Economy of Ukraine

December 9 at 18:46 All articles

Ukraine Macroeconomic Outlook

1. Long-term trends

From the 2000s onwards, household consumption has been the primary driver of GDP growth in Ukraine, whereas the contributions from exports and investment have been inconsistent.

Figure 1 - Share of consumer spending in Ukraine's GDP, %

Source: https://be5.biz/makroekonomika/consumption_expenditure/ua.html

Figure 2 - Share of private investment in Ukraine's GDP, %

Source: https://be5.biz/makroekonomika/consumption_expenditure/ua.html

In the sectoral perspective, it is important to recognize the significance of both the industrial and agricultural sectors. Ukraine saw a 5.9% increase in industrial production in 2023, which followed a 37% decline in 2022. Government programs played a significant role in boosting infrastructure (26.6% increase in construction materials production), while the machine-building industry also saw positive growth (16.7% increase in 2023).

One factor limiting sustainable economic growth is the economy's inertia, which is evident in the increasing focus on exporting raw materials - in 2023, agricultural products accounted for 62% of Ukraine's total exports, up from 53% in 2022. Additionally, the economy faces risks due to the accumulation of external debt affecting the balance of payments. In light of this situation, reduced investment levels and the necessity to adjust budget spending to accommodate the rising social demands heighten the potential for prolonged economic instability.

Mobilization and large-scale movement of people resulted in a shortage of labor in Ukraine: there has been a decrease in job opportunities and an increase in unemployment since the conflict began. Nevertheless, there is currently an increasing trend in labor demand, which, according to the National Bank, is linked to the economic recovery and seasonal patterns. A lack of workers, particularly manual laborers, was observed in 2023, with a 20-25% increase from levels seen in 2021.

High turnover among employees largely creates the illusion of a thriving labor market. The pattern is seen as unofficial employment becomes more appealing for both employers (cutting costs on taxes) and employees.

Figure 3 - Nominal GDP per capita in Ukraine 2002-2023, USD

Source: https://index.minfin.com.ua/economy/gdp/

Figure 4 - Consumer price indexes 2002-2023, %

Source: https://index.minfin.com.ua/economy/index/inflation/

In 2021, Ukraine made its initial payment on GDP-warrants from the 2015 debt restructuring, resulting in creditors forgiving 20% of the original value of Ukrainian Eurobonds. These duties do not have a set monetary value and ensure that payments to lenders are determined by how well the country's economy is doing. Important terms to note are payments of 15% if real GDP growth falls within 3-4% range, and payments of 40% if growth surpasses 4%; the bonds reach maturity in 2040.

A temporary fix during a slight improvement in the country's economy could become a future issue, particularly as Ukraine's GDP growth is primarily dependent on outside financial assistance. Should the actual growth rate be higher than 4%, the Ukrainian government will encounter substantial expenses.

Regarding energy, the transit route passing through Ukraine is still the sole pathway for Russian gas to reach landlocked nations in Western and Central Europe, such as the Czech Republic, Austria, and Slovakia. A five-year agreement was made in 2019 between the Ukrainian government-owned Naftogaz and Russian energy company Gazprom, which will come to an end in late 2024 without any plans for renewal. As per the agreement, Russia is required to transport 225 billion cubic meters of gas through Ukraine: 65 billion cubic meters in 2020 and 40 billion cubic meters annually afterwards.

2. Recent data

Ukraine experienced a 5.3% GDP growth in 2023 following a significant drop in 2022. Record crop yields and higher defense spending have been influential factors in driving economic growth in the past year, bolstering domestic demand as net exports experienced a decrease. External financing also played a crucial role in reducing inflation to 5.1% and replenishing international reserves, acting as another stabilizing factor. In March 2023, the IMF gave its approval for a $15.6 billion loan to Ukraine that will span over four years.

The opening of a new export corridor across the Black Sea for Ukrainian shipments of agricultural products, ores, and metals in 2023 is a beneficial factor for the recovery of international trade. As of February 2024 data, over 22 million tons of assorted cargo have been exported since the temporary corridor opening.

The GDP indicator increased by 4.5% year-over-year in January-March 2024. The trend is backed by the functioning of the Ukrainian sea corridor, growing mining industry production capacity, and heightened production of mineral fertilizers.

Figure 5 - Real GDP dynamics, y-o-y % changes

Source: OECD Economic Outlook 115 database; Central Bank of Ukraine; and State Statistics Service of Ukraine: https://www.oecd-ilibrary.org/economics/oecd-economic-outlook-volume-2024-issue-1_525034e4-en

3. Real estate sector

In the last two years, the construction industry has encountered several obstacles. Key factors hindering the sector's growth include low market demand, limited financing, complex logistics, and disruptions in construction material production. The price dynamics in the primary housing market reflected these trends: prices of developer homes rose in most regions, with significant increases in the central and western areas, regardless of housing class.

In 2022-2023, construction firms gave priority to complexes in the middle and final phases of completion, with minimal commencement of new projects. In 2023, the overall new housing supply reached 7.4 million sq. m., marking a 4% increase from 2022 and a 35% decrease from 2021. Simultaneously, approximately 100 million square meters of housing construction space were either damaged or demolished in 2023.

Due to the sluggish construction progress and the potential for unfinished complexes, the drop in consumer interest in new buildings was offset by a rise in completed purchase and sale deals in the secondary real estate market: by the end of 2023, the figure surged by 71%. Government initiatives also play a role in boosting consumer demand: the preferential lending program "єОселя" (offering mortgage at 3%) and the housing repair program "єВідновлення" (receiving state funds) are examples of such programs.

Simultaneously, with the population's limited purchasing power (the average monthly salary in late 2022 was 14 857 UAH - a nominal increase of 6% from 2021 but a 12% decrease in real terms), alongside high uncertainty in the real estate industry, no major shifts in demand are expected in the near future. Likewise, there is no anticipation of an increase in supply because companies are not interested in starting new construction projects.

4. Balance of payments and exchange rate

In 2023, there was a surplus in the balance of payments, resulting in the accumulation of foreign exchange reserves, which reached $9.45 billion. This was a significant increase from the deficit of $2.9 billion in 2022, despite contradictory dynamics in key indicators.

Figure 6 - Ukrainian balance of payments by years, mln USD

Source: https://index.minfin.com.ua/economy/balance/

The foreign trade balance in 2023 sees imported goods rise to $63.3 billion, which is 114% higher than in 2022 and 91% higher than in 2021, driven by increased domestic demand. Exports of goods stayed low ($34.5 billion) because of logistical issues, restrictions from nearby EU nations, and low prices for essential products. As a result of the hardships faced by farmers in the region, Poland, Hungary, Bulgaria, Romania, and Slovakia imposed limitations on the importation of Ukrainian agricultural goods such as wheat, corn, rapeseed, and sunflower seeds in April 2023. In the previous year, the service trade deficit dropped to $8.9 billion, lower than the $11.1 billion in 2022. The decrease in overseas spending by the population, alongside the arrival and integration of migrants who are now earning money locally, is reflected in the dynamics. One of the adverse patterns is a drop of 8.5% in the export of computer services, totaling $6.7 billion in 2023.

In 2023, the current account deficit was $9.8 billion, compared to a surplus of $8 billion in 2022. The financial account surplus reached a historic high of $19.1 billion, indicating a decrease in private sector currency outflows and an increase in external financial aid to Ukraine. By the conclusion of 2023, there is a rise in the current account deficit within the balance of payments, while the financial account displays a substantial surplus, nearly doubling the outflow from the current account.

The surplus in the balance of payments shows a considerable accumulation of foreign aid, which enabled the accumulation of large foreign exchange reserves by the end of 2023, totaling $40.5 billion. At the same time, there is a build-up of imbalances caused by the increasing foreign trade deficit. The structural deficit is caused by the reduction in export capacity.

The shift from a fixed exchange rate system to a managed float system has been in place since October 2023: the NBU sets the official exchange rate in the interbank foreign exchange market and imposes restrictions on exchange rate changes. The main goal is to maintain the stability of the exchange rate and decrease inflation to 5% in the future.

Since the start of the year, there has been a noticeable trend of the hryvnia depreciating against the U.S. dollar on the interbank exchange trading results. The dollar is rising in value due to a shortage of currency. The regulator sold $3.553 billion on the interbank foreign exchange market in December 2023, the highest amount since June 2022. Altogether, Ukraine's population spent a total of $4.793 billion in banks during 2023.

Figure 7 - USD/UAH nominal exchange rate dynamics, 2020-2024.

Source: https://ru.tradingeconomics.com/ukraine/currency

5. Financial sector

The credit market collapse defined the early months of 2022, with a cumulative rate of 3-5% in March, a drop from January. In 2023, the national financial system is still improving, with financial institutions lending 60% of pre-war levels in the first half of the year. The main limitation is the decrease in families' financial stability leading to the significant increase in unpaid loans in 2022.

The NBU's decision to lower the key rate to 14.5% (a decrease of over 10 pp) from June 2023 to March 2024 is connected to the decrease in inflation and better inflation forecasts in the country.

6. Ukraine's budget and debt position

By 2023, the state budget deficit had grown to approximately 20.5% of GDP, up from 16% in 2022. The indicator slightly declined in 2024 because of the decrease in government spending on non-defense matters and the use of domestic revenues to fund the military. The increase in domestic revenue comes from the rise in VAT and excise tax collections, along with the higher income tax rates for banks (with no change in the corporate income tax rate).

The national budget policy continues to heavily rely on the rising foreign funding inflow seen in February and March 2024. In 2023, Ukraine's government debt to GDP ratio reached around 85%, compared to 78.4% in 2022 and 48.9% in 2021. Simultaneously, a portion of the nation's foreign debt underwent restructuring: for G7 creditors, Paris Club - extended to March 2027, for commercial creditors (Eurobonds, GDP-warrants) - extended to August 2024. Nevertheless, even though the delay has occurred, the economy still faces a significant debt load since only some of the aid from the West is in the form of gifts - a substantial portion consists of loans from the U.S. and the EU, as well as other nations and institutions. In this context, there has been a substantial increase in government spending: 38.2% of GDP in 2022 compared to 17.7% in 2021.

Figure 8 - Dynamics of Ukrainian government expenditures, % of GDP

Source: https://ru.theglobaleconomy.com/Ukraine/Government_size/

7. Inflation

Increased agricultural production in 2023 resulted in decreased prices for several local food items, while the depreciation of the exchange rate curbed price hikes for imported goods.

The decrease in inflation to 5.1% in 2023 is a contributing factor to the NBU's decision to lower the key interest rate. Even though inflation is decreasing, the volatility risk of the indicator remains the same due to uncertainties in supply and external financing, which might cause a slight rise in the inflation indicator from its current level.

Figure 9 - Dynamics of the inflation indicator 2019-2023, %

8. Prospects for the Ukrainian economy

A report from the European Bank for Reconstruction and Development predicts a 3% growth in Ukraine's GDP in 2024. Restrictions on economic growth include electricity infrastructure disruption, low domestic demand, workforce shortage, and inadequate investment.

The growth of export corridor shipments is boosting the revival of agriculture, metallurgy, and mining sectors. An increase in exports and domestic military production could potentially increase economic growth estimates to 4.5-6% in 2025 with a faster recovery.

Nevertheless, the risks linked to port and electricity infrastructure have not changed. Reducing these risks depends on expanding export logistics, providing financial support to exporters, and obtaining external funding support. With the ongoing geopolitical tensions, a crucial factor to consider is that the country's economic development will suffer in the future if military spending rises while investments in the civilian economy decrease.

In terms of external financial aid, the EU has authorized a scheme to allocate €1.4 billion from frozen Russian assets in the EU to Ukraine for defense reasons. The approval of the decision was given even though Hungary was slow in implementing the required legal actions. The money will be sent in July 2024 and channeled through Germany, Denmark, and the Czech Republic to make the required buys. The EU budget approved a €50 billion aid program for Ukraine until 2027 in February 2024. Additionally, the commencement of talks for Ukraine's entry into the EU is set for June 25, 2024, with no definite timeline for approval, as the process could be lengthy and indeterminate.

Apart from EU financial assistance, Ukraine has also received a substantial sum of money from the United States: in the years 2022-2023, the total American aid reached around $75.4 billion, with over half ($46.33 billion) allocated for military purposes, $26.37 billion for economic support, and $2.71 billion for humanitarian aid. Even though there was disagreement within the Republican Party about providing additional aid to Ukraine, the most recent aid package was approved and distributed by the end of December 2023. Approximately $250 million of the funds allocated by Congress in 2022 were calculated.

The topic of Russian gas transit through Ukraine remains unresolved on the agenda. According to the outcome of talks between Ukraine and Slovakia, there is potential for supply to continue in 2025. On the other hand, the Ukrainian side firmly rejects the proposal to extend the soon-to-expire five-year agreement. It is acknowledged that the U.S. role in the European market and the significant export of U.S. LNG are of great importance to the state's interests.