Ukraine struggles to avoid hyperinflation as war costs soar | Business | Economic and financial news from a German perspective | DW

As the war with Russia enters its seventh month on Wednesday, Ukraine is caught between a financial rock and a hard place as it seeks to stay afloat while battling invading forces from Moscow.

Tax revenues have plummeted due to a plummeting economy while military spending has skyrocketed, leaving the government facing a budget deficit of $5 billion (5.02 billion euros) per month.

To compensate for the lack of liquidity, the country’s central bank has effectively printed money – buying government bonds to the tune of $7.7 billion over the past six months. The Financial Times reported that printing presses actually created $3.6 billion in June alone.

Soaring inflation could ‘destroy the economy’

With the war now likely to last indefinitely, the country faces the prospect of runaway inflation and possibly even hyperinflation – very high and accelerating inflation.

This would further erode the value of Ukraine’s currency, the hryvnia, which has already fallen by about a third. Inflation has reached 20% and is expected to reach 30% by the end of the year.

Earlier this month, a report by the London-based Center for Economic and Policy Research (CEPR) called for a “decreasing reliance” on money printing, or seigniorage, warning that Ukraine would likely face inflation much higher, to a currency crisis and even a banking crisis. crisis if she continued.

“Printing money makes sense at the start of the war, when there’s a lot of chaos, and allows you to raise funds very quickly,” the report’s co-author, economist Yuriy, told DW. Gorodnichenko from the University of California at Berkeley. “But it’s not a lasting solution. If you keep doing this, you’re going to destroy the rest of the economy.”

Hyperinflation is a phenomenon Ukrainians know all too well

Heartbreaking memories of hyperinflation

In 1992, shortly after the country’s independence following the collapse of the Soviet Union, the measure of price increases reached 2,000%. The country has become the first in the world to witness such a massive spike in inflation that is not the result of conflict. Inflation also soared to 50% in 2014 when war in eastern Ukraine broke out.

The CEPR report advised the Ukrainian government to raise taxes and seek additional foreign aid while limiting non-military spending – a policy Kyiv implemented from the start of the war. He also called for strict controls on capital outflows, restrictions on imports and greater exchange rate flexibility.

Tax revenues have collapsed to around a fifth of their pre-war level and now cover around a third of government expenditure. Money printing currently supports another third or so, while foreign loans, grants and local bond issues help cover the rest of the expenses.

Faced with the prospect of a further increase in taxes and import duties, Kyiv is aware that businesses and consumers are already under enormous pressure.

Economy hit hard by Russian invasion

Businesses have been forced to close in conflict zones and the flight of 5 million Ukrainians and the military conscription of men have caused a brain drain, while unemployment has already reached 35%. Those left in war zones, internally displaced or suddenly unemployed also need financial support.

The prospect of an ever-weaker economy, along with fuel shortages, power cuts or heat cuts this winter, could force many more businesses to close while testing public support for President Volodymyr Zelenskyy’s government. .

The World Bank has predicted that 55% of Ukrainians will live in poverty by the end of 2023, up from 2.5% before the conflict.

Ukrainian government must make ‘painful’ choices

Gorodnichenko acknowledged that the recommendations would be “very painful”, but would be better than a long war “creating high inflation, even hyperinflation”.

The CEPR report said it was “wishful thinking” to expect Western countries to cover most or all of the government budget deficit. But he also said the support of Ukraine’s allies remained essential, “not only for the survival of the country but also for the future of global order and security”.

About $38 billion in financial support has been pledged by foreign governments and international organizations over the past six months, the Financial Times reported, citing Ukraine’s finance ministry.

A separate tracker from Germany’s Kiel Institute for the World Economy (IfW-Kiel) showed that around 84.2 billion euros ($84.9 billion) in military, financial and humanitarian aid have been promised by some forty countries.

The United States alone has pledged more than €8.5 billion in humanitarian and financial aid, while European Union institutions have pledged to send €12.3 billion. But actual payments have been slow to arrive.

Only a quarter of the EU’s aid pledge has been dispersed, according to tracker IfW-Kiel. According to media reports, the delay is due to discussions over whether the aid should be in the form of grants or loans.

“The European Union is worried that Ukraine won’t be able to repay the loan, which is a legitimate concern, but it shouldn’t be a loan, it should be a grant,” Gorodnichenko told DW.

War bonds could prove profitable

As Ukraine negotiates a new loan program worth $15-20 billion with the International Monetary Fund (IMF), the government is also raising funds from the public through war bonds – a a measure that could easily be reinforced.

Ukrainians have already donated around $1 billion for the war effort through interest-free fundraising or any other incentives, Gorodnichenko said. Noting how large a shadow or unofficial economy Ukraine has, he said that could also be exploited.

“While it’s hard to know how much money there is, I imagine it’s a significant amount and, in principle, people might be willing to pull money from under their mattress to help pay for this war,” the economist told DW.

While some Ukrainians have hidden wealth hidden abroad or outside the banking system, millions of people are barely surviving on their remaining savings. Faced with soaring prices, unemployment and impending poverty, they may have no choice but to hold on to their cash.

Edited by: Uwe Hessler

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