War in Europe

Ukraine: Resisting the temptation of quick solutions

The full-scale Russian war against Ukraine became a major disruptor for the Ukrainian economy. The shock was multifold. Over 6 million Ukrainians became refugees in Europe and more than 5 million became internal migrants. More than 50 per cent of commercial companies suspended their activities. The traditional transportation and logistical chains for the biggest Ukrainian exporters were broken or damaged. The budgetary process burst into an uncoordinated puzzle. The revenue planning turned impossible while expenditures soared. Under the pressure of military risks and threats, both export and import flows disintegrated and turned into arbitrary pieces of humanitarian aid and supplies for the army. Investment was already poor in peacetime, and since the beginning of war in February both domestic and foreign investment was frozen.

The first reaction of the government and National Bank of Ukraine to the war shock was quite competent. The suspension of import duties, the easing of tax burdens, measures aimed at ensuring smooth operation of infrastructure, telecommunication and payment systems strengthened the trust of business and society in the authorities. Three months into the war, about 80% of the population are certain that things in Ukraine are going in the right direction, as a poll of survey group “Rating” has shown. It is in sharp contrast to what was observed before the war when only 23% of Ukrainians agreed that things in Ukraine were going in the right way.

Modus Operandi

However, after the initial moves towards economic liberalization, the government started to resort to the pre-war modus operandi. This became apparent as a number of controversial measures were introduced since April 2022, resulting in tension and obstacles that could have been avoided.

The first disrupting interventionist measure that the government has resorted to was its decision to set the retail price ceiling for fuel. As Ukraine highly depends on the import of oil products, this segment of the market needs price flexibility especially as the real market price of hryvnia plummeted by almost 20%. Setting the price ceiling way below the market equilibrium predictably led to fuel deficit and to huge fuel lines at gas stations. Soon a “grey” fuel market emerged where the price of 1 liter of gasoline was almost twice as high as the official price ceiling dictated. It took one car and driver about four hours on average to buy fuel at the official gas stations. The Ukrainian economy had to bear the costs of about $800 million per month due to the fuel chaos. However, the Ukrainian government has remained reluctant to abolish all price regulation.

Psychological stabilisation measure

The second questionable policy decision also concerned price regulation. In the first days of war, the National Bank froze the exchange rate of hryvnia to the US dollar at its pre-war level of ₴29.25 hryvnias per $1. While this measure served as a psychological stabilization measure in the first month of the war, with time passing it has arguably started to distort the currency market. In May 2022, the real market exchange rate increased to the level of ₴38 hryvnias per $1. However, Ukrainians who found refuge abroad kept withdrawing cash at the official fixed exchange rate, withdrawing the equivalent of $700 million in the first three weeks of May.

This discrepancy between the administratively fixed exchange rate of hryvnia used by the banks and the significantly higher real market rate used by currency exchange offices led to a considerable increase of the volume of speculative exchange operations. The gap between the official and real market exchange rates became a source of profit for currency dealers but turned into a headache for manufacturers and consumers.

Destruction of national unity?

The Ukrainian authorities failed to resist the temptation of price fixation for goods and services. Predictably, it has led neither to price stabilization nor to the balancing of goods and currency markets. Inflation has already crossed the 20% threshold. The National Bank was forced to finance budgetary expenditures via the purchasing of so-called military bonds. Ukraine needs to overhaul its pre-war fiscal policy in order to ensure the full-fledged support of the army in combat without breaking the backbone of the remaining national business. Sticking to administrative measures, price fixations, the announced restoration of business inspections alongside with raising taxes, could aggravate the state of the economy and break the very valuable national unity in the time of war.

In order to build up on the unique trust that has developed among society, state, the army and business inside Ukraine and the recently forged partnership between Ukraine and the EU, the Ukrainian government would deliver much better results if it focused on deregulation and abolishing trade and finance barriers. The overhaul of the state budget expenditures is a must. Jointly with the European partners and the USA, it would be desirable to, on the one hand, come up with a joint fiscal plan to ensure the financing of the military and social expenditures and, on the other, to design a tax and regulatory framework to stimulate the restoration of economic activities.

Jaroslav Romanchuk, Head for Economic reforms of Office of Simple Solutions and Results (Ukraine)