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Despite renewed Russian attempts to destabilise and potentially invade Ukraine, I think Ukraine’s macroeconomic outlook remains, to date, relatively encouraging. Clearly, a large-scale invasion by Russia would be highly damaging, but more limited scenarios should, in my view, help Ukraine recover or safeguard macro stability, which is more robust than at any stage since the fall of Communism. To an extent, Ukraine has learned to live with continued uncertainty and low-level conflict. Regardless of the outcome of the current standoff, Russia will remain an aggressor, generating periodic bouts of uncertainty and weighing on investment, but I do not think it will entirely halt Ukraine’s slow convergence with its better-performing peers in Central and Eastern Europe. I expect the US and the EU to increase their engagement and pressure for reform, thus helping to maintain gradual but positive momentum.
Ukraine’s growth has lagged that of its Central and Eastern European neighbours for decades and closing the gap in living standards will take a long time, but continued progress is still likely. Downside risks are limited by the drop in exports to Russia, which now stand at only 1.7% of GDP, compared to a peak of more than 12% in 2011.1
The banking and monetary policy reforms undertaken between 2015 and 2019 — considered best-in-class by the IMF — remain an important factor supporting Ukraine’s resilience. Despite concerns about political interference, the National Bank of Ukraine (NBU) has reacted credibly to the rise in inflation, hiking interest rates by 400 basis points to 10%. The country also benefits from good fiscal performance and positive public debt dynamics. Public debt peaked in 2020 at 61% of GDP and is currently projected to fall to below 50% of GDP by 20252. A current account deficit is likely in 2022, but it should be offset by foreign direct investment, absent further escalation of the current standoff. The NBU also reports a healthy increase in the country’s reserves to US$31 billion, the highest level since 2012. Reserves have fallen somewhat in recent weeks, but, to date, this decline has been manageable.
The momentum for macro reforms has remained positive during the first two and a half years of President Volodomir Zelensky’s term. President Zelensky negotiated a new IMF programme and has already signalled a desire for a follow-up one. We have seen advances in areas such as central bank governance and the appointment of judges; and while land reform was significantly diluted after COVID hit in 2020, some modest measures have been put in place.
This macro-related progress contrasts with more problematic actions elsewhere that have weakened the Zelensky administration. These include public demands for NATO accession despite US and European pressure not to do so; a variety of sudden personnel replacements; and controversial policies to curb the influence of oligarchs. The latter have raised concerns about the rights of Russian speakers in Ukraine and the targeting of political opponents’ media interests.
Irrespective of what is being said in public, I see the message from Western partners about NATO accession being out of reach only strengthening from here, meaning the Zelensky team will face a difficult task managing raised domestic expectations. I also expect greater pressure from the IMF, the US and the EU to accelerate reforms, reduce the potential for conflicts of interest and bolster transparency.
The next elections, in 2024, have the potential to undermine the significant progress made to date as a more populist presidential candidate could prevail. Having campaigned to negotiate peace in the Donbass region, President Zelensky cannot point to any progress in the Minsk II peace negotiations, while his other key aspiration, NATO membership, is also unlikely to be met. Moreover, despite trending higher in the past five to six years, GDP per capita has not grown in almost a decade due to the severity of the 2014 shock when Russia invaded Crimea and Donbass. The steep fall in Zelensky’s approval ratings from record highs of 75% to below 30% highlights the extent of the electoral challenge he faces, albeit, at present, he still is in the lead.
1Source: State Statistics Service of Ukraine | 2Source: International Monetary Fund, Ukraine Country Report, June 2020