Ukraine has bright recovery prospects

While Putin take Russia into a decade of darkness

Interesting to see the World Bank estimating that Ukraine will suffer a 45% real GDP contraction this year, and Russian real GDP declining by “just” 11%.

In reality this is all finger in the air stuff in reality. 

No one actually knows. 

For Ukraine much depends on the timing of the conflict, and the end state. Does Ukraine succeed in pushing back Russian forces to the February 24 contact lines, or is there a scenario where any peace sees Russia occupy even more territory? If it ends up taking the whole of Donbas and the southern ports through to Crimea, but including Mariupol, and possibly even Kherson, Mykolayiv, that is a disaster for Ukraine as it leaves it with little coastal access - - saving grace it would likely still retain the port of Odessa, but I guess Russian could make like difficult for exports through the Black Sea. 

So in the latter scenario Ukraine would see a large part of its industrial and export capacity destroyed or derailed. A huge amount of its infrastructure in the rest of the country will have been destroyed also - Ukrainian sources have put the loss at up to USD500bn, three times annual GDP. So herein 2022 GDP might be down from $180bn to perhaps USD100bn, and thereafter it’s GDP producing capacity will be massively reduced given the loss of infrastructure and the brain drain - how many of the 5 million plus people who have left will return?

Just very practically here, think that agriculture is a key sector, and it is now sowing season. How do farms get seed, fuel and labour to sow? They have grain in storage which they would normally be selling out of storage to export, but how do they transport the grain to ports, and how do the ports export the grain given they are in conflict zones? This suggests a catastrophic loss for the agricultural sector in the year ahead.

On the fiscal side government officials have indicated that budget revenues have collapsed, with the GDP contraction, and people are obviously concentrating on surviving , not paying taxes. The NBU suggested last week the government is running a monthly deficit of $4bn or 4% of GDP if you believe GDP is down to USD100bn. For the full year it is not difficult to imagine a budget deficit of 20-30% of GDP.

Now assuming the government in Kyiv survives, it will likely get huge financial support from the West to ensure it is sustainable after the war ends. There is talk of a new Marshall Plan for Ukraine, to rebuild the economy and importantly the Ukrainian military as a new bulwark for NATO which now faces a huge, and renewed threat from Russia. 

It is very difficult to put a number on the level of support required by Ukraine, but just in budget financing terms it’s needs were already something like $20bn plus gross financing even before the conflict given debt service falling due, and budget financing needs pushed this even higher. Debt markets have obviously more or less closed, hence the NBU provided UAH20bn in bond buying, printing money in effect last month. The deficit financing needs might easily more than double the gross financing needs to $40bn this year, perhaps even as high as $50bn.

So far financing commitments have included USD13.6bn from the US as per Congressional support, of which USD6.6bn is for humanitarian assistance the rest for military support, USD1.4bn from the IMF, EUR1.2bn from the EU, the EBRD $2bn, EIB €639m, World Bank $3bn. Various other governments have provided sums equal to perhaps a couple of billion dollars more. But set against the likely gross financing needs as above, the commitments thus far fall well short of what will be required just to meet this year’s annual budget financing needs. Then the needs in following years for reconstruction? If infrastructure loss is up to USD500bn, how much is the annual rebuild needs therein? Perhaps $10-20bn, or more?

Obviously it is encouraging that the EU is talking about finally giving Ukraine candidate membership status, and this will help anchor reform and investment into Ukraine. I have long argued that Ukraine’s struggles with reforms over the past thirty years relate significantly to not having a clear EU accession anchor. Herein if you look at countries like Poland, Hungary, the Baltics states et al, they only really reformed apace when the EU set a clear blue print for accession and reform, following the agreements reached at the Copenhagen Summit in 1994. Hopefully EU candidate member status will provide the required blueprint for reform which will now accelerate.

The obvious big concern/caveat with the above remains the position of Russia. Likely even with a peace agreement, Russia will remain a malign actor on Ukraine’s frontier for long to come, and as long as Putin remains in power. Russia will continue to act to undermine and destabilise Ukraine, hence the extra importance of the EU accession backstop. The EU and NATO have to fully recognise that if they are to stop the aggression and expansionism of Russia into Europe, it has to start in Ukraine, which is the new front line for Europe against Russia. I think the realisation is now finally dawning.

Given the huge aid sums likely needed by Ukraine, it is hard to ignore the likelihood that the private sector will be asked to share the burden in the defence of Western Liberal Market Democracy. Therein it is hard to see a scenario where a restructuring of Ukraine’s debt liabilities is avoided. Prior to the conflict the stock of public sector debt was around $93bn, close to 50% of GDP. But if GDP is down to $100bn or less, the debt to GDP ratio will have risen to over 90%, close to levels reached at the time of the last debt restructuring in 2015, indeed likely higher. Add to this a budget deficit of what, 20-30% of GDP, and the ratio likely goes well over 100%. This is clearly unsustainable. And indeed then the question also has to be asked, depending on the state of territory controlled by Ukraine, what will be the then GDP raising capacity of Ukraine - likely much less than before the conflict for an extended period of time. Again, it’s hard to see a scenario without private sector burden sharing - a debt write down, and likely maturity extension/grace period, and especially given that still around two thirds of debt is in FX.

All the above sounds depressing for Ukraine - well not if EU membership becomes a real perspective, and Western financing is forthcoming. Actually Ukraine then would have real recovery perspective. And this war could prove to be its defining moment, it’s State of

Israel moment, when it finally defeated Russia, affirmed its independence and pushed on to EU membership with strong economic development then resulting. Indeed, the way that Ukraine has conducted this war, with bravery, intellect, innovation, and real skill/honour/grace, it suggests that this nation can be truly successful - again drawing the comparison to the State of Israel how when faced with huge external threats and challenges, it has risen to the challenge as a nation and innovated to survive, because it had to.

Now contrasts will be made with Russia, and the World Bank above suggests only an 11% real GDP decline therein, but this is on an economy ten times the size. So if Ukraine suffers a 45% real GDP loss, equivalent to perhaps $90bn, the loss to Russia from even an 11% real GDP contraction is perhaps as much as twice the size, closer to $200bn. True, Ukraine is suffering huge losses in infrastructure - as noted above, perhaps has high as $500bn. But at least Ukraine has a positive recovery outlook after the war ends. For Russia as long as Putin remains in power, and because of all the war crimes committed in this war and revealed for the world to see, Russia will remain an international pariah for years to come. It will remain in default on its foreign debts for years to come, isolated from international capital markets, starved of investment, increasingly cut off from international trade and business - cut out of Western energy and commodity supply chains - suffering recession and stagnation, falling living standards and increased capital flight and brain drain. Putin will have put Russia back to the depressed late Soviet era, while Ukraine will finally have a clear Western and European perspective. Ukraine’s future will be bright, Russia’s will be dark for a decade or more to come, as long as Putin and his cliche remains in office. So my forecast is that the eventual real GDP loss to Russia because of Putin’s actions will end up being multiples of the losses now being predicted for Ukraine. Russia, and Russians, will end up being the biggest loser(s) here.