Tackling the destructive consequences of war and creating conditions for Ukraine’s sustainable development in a post-war period should rely on balanced and well-founded public expenditure policy. Experience of war-torn countries highlights the strong and indispensable role of public finances in restoration and modernization of public sector, as well as recovery of private assets.
World Bank estimated that in Ukraine about 80% of the short-term economic and humanitarian needs would need to come from public financing. This includes obligations related to recovery and reconstruction of assets within the public sector, implicit support of private assets for humanitarian reasons, and the need to kick-start recovery in the industry, trade and agriculture (The Ukraine Rapid Damage and Needs Assessment).
A range of reconstruction challenges that requires a substantial part of budgetary financing is represented by:
- recovery and upgrading physical infrastructure, in particular, transport infrastructure and energy distribution network;
- social rehabilitation of war’s victims, restoration of social infrastructure and social services to population;
- repairing and rebuilding the housing stocks;
- rebuilding the network of education and health care facilities, optimized for new needs, and resuming reforms in the education and health care systems;
- recovery and modernization of the industrial facilities, generation of new employment and support to small and medium-sized enterprises (SMEs);
- rebuilding the damaged agricultural assets, land de-mining and recultivation;
- strengthening institutional capacity of government and increasing the quality of state governance;
- extension of production capacities and formulation of the state orders for military-industrial complex.
In view of deficit of domestic resources in the economy, devastated by war, adequate foreign aid has a vital importance for successful reconstruction in Ukraine. With a high probability foreign aid will be allocated to Ukraine’s economy via two main channels:
(i) augmenting Ukraine’s own budgetary capacity for financing national reconstruction program (when foreign funds will be disbursed to budget directly);
(ii) supplementing Ukraine’s national programs with certain projects and programs, funded and monitored by external donors.
Prior to the war a share of consolidated budget expenditures in GDP ranged from 33,8% in 2021 to 37,8% in 2020. Major categories of expenditures recorded a downward trend, except spending on health care (driven by COVID-19 pandemic) and spending on economic activity (determined by boom in road constructions and repairs).
Russian invasion of Ukraine reversed the major trends in the trajectory of сonsolidated budget expenditures: they went up from 33,8% in 2021 to 57,7% of GDP in January-August 2022. However, this rise in expenditure was almost entirely due to the funding of defense, public order and security. Along with dramatic decline in real GDP, these functions accounted for almost half of the total expenditure and were equivalent to 27,3% of GDP. All other functions of government experienced slight increase in funding as a % of GDP but declined in real terms.
Before 2022 Ukrainian Government financed social protection system out of budget in a range of 6,7% – 8,7% of GDP. Rising unemployment and millions of internally displaced persons (IDPs) put an upward pressure on social expenditure in 2022, that approached 10,5% of GDP in January-August. In 2023 social spending, presumably, would be high with estimated level of 9,1% of GDP. Subsequently, this ratio may be reduced to 8,4-8,5% of GDP in view of expanding Ukraine’s GDP and minor reduction in demand for social assistance.
The main components of transforming social protection system in Ukraine in a time of war and post-war period would be:
- growth in payments to vulnerable categories such as newly impoverished and IDPs;
- driven by war rising payments such as survivor’s benefits or benefits related to disability;
- launching the programs of benefits to members of the military and families who lost a relative in combat, as well as war veterans’ pensions;
- expenditure on rehabilitation of war-affected groups, such as orphans, IDPs, and persons with disabilities;
- special incentives for restoration of the lost jobs – mobility grants, settling-in grants, wage subsidies for the employers.
Post-conflict experiences in other countries suggest that needs for financing military and war veterans’ pensions may be significant. The same is true for benefits to members of the military and families who lost a relative in combat, and loss-of-life compensation for civilian deaths.
Ukraine’s National Recovery plan in part of social protection is quite ambitious and requires huge amounts of public funds. Bosnia and Herzegovina (BiH) experience indicates, that foreign donors may assume some types of social obligations and fund them with their own resources. It’s relevant for such programs as rehabilitation of war victims, emergency demobilization and reintegration, public works and employment. In BiH case these programs consumed 5,1% of the total development assistance.
For the remaining social programs in Ukraine (under the direct responsibility of Ukraine’s Government) adequate financial resources will be lacking with high probability. Therefore, the Government will replace partially the programs existing before the war and will set up the new challenging programs in the social sector.
According to the World Bank and European Commission Report, housing recovery and reconstruction needs amounted to USD 69 bn as of June 1, 2022. 817 ths. residential units (apartments, single family houses, and dormitories) were damaged by the war.
International practise distinguishes three main kinds of activities aimed at recovery of the housing sector:
- repair support for partially damaged housing units;
- rental subsidies for vulnerable households;
- reconstruction of fully destroyed housing units.
Ukrainian government intends to use universal approach for subsidizing current repairs and reconstruction of housing, covering all affected households (as reflected in the National Recovery plan). However, the World Bank experts emphasize that in view of limited public resources and extensive recovery needs, it is necessary to define a set of prioritization criteria for investments and subsidies. Such selective approach would allow targeting the most affected population and prioritizing vulnerable households.
We expect that foreign donors would take the significant part of responsibilities for funding reconstruction of fully destroyed housing units and, to some extent, for funding repairs of partially damaged housing units with involvement of both international and local contractors. With regard to the rental subsidies and provision with temporary housing (shelters) it would be the sole responsibilities of the local governments. We project that budgetary financing of the function “Housing and communal amenities” will rise from 1% of GDP in 2021 to 2,5% in 2023 and 1,8-1,9% in 2024-2025.
In 2017-2019 Government financed road construction and maintenance in a range of 1,4% – 1,7% of GDP. Over 2020-2021 budget expenditure on this function increased dramatically: up to 3,2% – 3,4% of GDP. In January-August 2022 relative volume of this type of expenditure declined again. At the reconstruction stage additional financing needs for this sector would sustain and we project the level of its budgetary financing at 3% of GDP approximately over 2023-2025.
The challenging goals for recovery and transforming transport infrastructure in Ukraine over the medium-term are:
- performance of works related to rehabilitation of roads, restoration of road-, rail- and air- network functionality;
- extension of basic infrastructure network to support the broader reconstruction efforts across sectors, that rely on transport services;
- enhancement of westward road and rail linkages to the EU in order to promote economic integration with the EU and provide resilience to possible future disruptions of sea access;
- transformation of the infrastructure networks toward the EU standards for safety and service quality.
According to the World bank assessments, damage in Ukraine’s transport sector is large (USD 29,9 bn) and indicative of the strategic value that aggressor have placed on transport networks. Transport sector reconstruction is estimated to require USD 73,8 bn.
The scope of investments needed for infrastructure reconstruction is certainly beyond the budgetary capacity of Ukraine’s government. Foreign assistance in the form of grants, loans, and guarantees is foreseento augment the financial capacity of Ukraine. BiH experience suggests that reconstruction of the transport routes was a priority area for foreign donors which released 18% of total development assistance for this purpose.
In addition to external sources, the user charges are expected to support investment and long- term sustainability of transport infrastructure. Large-scaled investments will also require extension of public-private partnerships (PPPs). A key prerequisite for PPPs will be streamlining legislation and simplifying the selection and approval procedures for those PPP projects which will become a part of the reconstruction process.
Over 2015-2021 budgetary financing of energy sector was in a range of 0,1% of GDP with a major share consumed by the subsidies to coal industry. In a war time and first recovery years the energy sector companies will have to rely on government support for emergency repairs of equipment and liquidation of the shortages of fuel, spare parts, and tools in order to secure the provision of electricity, gas, and heating services to population.
The challenging goals for recovery and transforming energy sector in Ukraine over the medium-term (that would require budgetary funding or various mechanisms of state aid) are:
- repairs of damaged equipment and financial support for the purchases of fuel, spare parts, and tools, that are necessary for production of electricity, gas, and heating services;
- rebuilding of destroyed energy generating plants and district heating infrastructure with application of modern and more efficient standards;
- diversifying gas supply and integration with European gas markets;
- increasing capacity and security of the nuclear energy (new blocks at nuclear power plants, new safety standards, sustainable uranium mining).
Energy sector reconstruction would require not only the budgetary financing, but also a powerful support of foreign donors in the form of grants, loans, equity and guarantees. In BiH recovery of the energy sector was a considerable component of aid-driven reconstruction. Foreign donors allocated 13,3% of total financing for the emergency recovery of electric power-generation stations and reconstruction of gas distribution network. Apart from the foreign support, attraction of the private capital and promotion of the PPP schemas would be necessary for successful Ukraine’s reconstruction.
Prior to the war Ukrainian Government financed education in a range of 5,7% – 6% of GDP. Declining real GDP of 2022 raised this ratio to 6,3% of GDP. In a post-war period, taking into account numerous challenges and emergency needs, allocations of the budgetary funds for educational purposes is likely to be moderate. We forecast the level of budgetary financing of education at 6% of GDP in 2023 and at 5,4-5,5% of GDP over 2024-2025 (See Table 1).
Table 1: Dynamics of Consolidated budget expenditure, % of GDP
|Categories of expenditure||2019 actual||2020 actual||2021 actual||2022 Jan.-August||2023proj.||2024proj.||2025proj.|
|General state functions (excl.debt service)||2,1||2,0||1,7||2,8||2,7||2,0||1,9|
|Public debt service and GDP-warrants||3,0||2,9||2,9||2,8||4,6||6,6||6,1|
|Public order, safety and judiciary||3,6||3,8||3,2||8,3||5,8||4,5||4,0|
|Housing and communal amenities||0,9||0,8||1,0||0,7||2,5||1,9||1,8|
|Culture, arts and sports||0,8||0,8||0,8||0,7||0,6||0,5||0,5|
|Social protection and social provision||8,1||8,2||6,7||10,5||9,1||8,5||8,4|
|of which: transfer to Pension fund||4,6||4,8||3,7||4,0||3,9||3,7||3,7|
|other social protection expenditure||3,5||3,4||3,0||6,5||5,2||4,8||4,7|
Source: author’s projections and Ministry of Finance actual data.
The challenging goals for recovery and reforming education system in Ukraine over the medium-term are:
- rebuilding the network of education facilities, optimized for current student needs and efficiency gains;
- purchases of education materials for replacing those lost or damaged during the war;
- resumption of reforms in the education system, targeted at the increase in quality and efficiency of education.
Essential task in the first years of reconstruction is observance of the new safety and sustainability standards in education sector. This means that all affected or vulnerable institutions has to be equipped with bomb shelters and improved educational equipment (electronic devices).
An important task in rebuilding the sector is optimization of network of educational institutions. In locations that have been severely affected by war, rebuilding educational network has to take into account long-term trends in population movement and displacements, so that critical public investments are based on the “new” needs of specific locations.
Experience of post-conflict BiH suggests that foreign donors allocated some funds for recovery of the education sector, which amounted to 5% of the total development assistance. In Ukraine foreign aid is likely to be essential for carrying out energy saving measures and observance of the modern safety, sustainability, and quality standards in the educational institutions. However, a significant part of post-war recovery and reconstruction needs in education system would be primarily the obligation of the central government and local governments in Ukraine.
Before the russian invasion Ukrainian Government financed health care sector in a range of 3,3% – 4,2% of GDP. Warfare and a large number of injured people increased the needs in public funds in 2022. At the reconstruction stage additional financing needs for health care would sustain, however, financial constraints would force the government to maintain the ratio of health expenditure. We project the level of budgetary financing of health care sector at 3,6-3,7% of GDP over 2023-2025.
The challenging goals for recovering and transforming health care sector in Ukraine over the medium-term are the following:
- rebuild and repair health care entities in an efficient, climate-neutral and digitally enhanced manner;
- rebuild health care facilities network, in a way that is compatible with a new model of medical services provision and financing on the basis of “money follow the patient” principle.
Experience of post-conflict reconstructions in other countries shows that foreign donors don’t tend to disburse impressive amounts of funds for health care sector (except for emergency assistance and rapid response actions). In BiH the whole reconstruction program included foreign financing of the health care sector (project “Essential Hospital Services”) in the amount of 1,8% of the total foreign assistance. Thus, the major part of post-war recovery and reconstruction of the health care sector is likely to fall on the central and local budgets of Ukraine.
While planning future expenditure, Government is to provide needed financing for the restoration of medical services delivery. Under the conditions of war-fare the provision of basic care was discontinued for many citizens of Ukraine, and some efforts are required to reconnect people with health care providers.
In 2015-2021 Ukrainian Government spent equivalent of 2,4-2,9% of GDP on defense from the budget. Since the outbreak of russian invasion, budget expenditure on defense increased sharply and approached 18,2% of GDP over January-August 2022. In addition, as of October 3rd Western partners committed military aid to Ukraine in the magnitude of EUR 37,5 bn that is equivalent to 28% of GDP. In a draft budget-2023 budget appropriations for defense needs amount to UAH 870 bn that is equivalent to 13,6% of GDP.
After the end of russian war realistic forecast of budgetary allocations for defense and development of military-industrial complex would amount to 6,5% of GDP roughly in the course of 2024-2025. International experience suggests that war-torn countries, countries under the threats of military attacks and involved in military operations distribute 4,2-7,6% of GDP of the budgetary funds on the defense purposes (see Table 2).
Table 2: Countries with highest ratios of budget expenditures on defense
over 2000-2019 (ten subsequent years of highest ratios), % of GDP
|Country||1st year||2nd year||3rd year||4th year||5th year||6th year||7th year||8th year||9th year||10th year||Eve-rage|
Source: composed by author on the basis of IMF’s COFOG database.
For strengthening and development of the defense industry the National Recovery Plan prescribes a design and implementation of the state targeted programmes of weapons development and military-industrial complex modernization, including a production of: armoured vehicles; high-precision weapons; aircrafts; radio communication; artillery, anti-tank and anti-ship weapons; radar systems, ammunition and special chemicals; missile weapons.
In addition to state targeted programs, the Government would extend significantly the state procurements for covering defense needs. As compared to the pre-war time, the scale of state such procurements has to be increased by several times.
Public-private partnership projects and private investors participation in the building-up of the modern military-industrial complex are to play an important role too. Important measures for modernization and improving the provision for national armed forces are:
- establishment of the legal instruments for efficient operation of the state-private partnership and of joint ventures in the interests of national security and defense;
- extending the scope of the Law of Ukraine “On Industrial Parks” and application of other instruments of state support and targeted incentives for development of the military industrial complex.
Projected indicators of budgetary financing across the function of government over 2023-2025 period are summarized in Table 1. These indicators are based on our own assumptions related to the priorities of post-war recovery and reconstruction, assignments of some responsibilities for financing by foreign donors and international institutions and availability of overall financing in the form of collected revenues, released foreign grants and loans.
Currently the EU institutions are ready to support financially the four major pillars of reconstruction:
· rebuilding the infrastructure, health services, housing and schools, as well as digital and energy resilience in line with the most recent European policies and standards;
· modernising the state and its institutions to ensure good governance and respect for the rule of law;
· promoting sustainable and inclusive economic competitiveness, sustainable trade, and private sector development, contributing to the green and digital transition of the country(https://reliefweb.int/report/world/communication-commission-european-parliament-european-council-council-european-economic).
Except project financing with a focus on above priorities, a part of donor financing is to be directed toward Ukraine in the forms of budget support. In such a way aid-driven post-war reconstruction of Ukraine would be partially financed through national budget under the direct responsibility of national institutions.
International experience suggests that in the reconstruction process external donors and international organizations should work through national institutions to the extent possible, reinforce internal abilities and avoid trying to replace existing administrative capacities. Working with national institutions and cultivating national ownership would ensure the best positive outcomes and sustainability of the reconstruction efforts.