Ukraine

Entrenched war as Western aid diminishes

On 24 February, 2022, Russia invaded Ukraine after months of tension, interpreting Ukraine's desire to approach Western countries and join NATO as a threat. However, the origins of the conflict trace back to 2013 when the Ukrainian government refused to sign an agreement with the European Union (EU) in favour of closer ties with Russia. The Euromaidan protests and the subsequent change of government in February 2014 led to the assault on the Crimean Parliament by armed Russian groups and the organisation of a referendum by the new pro-Russian Prime Minister, resulting in the annexation of Crimea by Russia. These events escalated into the war in Donbas, with Russia recognising the independence of the Donetsk and Luhansk People's Republics on 21 February 2022, three days before the invasion began.

After two years of conflict, the Russian army controls approximately one-sixth of the Ukrainian territory, primarily in the southeast and south as the Ukrainian counter-offensive officially launched in June 2023 failed to break through Russian defences to regain control of the Azov Sea shores. Despite Ukraine's intensive bombing of the Russian border city of Belgorod in early 2024, drone attacks on Crimea, and Russian bombardments of Ukrainian cities, the conflict is entrenched, and Ukrainian stocks of weapons and ammunition are depleting. While the invasion of Ukraine has been strongly condemned by Western countries, especially the United States and the EU, their massive financial and military assistance could wane in 2024. The Republican majority in the House of Representatives opposes unlocking additional funds until they secure credits to address immigration at the Mexican border, and the prospect of the November 2024 elections is likely to intensify tensions on the matter. EU aid faces reluctance from some member countries. While Japan and Korea have announced an increase in financial assistance, it may be insufficient to compensate for a decrease in aid from the United States and the EU.

While improbable, calling elections in Ukraine could also impact the strategy adopted in dealing with Russia. The presidential election, initially scheduled for March 2024, may be postponed, similar to the legislative elections in November 2023. President Volodymyr Zelensky has expressed that the situation is not conducive to organising elections due to the thousands of displaced Ukrainians within the country or abroad due to the war. In addition, the Ukrainian Constitution indirectly prohibits holding elections when the country is under martial law, which has been in effect in the country since the beginning of the conflict.

Economy geared for war

In 2024, Ukraine's growth will continue to heavily depend on the course of the war. Despite the ongoing deterioration of its human (emigration, enlistment, injuries, deaths) and physical capital (one-third of the latter annihilated since the conflict's onset), and despite the disorganisation of supply chains often associated with rising input costs, Ukraine experienced more resilient growth than expected in 2023. This trend is expected to continue in 2024, supported by domestic demand. Private consumption is expected to contribute more to growth as inflation slows down, and interest rates have already begun to decline. At the beginning of the invasion, the National Bank of Ukraine (NBU) significantly raised its interest rate (by 15 percentage points in mid-2022 from 10% to 25%), before gradually lowering it from mid-2023 to reach 15% in January 2024. The NBU introduced a series of measures to limit capital outflows, resulting in some stability for the hryvnia. Coupled with foreign aid bolstering foreign exchange reserves, this has recently allowed it to transition from a fixed exchange rate to a managed floating exchange rate regime.

However, new attacks on Ukrainian infrastructure expected during the winter of 2023-2024 could weigh on economic activity. Additionally, the contribution of net exports to growth is likely to remain negative even with an increase in agricultural and food production in the case of a good harvest. The secured grain maritime corridor disappeared following Russia's withdrawal from the Black Sea Grain Initiative in July 2023. Despite the (arduous) development of alternative trade routes via the Danube and by rail and road, and the creation of a temporary corridor through Romanian and Bulgarian territorial waters since August 2023, cereal exports continue to be challenged. Polish farmers' blockades at the common border could persist, while differences in railway gauges, a shortage of wagons, and a lack of cross-border roads limit land trade and maintain the attractiveness of maritime routes. Additionally, bombings of port facilities and storage sites is set to continue.

Significant twin deficits related to the conflict

In 2023, the budget deficit continued to widen, with the increase in spending resulting from the conflict surpassing the growth in revenue linked to international aid. In 2024, the deficit is expected to narrow as Ukraine persists in its efforts to prevent the erosion of its tax base. The National Revenue Strategy adopted at the end of 2023 aims to strengthen the state's budgetary capacity. It also seeks to align its fiscal and customs legislation with EU standards and prepare for the post-war economic recovery. Additionally, public debt will continue to rise to support the war effort, as the parliament suspended the provisions of the law prohibiting the National Bank of Ukraine from purchasing government bonds in the primary market.

However, Ukraine will continue to benefit from international assistance to finance its deficit. Initially, Ukraine's official creditors granted a payment suspension for its debt service. Four disbursements are planned in 2024, totaling USD 5,366 million (8% of GDP). These disbursements are part of the Extended Financing Facility of $15.6 billion, signed in March 2023 with the IMF for 48 months, of which $4,476 million has already been disbursed. Nevertheless, assistance from key donor countries may weaken. In addition to the previously mentioned challenges on the US side, in the EU, the veto from Hungarian Prime Minister Viktor Orbán on the financing plan to support Ukraine's economy and war effort (EUR 33 billion in loans and EUR 17 billion in grants over four years) could prompt each EU country to implement its own aid plan.

Furthermore, despite significant transfers from emigrants and bilateral and multilateral donors, the substantial current account deficit will only modestly decrease in 2024, thanks to an increase in exports. In addition to the development of alternative trade routes, Ukrainian authorities, with Western support, established an insurance mechanism in November 2023 for ships using the temporary corridor created in the Black Sea. High war-related import needs and strong logistical constraints that are squeezing exports will continue to sustain the trade deficit. The current account deficit, reflecting the budget deficit, will be financed by international aid in the form of concessional loans and multilateral and bilateral grants, primarily from the United States, mainly in the form of arms supply, followed by the United Kingdom, Germany, Canada, Poland, France, Norway, the Netherlands and Italy.

Last updated: March 2024