Ukraine's national postal service, assisted in the relocation of businesses.
“The state is never an effective manager at the micro level when it comes to enterprise and business management,” explained Eugene Dubogryz from the CASE Ukraine think tank. “This is valid both in peace and wartime, but in wartime, businesses find it difficult to coordinate, and difficult, not to say impossible, to plan. Therefore, the state remains the only manager, because businesses do not work.”
Vyshlinsky noted that the CEOs of Ukrzaliznytsia and Ukrposhta, the most successful SOEs, were selected after a corporate governance reform which included appointing a supervisory board with independent members as well as competitive selection.
As a result, many Ukrainians felt that the state had shown itself as a more effective manager.
“This is a questionable statement,” Fursa noted.
Private businesses have managed to catch up with state enterprises. Anecdotal evidence indicates that in formerly occupied cities, like Kherson, privately owned courier Nova Poshta delivers faster than the national postal service, and trucks belonging to private supermarket chain ATB and online store Rozetka arrive earlier than trains.
For Dubogryz, the state was quick in identifying bottlenecks in the supply chain.
“This is particularly true for military goods and services,” he said. “The state can quickly establish and coordinate supplies and resource allocation. In addition, the state has actually unlimited monetary resources, and can quickly distribute them to military targets. Private businesses cannot do it as quickly. An example here is lending: defence enterprises need loans, and the state lends them through state banks.”
The state, through the ministry of finance, owns about half of the country’s entire banking sector. Financial analysts see the nationalisation of Alfa-Bank Ukraine, the country’s largest private lending private bank, as probable. Its association with Russia - Alfa Bank is Russia’s largest commercial lender - led the shareholders to change the name into Sense Bank on December 1, 2022.
“Before the war, many businesses belonged to Russian business,” Dubogryz continued. “These owners must be changed. It is impossible to sell assets during a war to private investors when it comes to large enterprises or banks. Therefore, the state forcibly becomes the owner of such assets, so as not to close them.”
According to YouControl, a platform that provides business and financial analysis, about 17,000 enteprises in Ukraine are connected to Russian individuals.
As the war rages and winter bites, it is hard to predict whether the state will retreat to its pre-war share of the economy.
“We can only hope for that,” Fursa commented.
Dubogryz remained positive.
“This will happen by creating new businesses, there will be just more of them, so the share of the state will decrease,” he said. “As for the current state-owned enterprises, and those that [have just been] transferred to the ownership of the state, it will be problematic to sell them, except for banks, because the state aims at managing these assets as long as possible. Also, politically, the society at large will want these companies, in particular the one [dealing with] defence, to remain in state ownership. The sale will not be approved”.
International support remains key to facilitate the inflow of foreign investment once the war will end.
“Ukraine will need military risk insurance funded by the international partners to enable FDI to flow in immediately after the war,” Vyshlinsky noted. “Otherwise, the postwar economy will still rely on the SOEs and limited local private investment capital.”
