Economics of War: What Price Increase Should be Expected in Ukraine in Six Months

ANDRIY VOLKOV, Founder and Partner of Investohills Group in Mind.

Many people in Ukraine and abroad are asking a particularly important question now: What will happen to Ukraine’s economy after the war? Everyone realizes how difficult it is to answer this question in the current situation. Nobody knows how much time the ongoing hostilities in the country can take.

Let us take, for instance, a moderately optimistic scenario that the state of martial law in Ukraine will take 3 to 6 months more. What will happen to the national economy during this time?

First of all, we will face high inflation. The Government had to turn the “printing press” on to pay social benefits. They include UAH 6,500 paid to Ukrainians who lost their jobs or businesses due to the war (more than 5 million applications were received for this benefit). They include the benefits for internally displaced persons (IDPs) of UAH 2,000 per adult and UAH 3,000 per child. In addition, the Cabinet of Ministers announced a new program of benefits to be paid to employers who hire the IDPs from other regions. Companies will be paid UAH 6,500 per hired IDP.

Also, one has to bear in mind various preferential lending programs. For example, in March, the Government issued two Resolutions—Nos. 274 and 312—amending the 5-7-9 program and offering businesses an opportunity to get zero-interest loans during the period of martial law.

This campaign of the distribution of money not funded by taxes collected and goods made in Ukraine will give rise to inflation during the months to come because, according to various estimates, 30 to 50 percent of manufacturers either froze or terminated their operations. The remaining companies are physically unable to produce goods in amounts commensurate with the growing money supply. The stock of goods will be exhausted, and prices will start growing. Actually, they already are. According to my estimates, consumer inflation will be close to 30 percent in 2022.

Definitely, the Government could not have proceeded differently. Any support for the population and businesses during the war is the right decision. The emission would not affect the economy if the hostilities took only a couple of months. However, decisive measures need to be taken because the war becomes protracted.

International partners provide strong support to Ukraine through grants and loans. This inflow from abroad would contribute to partly balancing the budget (by reducing the fiscal deficit, enabling disbursement of social benefits) and keeping the exchange rate.

However, no foreign aid can fully solve the “printing press” issue. In theory, foreign goods can be paid in USD and then delivered to Ukraine to support the UAH emission. However, the war gave rise to huge difficulties in logistics for importers and exporters alike.

The lion’s share of the country’s foreign trade used to go via seaports. Currently, most of them (except for the small ports of Izmail and Reni) are blocked by the Russian Navy; because of that, agrarians are physically unable to deliver grain and oilseeds to China, India, Egypt, Turkey, et al. Importers also face major issues caused by the loss of the well-organized chains for the supply of goods to Ukraine.

This situation could be addressed by redirecting cargo flows to rail and road. However, the throughput of the rail-and-road logistics chain is severalfold smaller than that of the sea routes. Therefore, it will be expensive and slow. Thus, we cannot secure enough imports even having foreign currency in the country. It will also give rise to inflation, not only in hryvnia but also in dollars.

The foreign-currency inflation will be noticeable especially well at the backdrop of the fixed exchange rate maintained only by the power of the National Bank and the administrative tools it applies. They include the restrictions on the capital outflow abroad and sales of foreign reserves that went down by USD 1.5 billion in March. The NBU will be able to keep the UAH/USD exchange rate long enough if we consider the volume of the foreign exchange market, international aid, and foreign-currency loans. However, it won’t be able to target inflation in this case, and inflation will spiral out of control.

How can one check prices in Ukraine and prevent them from an uncontrolled increase? Reducing the consumption of goods is the worst-case scenario. There is a somewhat “better” option of resuming imports, while foreign partners provide financial support in amounts sufficient to support the imports. It is absolutely realistic if the ports can be unblocked. However, the most appropriate path would be to reboot Ukraine’s economy and bring the production to a level matching the domestic demand. It will not be easy to implement the third scenario under the current circumstances. However, it is the only scenario to overcome the consequences of the war sooner rather than later (provided that it is over in 3 to 6 months) and prevent the economy from going down the drain.