KYIV, Ukraine—Ukraine’s defense against Russia’s invasion is gradually strengthening as its army grows and more Western weapons arrive. Sergii Marchenko’s problem is how to pay for it all.
The Ukrainian finance minister is struggling with a yawning gap between the cost of the war and depressed tax revenues in an economy battered by the invasion. Ukraine’s Western supporters—particularly the European Union—are sending promised financial help only slowly.
Ukraine’s central bank is having to make up the difference, printing money so the government can pay soldiers’ salaries and buy arms and ammunition. That is weakening the national currency, the hryvnia, pushing up inflation and raising fears that fragile finances could undermine Ukraine’s ability to sustain its war effort.
“Every day and night it’s a constant headache,” said Mr. Marchenko, a 41-year-old economist and government veteran picked as finance minister by Ukrainian President Volodymyr Zelensky.
Ukraine was one of Europe’s poorest countries before the war, in terms of per-capita income. Several economic crises have set it back, while other Eastern European countries have joined the EU and grown strongly. Ukraine’s aspirations to reorient its economy westward, and Russia’s resistance, are among the causes of the conflict.
Ukraine’s economic output plunged after Russia invaded in February, with monthly gross domestic product falling by close to half in March as businesses shut down and millions of people fled the country.
Russia’s strategy for subjugating Ukraine includes suffocating its economy. Russian missiles have destroyed factories, oil refineries and other economic infrastructure. Russia’s navy has blockaded the Black Sea, choking off Ukrainian exports. A Turkish-brokered deal to allow grain shipments is beginning to offer partial relief.
With Ukraine’s defenders slowing Russian forces’ advance, the economy is showing signs of stabilizing at a depressed level. The government expects GDP for this year to be around 30% lower than last year. But the economy depends on how the military effort fares, just as sustaining the war depends on bolstering Kyiv’s finances.
Lack of money threatens to become Ukraine’s Achilles’ heel. Before the war, the government’s budget was roughly balanced. Now, tax revenues only cover around 40% of government spending. War costs are more than 60% of the budget. Mr. Marchenko has cut nonessential spending to the bone.
The government needs about $5 billion a month to cover nonmilitary spending. Western governments have promised to support the civilian budget with grants and loans, leaving Kyiv able to use more of its own resources for the war.
But Western governments’ total pledges of around $30 billion for this year fall short of Kyiv’s needs. And disbursements are lagging behind promises.
Mr. Marchenko spends much of his time urging Western governments to act faster. “The support we get now gives us the opportunity to win this war and to do it sooner rather than later,” he said. “Without this money, the war will last longer and it will damage economies more.”
On Wednesday, he received some good news: Ukraine’s international bondholders approved his proposal to freeze debt payments for two years. The bond standstill, together with a similar agreement with official creditors last month, will save Kyiv around $5.9 billion over the next two years. But that only covers a small part of the financial shortfall.
Ukrainian officials say the U.S. and U.K. are delivering on their funding pledges, but they are frustrated that the EU’s promised support has become caught up in internal wrangling between Germany and the bloc’s executive, the European Commission.
Only €1 billion out of €9 billion, equivalent to $9.3 billion, promised by Brussels has arrived so far. Germany, which sent Ukraine a separate bilateral grant of €1 billion in June, objected to the commission’s plan to offer low-interest loans backed by guarantees from EU member states. Discussion about whether to offer grants or loans, and how to share the burden, has dragged on all summer. The commission says it is working on a new proposal.
Ukraine doesn’t have time for the EU’s long debates, said Rostyslav Shurma, economic adviser to Mr. Zelensky. “If we acted this slowly, the Russians would be at the Polish border by now.”
To cover its shortfall, the government is offering war bonds to its citizens, but the population’s savings are limited. Many Ukrainians are living off their savings, including millions who are refugees.
Most of the gap is being covered by central-bank money printing. “It was a very painful decision for us,” said Sergiy Nikolaychuk, deputy governor of the National Bank of Ukraine.
The central bank strengthened its political independence in 2015, as part of reforms demanded by the International Monetary Fund after Ukraine’s last economic and financial crisis, which followed Russia’s annexation of Crimea and covert invasion of the eastern Donbas region in 2014. Since then, the National Bank has followed an orthodox anti-inflation policy. But when Russia launched its full-scale invasion in February, the bank had to choose between orthodoxy or saving the government from bankruptcy.
“We had no choice. Otherwise there would be a collapse of the public finances,” said Mr. Nikolaychuk. The bank prints money and buys government bonds, depending on how much Western financial aid arrives each month. Heavy money printing in June put the hryvnia’s exchange rate under pressure, leading the central bank to devalue the currency against the dollar in July. The hryvnia’s value has fallen about 30% since the war began, pushing up inflation via the cost of imports. Inflation is over 20% and rising.
If Western governments disbursed around $3 billion a month, the National Bank could keep its money printing to a manageable level, said Mr. Nikolaychuk.
The National Bank is pressing the government to raise taxes and cut spending to help protect financial stability. Mr. Marchenko doesn’t see much scope for that.
“Sometimes we have a different point of view from the National Bank,” said Mr. Marchenko. “We have to worry about winning the war. It is better to risk high inflation than not to pay soldiers’ salaries.”
Mr. Marchenko is planning for a long war, and how to pay for it next year too. “This is a war of attrition. You have to think in these terms, to think about 2022 and 2023. It’s a marathon.”
The government is in talks with the IMF about a new loan program, and last week sent the fund a formal proposal. An IMF program would help give Ukraine’s plans credibility and encourage Western governments to step up their financial support, Mr. Marchenko hopes. “Without an IMF program, it will be very tricky to look at 2023,” he said.
The difficulty facing IMF staff is how to predict Ukraine’s financial needs when much depends on how successful its army is against the Russians. “It’s a question of the reliability of data and forecasts. It’s not easy to construct a program with a country in a war,” Mr. Marchenko said.