Post Image

Bogdan Tetiana – Scientific Director of “Growford Institute”, Guest Researcher of Vienna Institute for International Economic Studies (WIIW)

Warfare and shrinking economy put a downward pressure on budget revenue. Total consolidated budget revenue decreased by 12,3% in real terms over January-July 2022 relative to the same period of 2021. However, foreign grants made up 15,7% of total budget revenue in 2022 and was close to zero in 2021. Having deducted foreign grants from total revenue, we see the real decline of budget revenue by 26% as compared to the same period of 2021 (see Table 1).

Excise tax, VAT on imported goods and import duty witnessed the most substantial reduction, that was attributable to collapse in imports at the beginning of war and to tax exemptions for imports, that was effective in April-June.

Table 1: Consolidated budget revenue 

in absolute and real terms in January-July 2022

Revenue indicatorsAbsolute volume, bn UAHReal growth rates relative  to 7 month of 2021, as a %*
Total revenue1022,5-12,3
Total revenue excluding foreign grants862,4-26,0
Tax revenue717,1-27,9
  Personal income tax218,0-14,0
  Corporate profit tax77,7-24,1
  Royalties for entrails utilization50,630,4
  Excise tax:57,2-54,6
     – on domesticaly produced goods28,2-52,2
     – on imported to Ukraine goods24,3-60,2
            – on domesticaly produced goods 131,815,2
            VAT receipts172,7-24,6
                VAT reimbursements-40,924,9
      – on imported to Ukraine goods118,4-53,8
  Import duty8,6-67,9
  Local taxes and fees47,4-29,0
                 Real estate tax20,1-39,5
        Single tax for enterpreneurs27,1-18,7
Non-tax revenue143,3-14,2
             NBU profit transfer18,8-42,3
    Own receipts of budgetary entities60,4-17,1
Official grants from the EU, foreign govern-ments, IFIs, donor entitites160,141997

Source: Ministry of Finance of Ukraine, author’s calculations. 

* real indicators are computed on the basis of GDP deflator over the last year. 

Tax revenue which are highly susceptible to economic conjuncture and domestic demand also experienced the sharp decline, among which: corporate profit tax, VAT, single tax for entrepreneurs. However, royalties for entrails utilization and VAT on domestically produced goods performed quite well. The last phenomenon was explained by freezing VAT reimbursement since the outbreak of war. 

In general, over January-July 2022 the government’s own revenue (tax, non-tax and capital collections) covered only 63,1% of the expenditure needed to run the economy and defend the country. As to alternative financing tools, 18,3% of expenditure was covered by NBU monetary financing; 11,7% by foreign grants and 14,2% by foreign debt accumulation. Meanwhile, net contribution of government domestic borrowing was negative.

Warfare and extraordinary challenges for Ukraine’s state brought about considerable shifts in public expenditure structure. Spending on defense, security and pubic order make up 50% of total budget spending over March-July. Chart 1 reveals the shares of public funding across functions of government in 2022 and their respective shares in 2021. We found that share of defense spending increased by more than forth-fold and share of public order and security spending by 1,5 times. Simultaneously, relative weights of expenditure on education, economic activity, health care and general state functions decreased dramatically.

Chart 1. Structure of consolidated budget expenditure in January-July 2022 

versus January-July 2021 as a % to total expenditure

Source: author’s calculations on the basis of Minfin data. 

Total consolidated budget expenditure in real terms went up by 15,1% over January-July 2022 as compared to respective period of 2021. However, deduction of expenditure on defense, public order and security out of total spending provides completely different picture. These remaining expenditure categories plummeted by 23,8% in real terms (see Table 2). Across functions of government spending on economic activity recorded a decline by 61,9%, environment protection – by 43%, culture, arts and sports – by 33,9%, government lending – by 84,9%. 

Table 2: Consolidated budget expenditure

in absolute and real terms in January-July 2022

Expenditure indicatorsAbsolute volume, bn UAHReal growth rates relative to 7 month 2021, as a %
Total expenditure1026,215,1
Total expenditure excluding expend. on defence, public order and safety565,9-23,8
General state functions (excluding debt service)33,4-31,8
Public debt service and payments on GDP-warrants69,2-13,5
Public order, safety and judiciary147,170,0
Economic activity37,2-61,9
Environment protection1,8-43,0
Housing and communal amenities12,9-6,6
Health care82,3-18,0
Culture, arts and sports13,4-33,9
Social protection and social provision193,6-5,8
Budget deficit258,61305,1

Source: Ministry of Finance of Ukraine, author’s calculations. 

Since the outbreak of russian aggression government financing needs increased tremendously and budget deficit approached 17% of GDP in the first half of 2022. Such deficit and rapid accumulation of public debt have been explained, to large extent, by revenue erosion and funding of the national armed forces. Public debt is projected to increase by 42,7% of GDP over 2022. These processes have been accompanied by heavy government borrowings, both from domestic and external sources. 

Table 3: State budget deficit and its financing, bn UAH

Indicators2021  7 month2022  7 month
Budget deficit and its financing18,4344,3
Gross borrowings304,8620,2
gross domestic borrowings238,3402,3
gross foreign borrowings66,5217,9
Net borrowings (excluding debt amortization)35,8356,1
net domestic borrowings-4,0162,3
net foreign borrowings39,8193,8

Source: Ministry of Finance of Ukraine, author’s presentation. 

State budget deficit and the main components of its financing are shown in Table 3. At a first glance, gross domestic borrowing seems to be the main contributor to deficit financing accounting for 2/3 of total financing. However, excluding public debt redemption enhances the significance of foreign financing. Over January-July 2022 net foreign borrowing makes up almost 55% of the total budget deficit financing.

Russia’s invasion has devastated the economy and exhausted public finance, under such conditions foreign concessional financing appeared as a considerable mean to bridge fiscal gaps. Since a start of the full-scale war Ukraine’s government has received USD 17,4 bn to budget in the form of external loans and grants (as of September 6, 2022).

Statistical data demonstrates that foreign financing was minor in April, May and June. However, situation improved radically in July and August, when the influx begins to take hold and Government received USD 5,5 bn in foreign grants and USD 1,6 bn in foreign loans. We should note, that a share of foreign loans in budget deficit financing constituted 58,9% in January-August 2022.

Altogether, Ukraine has been promised more than USD 33,5 bn in budgetary aid by the foreign donors. It implies that approximately USD 16 bn in foreign grants and loans will be provided to Ukraine over the last month of 2022 and first month of 2023. 

Chart 2 indicates the disbursements of foreign resources across the major donors since the start of the full-scale war. The most important donors which provided grant support to Ukrainian budgets are represented by the USA (released 6,99 bn dollars), Germany (EUR 1,0 bn), Italy (0,3 bn), UK (0,13 bn) and European Union (EUR 0,13 bn).

Chart 2. Foreign grants and loans across the creditors (donors) 

in January-August of 2022, bn USD

Source: author’s calculations on the basis of Minfin data. 

Among foreign creditors of Ukrainian Government, we should mention the EU (disbursed USD 2,28 bn), Canada (USD 1,5 bn), the IMF (1,4 bn), the World bank (0,9 bn), EIB (0,7 bn), Japan (0,6 bn) and the UK (USD 0,4 bn).

Thus, Ukrainian Government received quite substantial amounts of foreign financing from the collective West as a form of solidarity during the unprecedented war in Europe. However, this financing proved to be below what is needed to cover the large costs and implications of the war. Obviously, Ukraine needs substantial resources not only for future reconstruction, but even more urgently now for helping to withstand the struggle with an aggressor country and for keeping state’s capacity to provide public services.

In January-July 2022 gross domestic borrowings to budget exceeded foreign borrowing by two times almost: UAH 402,3 bn versus UAH 217,9 bn. However, the depth and liquidity of internal market for government bonds was limited, that forced Government and NBU to resort to monetary financing of budget deficit. At the end of August monetary financing amounted to 285 bn UAH and was equivalent to 13% of GDP for that period.

Table 4: Indicators of budget deficit financing

from domestic sources in January-July 2022

Domestic financing indicators2021 7 month2022 7 month
Gross domestic financingall types of creditors238,3402,3
borrowings from National bank0,0250,0
borrowings from other domestic creditors238,3152,3
Net domestic financing (excluding debt amortization), all types of creditors-4,0162,3
Net domestic financing without National bank -4,0-87,7

Source: author’s calculations on the basis of Minfin data. 

While gross domestic borrowing from all types of creditors amounted to UAH 402,2 bn, net domestic borrowing constituted 162,3 bn only. And this sum of net borrowing was more than provided by the NBU (see Table 4). Net domestic financing of budget deficit, excluding the NBU, was negative and reached UAH -87,7 bn over January-July. 

The major driving forces for such disappointing outcomes have been: the declines in real incomes of Ukrainian residents since the outbreak of war, negative real yields on government bonds, starting from April, lack of special channels of bonds floatation for retail investors, NBU’s placements among banks of highly profitable certificates of deposits, which compete directly with the short-term government bonds. 

Share of NBU loans in the structure of budget deficit financing (on the gross basis) approached 40% roughly in January-August 2022. With significant monetization of budget deficit, inflation has accelerated from 10,7% annually in February to 22,2% in July. The main determinants of inflation spike also have been the imbalances between supply and demand at the domestic markets, inflationary expectations and pass-through effect of devaluing exchange rate. Rising inflation and related uncertainty would erode hryvna savings, enhance dollarization of the financial flows and discourage private investments, devastating effects of which will be pronounced during and after the war. 

Another worrisome aspect is that attracting domestic and foreign loans the Ukrainian government is building up public debt burden, which would incur significant costs for the post-war economy, if not tackled in appropriate way. 

Our medium-term forecast suggests, that Ukraine will see its debt-to-GDP ratio shooting up in 2022-2023 from a modest ratio of 49,6% of GDP prior to the war. Public debt would reach a peak of 102,5% of GDP at the end 2023, that would imply a rise by 42,7 p.p. of GDP in the course of 2022 and by 10,2 p.p. in 2023. Our forecast also yields a pessimistic dynamic of government gross financing needs, whose magnitude would rocket from 11,6% of GDP in 2021 to 27,4% in 2022.

Overall, without corrective policy actions public debt is assessed as unsustainable. In particular, deep economic recession, sharp exchange rate devaluation and significant primary deficits would result in dramatic increase in public debt. As government has limited capacity to cut budget deficit during a war, logical responses to such outcome would be raising more foreign grants, attracting more official loans on concessional terms and restructuring of debt owned to euro-bonds holders.

Assessing Ukraine’s public finance perspectives, we have to proceed from depressed tax and non-tax revenues of government in foreseeable future, inability to borrow externally on the capital market and limited potential of the domestic capital market to absorb the public debt issuance. Under such circumstances Government must mobilize substantial resources to pay for extra-ordinary defense expenditures, as well as to assist the population suffered from the war. 

In general, the following trends have prevailed in Ukraine’s fiscal sector in a state of war:

  • erosion of domestic resource-generating capacities and a sharp decline in budget revenues – by 26% in real terms as compared to previous year;
  • logical for a war public expenditure growth (by 15,1% in real terms) and their reshuffling in favor for defense and security needs with offsetting cuts in spending for education, general state functions, economic activity and culture;
  • pronounced growth in budget deficit and attendant public debt build-up; debt is projected to reach 92,2% of GDP at the end of 2022, that imply an increase of 42,7 p.p. of GDP over 2022; 
  • closure of international capital market and substantial financial support, provided by official foreign lenders and donors; however, it was not sufficient for covering evolving fiscal gaps;
  • slack domestic market for government borrowings with negative net financing to budget and utilization of the monetary financing of budget deficit (in the amount of USD 9,3 bn over February-August 2022).

Through the first 6 month of war Government used such policy mix to maintain public finance and support the war efforts: printing money by central bank (seigniorage), foreign aid from western allies and cuts in non-military spending. For the future steady and sizable financial flows from abroad are needed to Ukrainian budget with simultaneous increase in the collections of tax revenue, further prioritizing non-military expenditure and decreasing reliance on seigniorage. Ukrainian government should also consider the possibility of introducing a progressive tax scheme for individual income or imposing higher war fee for income above the certain threshold. Any forms of “tax expenditure’ must be avoided (tax exemptions, tax reductions and holidays) for business and areas not directly affected by military actions.