Ukraine needs ‘radical’ reform to sustain war effort, warn economists | Ukraine

Ukraine’s government needs to overhaul its tax and spending policies or risk an economic crisis that could “cripple its ability to sustain the war effort”, according to a group of leading economists.

With inflation racing to more than 20% and a debt crisis looming, President Volodymyr Zelenskiy must introduce reforms to stabilise the economy’s shaky foundations, they warned.

“Ukraine’s survival – and Europe’s future – is at stake,” the economists said, adding that “extraordinary challenges must be matched by extraordinary policies and extraordinary support from Ukraine’s international partners”.

Measures to widen the number of people paying tax would improve the government’s finances, while greater coordination between the central bank and the finance ministry would support the currency, the group said.

They also recommended anti-corruption measures to limit the amount of cash leaking out of the economy, helping the government to cope with the costs of a long war.

After Russian forces invaded Ukraine in February, Kyiv implemented a series of emergency economic measures to cope with the disruption and extra military costs. While foreign governments have financed and supplied military hardware and training to support the war effort, Kyiv has funded most of its domestic policies by printing the local currency, the hryvnia, and deferring payments on $20bn of foreign debt.

Nine economists working for an academic network of economists, the Centre for Economic Policy Research, which includes the former International Monetary Fund (IMF) economic advisers Simon Johnson, Barry Eichengreen, Maurice Obstfeld and Kenneth Rogoff, said the emergency measures had run their course and Ukraine needed to adopt a more strategic approach.

The rating agency Moody’s has forecast that Ukraine’s budget deficit will hit 22% of GDP this year – $50bn – forcing the government to print money to fill the gap.

A recent devaluation of the hryvnia has failed to ease pressure from international investors who have seen that “moral support for Ukraine is only partly translating into a strong financial lifeline”.

An increase in the central bank base rate to 25% has similarly failed to instil confidence in the management of the economy.

The economists said the government should stop relying on the central bank to print money and begin taxing wealthy Ukrainians and sell war bonds to ordinary citizens. Ukraine has a flat personal income tax rate of 18%. A military levy introduced in 2015 adds a further 1.5 percentage points.

“If the government cannot make these taxes progressive, it can introduce a progressive ‘war surcharge’. For example, the surcharge would apply only to income or capital above a certain threshold that may be easier to accept politically and could be rolled back after the war,” the report says.

The G7 and EU have announced official financing commitments to Ukraine worth $29.6bn. However, the country’s allies and international financial institutions are understood to have only disbursed $12.7bn.

The economists’ report coincides with analysis by the World Bank, the EU and Kyiv that shows the impact of the war on the fabric of Ukraine and how the invasion has harmed its infrastructure, education system, health sector and pushed up poverty levels.

As of 1 June, direct damage had reached more than $97bn, they said, with housing, transport, commerce and industry being the most affected sectors. Disruption to the economy is expected to cost another $252bn this year, cutting Ukraine’s GDP by 15.1% and increasing the proportion of people in poverty from 2% to 21%.

“In the next 18–36 months, about $105bn will be needed [from internal sources of finance and external donors] to address the most urgent needs,” the report said.

The economists’ report suggests widening the tax base and increasing taxation rates to survive the period of conflict, pointing out that wartime governments have always done so.

Moving away from a fixed currency would also alleviate pressure on the central bank to repeat July’s 25% devaluation. A high-value currency encourages firms to rely on imports, which increases an already large balance of trade deficit. However, a free-floating currency could be highly volatile against the backdrop of see-sawing news about the conduct of the war.

More controversially, the authors argue that market forces should become a larger feature of Ukraine’s highly regulated economy. They said the government’s achilles heel was persistent corruption and a hidden, untaxed business sector that would be difficult to reform using existing institutions, adding: “To this end, the aim should be to pursue extensive radical deregulation of economic activity, avoid price controls, and facilitate a productive reallocation of resources.”

Kyiv has recently begun selling its surplus electricity to the EU to generate foreign exchange after a loosening of constraints on generators. It has also put in place reforms of the labour market that allowed firms to “fire workers relatively easily and unilaterally suspend elements of labour contracts”. Equally, workers who want to move jobs no longer need to give their employers advanced notice.