Since the beginning of the war in Ukraine, most of the media’s attention has been placed on Military developments in the battlefield, but what may be more decisive than any single battle is a devastating effects the war has had on the Ukrainian economy.
Before the war, Ukraine was already one of the poorest countries in Europe, with an average annual income of less than four thousand dollars per person, with missiles destroying critical infrastructure. All across the country, GDP is forecasted to Fall by as much as 50 in 2022. Fighting a war is expensive.
You have to pay for soldiers, salaries and food rations, Fuel and maintenance for the equipment and many other expenses. This massive increase in expenses comes at a time when tax revenue has been cut in half more than 6 million people have become internally displaced within Ukraine itself.
It’s difficult for these people to find jobs and the official unemployment rate has increased to a staggering 35 percent without jobs. These people cannot pay taxes, putting even further straight on public finances. Given the precarious situation, no investors will be willing to buy Ukrainian government bonds anytime soon.
Thus far, their finances have been kept afloat by financial aid from Western countries, but as a fiscal situation deteriorates, the cash burn has grown far higher than whether Western countries are ruling or able to give. So what do you do when your expenses are higher than your revenue, and you can’t borrow money you print it? Ukraine has been forced to do this on a massive scale.
The rate of inflation has increased from 24 in the month of August, and the Central Bank expected it to rise to 30 at the end of this year. In fact, the only reason why inflation rates aren’t even higher is because many regions have implemented rationing schemes for essential Commodities like food and fuel in the winter, things are going to get even worse.
As the country’s average temperatures slightly below freezing European natural gas prices are sitting at more than 10 times their normal levels, with their domestic energy industry severely damaged, they will have to print even more money just to keep the lights on.
Ukraine is already facing a severe inflation crisis and, as the situation continues to deteriorate, we could very well see this turn into a hyperinflationary spiral.
The modern economy of Ukraine started in 1991 after they gained independence from the Soviet Union. Immediately following the collapse of the Soviet Union, there is a deep recession, as the old communist Industrial Enterprises abruptly shut down, with no private owners to run them.
This caused Ukraine’s GDP per capita to be cut in half from fifteen hundred dollars per year to just six hundred dollars per year in 1999, making it one of the poorest countries in Europe to combat the recession.
The government turned on the printing press printing, hundreds of billions of their own currency, which was called the Ukrainian carb of honors. Inflation reached an annualized rate in excess of ten thousand percent in 1993, putting the new country comfortably within hyperinflation territory. This is a picture of a 1 million carbavonets bill from 1993
You know your country is in a bad situation when they start printing million unit bills. By this point, the currency was basically a useless piece of paper, so they got rid of it and replaced it with the harivnia which is still used to this day. Not wanting to repeat the mistakes of the past, they decided to Peg the harivnia to the US dollar.
This means that anyone can go to the Ukrainian Central Bank and exchange their currency at a fixed rate of 5 arrivnia for each US dollar in the early 2000s. The economy gradually started to recover with a stable currency. Private Enterprises were able to raise capital and import industrial machinery for their Agricultural and metal Enterprises, and the country became a major exporter Within These two sectors.
From 2000, through 2014, the economy rapidly expanded with per capita income increasing Sevenfold from 600 to more than four thousand dollars. They took a hit in 2008 as steel prices decreased, but even this they quickly recovered from by this point, it looked like they were well on their way to becoming at least a middle-income country.
This period of economic stability was abruptly ended in 2014, when Mass protests forced the pro-russian government to dissolve and was replaced by a pro-western government. Putin used this as an opportunity to Annex Crimea and provide Military Support to pro-russian separatists in eastern regions.
Given the political uncertainty, foreign investors and Ukrainian oligarchs alike started fire selling their Ukrainian assets and moving their money to safer markets like the US and EU. Remember that Ukraine maintained a fixed exchange rate with the US dollar. Investors started taking advantage of this to convert their harivnias to US Dollars hand over fist.
This caused the net outflow from the Ukrainian Central bank’s U.S dollar reserves. Eventually, they would run out of U.S dollars, leaving them unable to uphold the peg to prevent this. The central bank had no choice but to depreciate the exchange rate by 70 percent.
That’S the problem with currency pegs. If you have a sufficient stockpile of foreign currencies, you can keep the currency stable and the economic benefits are very attractive. But whenever you have a destabilized event like a Russian invasion, you were forced to depreciate the currency. This creates a massive shock that can take years to recover. From from 2014 to 2016, GDP per capita was cut in half from four thousand dollars per year.
To two thousand dollars, a few months after the Crimea, annexation, Russia and Ukraine both signed the minska court, which is meant to end the fighting on separatist regions of the country.
While there was still some fighting going on, the situation was stable enough for the economy to gradually recover. Of course, this all changed with the launch of the full-scale invasion. In 2022, the War caused severe losses to the civilian infrastructure across the country.
As of August, authorities have documented 110 billion dollars worth of direct property damage, most of which are residential housing, but there has also been significant damage to Transportation, industrial and agricultural infrastructure, and the Russian blockade of the Black Sea makes it difficult to export the small amount Of products that they are able to produce millions of tons of grain are stuck sitting in silos and are slowly starting to Rob even after a deal was struck to allow some Ukrainian grain to leave Black Sea ports.
Export volume is only about half of pre-war levels. In addition to the direct infrastructure damage, 5 million people have fled the country and another 7 million people are internally displaced. In total, this counts for more than a quarter of the pre-war population.
The people who left the country are clearly no longer contributing to the domestic economy or tax base and for the most part internally displaced people are unable to find jobs, and the unemployment rate has skyrocketed to 35 percent. It’S fair to say that there has been an almost complete collapse of the Ukrainian economy.
On top of that, hundreds of thousands more have joined the military. These people used to have jobs in the private sector, contributing to the tax base. Now they are on the government. Payroll as a further drain on public resources with tax revenue collapsing, Ukraine was unable to make interest payments on its public debt. In August, they agreed with their creditors to a two-year freeze on All Foreign debts.
This technically may not be considered a default because it was agreed to by the creditors, but the result is the same. No foreign investor will lend Ukraine money at least until the war is over. The only thing that’s kept them afloat. So far is financial aid from Western Nations and as generous as it’s been it’s nowhere near enough. Ukraine says they are running a budget deficit of nine billion dollars per month.
So far, the collective West has committed about 30 billion dollars of direct funding for 2022, which amounts to roughly 3 billion dollars per month, even at the current rate. There’s a 6B million dollar per month Gap, and there are question marks around how long Western Nations can even keep up the existing level of Aid. It’s one thing to send weapons. The tanks and ammunition delivered to Ukraine were previously sitting in warehouses. Doing nothing at some point: they’ll have to be restocked, but this can be done years down.
The line, giving direct financial aid to Ukraine will give them the foreign currency that they need to continue funding their trade deficit. They can buy more things like food, Fuel and consumer goods. This means more money, chasing fewer goods and will increase inflation, which is already sitting at 40-year highs across Europe and the US and these problems will compound exponentially going into winter in retaliation for Western Military Support.
Russia has drastically reduced natural gas sales to the European Union and there are fears that they could turn off the Taps completely this winter.
In normal times, European natural gas costs about 15 euros per megawatt hour. This has increased to 218 euros and is expected to rise even higher this winter, as people have to heat their homes. There are questions as to whether rich countries like Germany and the UK will have enough gas to avoid shortages. This winter and, however cold the winter will be in Germany. It will be a lot colder in Ukraine.
As of 2019. Ukraine produced about 74 of the natural gas that it consumes with the remaining 26 percent being imported. They used to import significant amounts of natural gas from Russia. After the 2014 annexation of Crimea, they decided to Halt all purchases from the country. For understandable reasons, the problem is, it doesn’t make much difference to the economic situation.
Today, Ukraine Imports natural gas from Trading companies in Europe. These trading companies Source their gas from multiple sources, including Russia. So while Ukraine hasn’t bought gas directly from Russia for the past seven years, Russian gas has still found its way into the country, regardless Ukraine has to buy this gas in the European market, which is a big problem.
Ukraine’s state-run energy Monopoly NAFTA gas said the country will need to buy 6 billion cubic meters of gas to get through the winter at current market prices, that would cost them seven billion dollars. So how is Ukraine going to get this money?
The chances of the EU helping Ukraine out with natural gas supply is extremely low by their own estimates. The EU must decrease gas consumption by 15 to get through the winter. This will likely entail rationing of Supply such that energy. Intensive Industries are forced to shut down. This will entail a deep recession with mass unemployment.
There are already signs of public backlash over the energy situation. A few weeks ago, 70 000 protesters marched on the streets of Prague, demanding the resignation of the pro-eu government and an end to the economic war between Europe and Russia.
While most European leaders are supporting Ukraine, now it’ll be a tough sell to give them Direct Energy Assistance when their own constituencies are struggling to heat their homes, unable to raise the money through taxes or borrowing.
Ukraine will have one option to acquire gas printing money. Ukraine’s Central Bank has already printed hundreds of billions of new harivnias since the start of the war they’ve drawn down about six billion dollars of their original 31 billion dollars of foreign currency reserves, but as tax revenues continue to decline, this burn rate is set to accelerating, In July they depreciate their currency by 20 versus the US dollar, and effort to stem currency outflows.
Remember that in 2014 they had to depreciate by 70. The current war is orders of magnitude more destructive than the 2014 War. So how is it possible that the currency is doing better this time around? They achieved this by effectively introducing Capital controls, the Central Bank banned, transferring foreign currency abroad to repay and service debts of Ukrainian businesses towards non-residents.
Every foreign investor wants to take their money out of Ukraine. If you lend money to a Ukrainian business, there’s a good chance that tomorrow, all that will be left is a blown up building by implementing Capital controls. You can prevent them from taking out their money, but no foreign investor will be putting any new money into Ukraine anytime soon.
So while you avoided currency collapse in the short term, the long-term picture is just as Bleak if they end up printing 7 billion dollars worth of new harivnias to buy a 6 billion cubic meters of gas, they need for the winter, they will have to devalue the Exchange rate by a lot more than 20 percent it’ll probably be closer to the 70 depreciation that they did in 2014.
Assuming the war is still ongoing by this point, the government will need to continue printing money to fund the war effort and, if the exchange rate depreciates by 70 percent, this means that they’ll have to print three times as much money to achieve the same purchasing power.
This will put them into an inflationary spiral and they risk repeating the 1993 hyperinflation episode which destroyed their previous currency. The economic situation in Ukraine is rapidly deteriorating, there’s no way to sugarcoat it at the current Pace. The Horizon is pegged with. The US dollar is unsustainable. At the current exchange rate, but even if the currency collapses, this doesn’t necessarily mean that they will lose the war.
They can introduce rationing and give the little supplies of food and fuel that they will have left to their soldiers on the front line. But if the war lasts into 2023, as most analysts currently expect, it’ll require such a huge amount of money. Printing that hyperinflation is all but guaranteed after the war they will likely have to replace the harivnia with a new currency. If this happens, it will be devastating for the economy. People will deposit their herrivnias and get the new currency in return.
But at this point there will be so many trillions of harivenias in circulation that your life savings that have been worth the equivalent of 10 000. Us Dollars before the war might end up being worth ten dollars. This is an unavoidable reality, as a cost of hyperinflation will be felt by everyone in the country.
It will take years for people to build back their savings and, in the meantime, they’ll refrain from discretionary purchases leading to a collapse in retail demand. Almost every time a country introduces a new currency after hyperinflation, the economy faces a severe recession.
We can see this from Ukraine’s own history after they introduced the harivnia in 1993. They almost immediately solved the hyperinflation crisis, but it took another six years for GDP to trough at 600 per capita, a 50 decline.
If anything, the current situation will be even worse because they are also facing 110 billion dollars of infrastructure damage in a 20 decline in population, with both of these numbers increasing every data, the board drags on.
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