The West should already be planning how to finance Ukraine’s reconstruction

Ukraine’s economy has so far held up well. But the costs of reconstruction are likely to be high, and western allies should already be thinking about how the recovery will be financed.

The impact of the full-scale invasion launched by Russia on February 24 on Ukraine’s economy and society is already dramatic and will become even more so.

Almost two million people have fled the country, while many more have become internally displaced, adding to the hundreds of thousands who had already fled fighting in eastern Ukraine since 2014. Sea ports and airports are closed and have been damaged, and many roads and bridges have been damaged or destroyed. Economic activity in Ukraine is likely to contract by well over a third this year.

Whatever the outcome of the current war Ukraine, which began when Russia launched a full-scale invasion of the country on February 24, the cost of reconstruction is likely to run into the hundreds of billions.

According to Olga Pindyuk, an economist at the Vienna Institute of International Economic Studies (wiiw), speaking on March 8 at a webinar looking at what the West can do for Ukraine, the country’s economy has so far held up well. The government has been adamant that it will not default on any repayments of its current international financing commitments, in large part thanks to its healthy foreign currency reserves of around 27 billion euros. Repayments this year total no more than six billion euros.

There have nevertheless been calls for part, or even all, of Ukraine’s foreign debt to be cancelled, so that urgently needed social services and humanitarian assistance can be instituted immediately and in the future.

Clues from Donbas

Should the war drag on, as appears increasingly likely, a look at what happened to the economy of the Donbas region – parts of of which have been under Russian occupation since 2014 – offers a few clues as to the level of damage that could be inflicted on the economy of Ukraine as a whole.

Industrial production has contracted by 60 per cent in Donetsk Oblast and 80 per cent in Luhansk Oblast. By 2017, exports from the region had fallen to 10 per cent of Ukraine’s total – down from 25 per cent just three years earlier.

In Russian-controlled parts of Luhansk Oblast alone, 25 plants and factories and 41 mines were closed. Those which remained operational reduced their output. Consequently, unemployment in the region was – at the time of the full-scale Russian invasion, significantly higher than the national average – in 2020, it stood at 14.5 per cent in Donetsk and 15.2 in Luhansk, compared to the national average of 9.2 per cent.

Between 2014 and 2018, foreign direct investment was less than one per cent of the Donbas region’s GDP.

Shortly after he was elected as Ukraine’s president in 2019, Volodymyr Zelensky said that the reconstruction of the Donbas region would cost more than 10 billion euros.

It was a wildly inaccurate estimate. In 2020, wiiw published a detailed report that suggested the reconstruction of Donbas would cost at least 21.7 billion US dollars, or 16 per cent of Ukraine’s GDP.

The report said that Ukraine would not be able to meet the cost of reconstruction alone, and recommended various sources of finance, including both court-ordered compensation and voluntary contributions by Russia (something that now looks highly unlikely), while admitting that international finance would be the most viable option, conditional on the stability of financial markets.

IFI support

As long as the war goes on, Ukraine will receive major financial (as well as military) support from much of the rest of the world. Earlier this week, on March 7, the World Bank approved a supplemental budget support package for Ukraine, called Financing of Recovery from Economic Emergency in Ukraine – or FREE Ukraine – of 489 million US dollars.

The package consists of a supplemental loan for 350 million US dollars and guarantees in the amount of 139 million US dollars. The bank is also mobilising grant financing of 134 million US dollars and parallel financing of 100 million US dollars, resulting in total support of 723 million US dollars. The fast-disbursing support will help the government provide critical services to Ukrainian people, including wages for hospital workers, pensions for the elderly, and social programmes for the vulnerable.

The World Bank Group is also preparing a package of support worth three billion US dollars for Ukraine in the coming months and additional support to neighbouring countries receiving Ukrainian refugees.

The IMF is also doing its bit, responding to Ukraine’s request for emergency financing of 1.4 billion US dollars through the Rapid Financing Instrument, which could be approved as early as next week.

In addition, the IMF continue to work on Ukraine’s Stand-By Arrangement programme, under which an additional 2.2 billion US dollars is available between now and the end of June. The European Union has also pledged 1.2 billion euros in support.

But these figures are likely to be dwarfed by the costs of reconstruction in Europe’s second biggest country.

“While it is very difficult to assess financing needs precisely at this stage, it is already clear that Ukraine will face significant recovery and reconstruction costs,” said Kristalina Georgieva, managing director of the International Monetary Fund (IMF), last week – something of an understatement.

Olga Pindyuk believes that the West should already be making provision for Ukraine’s reconstruction.

“Ukraine will have to receive a lot of financial assistance. The EU must have this in mind now,” she said, adding that any reconstruction must promote technology.

Ukraine already had big plans to boost its IT sector considerably. “We want to transform Ukraine into a country of start-ups,” Zelensky said in February, before the new Russian invasion. “We expect the technology share of GDP to grow from four to 10 per cent by 2025, up to 16.5 billion US dollars, making us the largest tech hub in Europe.”

When it emerges from the war, the IT sector is likely to be more important than ever.

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