Ukraine’s economy is expected to stabilize this year, but major downside risks loom. After a -34% drop in production last year, we expect marginal real GDP growth in 2023 of around +1%. However, the ongoing war creates major downside risks to the economic outlook, particularly the ongoing destruction of vital infrastructure, such as Ukraine’s power grid. Since October 2022, electricity has been rationed in Ukraine through rolling blackouts. Annual inflation has accelerated from 10% to over 25% and shows no sign of abating. Both growth and inflation have put enormous pressure on household accounts, despite large amounts of foreign aid. Ukraine’s public deficit has quadrupled and public debt has increased by 40 percentage points, with gross external debt reaching 90% of pre-war GDP. The Ukrainian currency has also lost a fifth of its value against the dollar.
The reconstruction process must start as soon as possible to strengthen the country’s socio-economic resilience, but Ukraine’s reconstruction will be costly. The painful experience of past wars has taught us what it takes to rebuild countries devastated by armed conflict. Aside from immeasurable human suffering, wars destroy infrastructure, disrupt production and rearrange trade flows. And they tend to bankrupt governments when economic activity collapses while debt builds up. If we take the post-WWII reconstruction of Western Europe as an example, the size of the Marshall Plan in today’s purchasing power values is comparable to the estimated reconstruction costs for Ukraine over the next 10 years (up to EUR 1 trillion).
However, Ukraine cannot do this on its own given rising public debt and a growing budget gap. The cost of rebuilding infrastructure alone is expected to require at least EUR 300 billion (the same amount, by the way, that was needed to expand infrastructure in East Germany during German reunification) – that’s three times the total (fiscal) budget of the Ukraine last year. Back in September, the European Commission (jointly with the Government of Ukraine and the World Bank) estimated in its Rapid Damage and Needs Assessment (RDNA) that the current cost of reconstruction and recovery in Ukraine amounts to EUR 349 billion. In the meantime, this number has more than doubled in the course of the war. Thus, for a credible commitment to Ukraine’s reconstruction, private external financing would need to complement public sector finance and development assistance.
Investments in infrastructure, health services, housing and schools, as well as digital and energy resilience for sustainable recovery and reconstruction have priority. This will (i) increase the willingness of Ukrainian refugees to return home, (ii) improve logistical (and trade) links to Europe, and (iii) increase private investors’ appetite for investments in the country. We believe this will require at least €100-150 billion in private investment (in addition to €350 billion in foreign aid).
Greater public-private cooperation can also help create an appropriate investment climate, which is also a goal of the EU Facility for the Reconstruction of Ukraine. In order to attract sufficient private investment, the state and its institutions would have to be modernized further; This will strengthen governance and respect for the rule of law, including permanently reducing the undue political influence of oligarchs.
For this to work, two essential elements must be in place – credible security guarantees and foreign economic aid. Without security guarantees to deter renewed Russian aggression, Ukraine will have difficulty recovering human capital and importing foreign private capital. The West needs to give Ukraine such credible guarantees (or public sector backing for companies investing in Ukraine while the country is under attack). Moreover, without generous foreign aid, Ukraine’s economic recovery will be delayed until the end of the war; this could jeopardize both its fledgling democracy and its gradually improving security situation. There is a lot of goodwill in Ukraine’s favor, but foreign aid is still too small. Greater coordination between the supporting countries will be needed, especially when it comes time to negotiate war reparations (in the form of reserve assets, securities, or in kind such as commodities, oil and gas) with Russia.
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