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Inflation rates in Ukraine are still significantly higher than in the USA and the EU

For January-November 2022, the current account of the balance of payments was positive and reached USD 8.5 billion, while in the same period of 2021 there was a negative balance of USD 2.8 billion. The current account surplus was driven by an increase in current transfers due to grant supportand humanitarian aid received from international partners and a reduction in dividend payments and interest on loans. On the other hand, the deficit of the trade balance rose from USD 1.8 billion to USD 20 billion while there was a dramatic decrease in both exports and imports. However, the goods tradedeficit more than doubled to USD 12.1 billion, and the surplus of trade in services turned into its deficit and reached USD 8 billion. The main reason for this change was the expenses of Ukrainian refugees abroad of USD 13.8 billion (which were included in the import of services).      

The current account surplus of USD 8.5 billion means that Ukraine received more income than it paid for current operations with non-residents (see table). The net position of Ukraine in terms of external assets increased by the same amount.    

Table. The main aggregates of Ukraine’s balance of payments for January-November of 2021 and 2022, million USD     

Description11 months of 202111 months of 2022
Current account-2 7978 450
Goods and services (net)-1 814-20 049
   Goods (net)-5 318-12 055
Exports of goods56 74837 626
Imports of goods-62 066-49 681
   Services (net)3 504-7 994
Exports of services16 43714 554
Imports of services-12 933-22 548
Compensation of employees (net)12 32112 409
Investment income (net)-17 495-4 090
Current transfers4 19120 180
Financial account2 904-11 903
Direct investment (net)6 566285
Portfolio investment (net)1 050-1 845
Trade credits of residents-1 029-10 520
Foreign credit and loans, liabilities1 29011 887
     general government and NBU93112 990
    banks and other sectors359-1 103
Foreign cash outside the banking system-4 754-10 266
Overall balance121-3 428

Source: compiled by the author according to the National Bank of Ukraine.

For 11 months of 2022, the value of exports of goods from Ukraine decreased by 33.7%, and imports decreased by 20%. The exports declined the most in the following goods categories: ferrous and non-ferrous metals (by 60.5%), mineral products (by 47.3%), chemicals (by 44.2%), manufactured goods (by 39.2%), machinery and equipment (by 38.6%).  The main reasons for this situation aredestruction of production facilities and energy and transport infrastructure, disruption of foreign trade logistics, termination of economic ties with the aggressor, partial loss of labor force as a result ofemigration and mobilization.         

As part of Ukraine’s merchandise imports, the import of ferrous and non-ferrous metals and their products fell the most – by 40.3% compared to January-November 2021. The imports of timber and wood products, machinery and equipment imports and chemicals also significantly decreased.        

Under the conditions of Russia’s armed aggression, the share of the CIS countries in the export and import of goods to Ukraine quite expectedly decreased, while the share of the EU countries increased rapidly. For example, in the geographical structure of goods exports, the share of the EU increased from 32.9% in November 2021 to 67.1% in November 2022. And the share of CIS countries in Ukrainian imports decreased from 24.3 to 2.7% for the same period.

The export of services from Ukraine fell by 11.5% for this period, while the import of services rose by 1.7 times. The largest increase in imports was recorded under the “personal travel” –  from USD 2.3 billion to USD 13.8 billion, which is due to the increase in Ukrainian immigrants’ expensesabroad. The number of Ukrainian immigrants in the EU, who left Ukraine after February 23, is already close to 8 million people.

The inflow from wages received by Ukrainians abroad did not change significantly compared to the previous year: USD 12.4 billion against USD 12.3 billion. That is, Ukrainians continued to actively work abroad and support their families and the country’s balance of payments with their remittances.

However, the outflow of currency under the “investment income” decreased three times – from USD 11.8 billion to USD 3.8 billion (excluding reinvested earnings). This was due to the official suspension of payments for the service of external public debt, the decrease in the return on foreign investments in the war economy, and the introduction of currency control measures after February 24.

In 2022, foreign grants and humanitarian aid (or current transfers) received from international partners were one of the most significant items of supporting the balance of payments. They reachedUSD 22.6 billion and were 3.5 times higher than last year. Almost 60% of current transfers went to the general government sector.

The current account surplus of approximately 7.1% of GDP was combined with a large-scale budget deficit, which reached 19.2% of GDP. This was evidence of a violation of the well-known in theory phenomenon of twin deficit, when the budget deficit fuels the current account deficit through the increase in imports and aggregate demand. The main factors of the abnormal situation in Ukraine (huge budget deficit and current account surplus) were significant private savings, including foreign ones, and minimal private investments in the economy of Ukraine.

In general, the main items of inflow of foreign currency to Ukraine according to the balance of payments were (see Figure):

current transfers from non-residents (USD +20.2 billion);

foreign loans received by the general government (USD +13.1 billion);

balance of resident- non-residents compensation of employees (USD +12.4 billion).  

Figure. Main components of inflow and outflow of foreign currence, January-November of 2022

Source: compiled by the author according to the National Bank of Ukraine.

However, there was a significant outflow of foreign currency for the following items of the balance of payments:   

the difference between export and import of goods (USD -12.1 billion);

trade credits provided by Ukrainian exporters to importers (USD -10.5 billion);

purchase of foreign currency by residents of Ukraine and its increase in non-bank circulation (USD -10.3 billion);  

negative balance of services (USD -8 billion).

Since the beginning of the war, there has been a huge increase in the trade credits provided by Ukrainian residents to non-residents – from USD 1 billion for 11 months of 2021 up to USD 10.5 billion for 11 months of 2022. This situation indicates that Ukrainian exporters do not want to return foreign exchange revenues to Ukraine during the war. But this behavior is one of the factors in maintaining the balance of payments deficit. The logical reaction of the government and the NBU in this situation should have been to strengthen currency regulation measures, which, unfortunately, is not happening.         

The deficit of the financial account of the balance of payments was USD 11.9 billion, even while the public sector experienced large-scale foreign lending. For comparison: the surplus of this account was USD 2.9 billion for 11 months of 2021. The main factors of the deficit in 2022 were the large-scale outflow of foreign capital from the private sector and the accumulation of foreign assets by residents of Ukraine. The outflow of foreign currency under portfolio investment and other private sector investments amounted to USD 2.4 billion. And the increase of foreign currency in non-bank circulation of Ukraine reached USD 10.2 billion.     

The public sector of the economy became the net recipient of funds within the financial account, which received USD 11.6 billion (net) against USD 0.8 billion for January-November 2021. The net credit resources in the public sector in 2022 amounted to USD 13.1 billion. Totally from January 1 to December 27, gross lending and grant support of the budget by foreign donors reached USD 30.8 billion.     

The most significant financial assistance to the government was provided by the US administration, which allocated almost USD 12 billion in the form of grants. The financial support from the EU (USD 8 billion) came mostly in the form of loans. In 2023, the EU pledged to allocate EUR 18 billion to Ukraine, but again through the loans. It seems that the EU governing bodies are diligently protecting their budget from “non-productive”, in their opinion, expenses for the benefit of Ukraine.      

Other creditors and donors of Ukraine were the IMF (USD 2.7 billion), Canada (USD 1.9 billion), Germany (USD 1.6 billion), the World Bank (USD 1.1 billion), Great Britain (USD 1.1 billion), the European Investment Bank (USD 0.7 billion) and others. The share of grant funds in the total financial support of the Government of Ukraine was 45%.        

The military invasion of Russia and the dramatic increase in country risks have closed the access of the national economy subjects to the resources of the international capital market. As a result, the private sector suffered an outflow of funds from the financial account in the amount of USD 23.5 billion. This indicator signals the high vulnerability of Ukraine’s balance of payments in terms of financial transactions and its significant dependence on attracting external official financing.

The positive current account balance of USD 8.5 billion and a significant negative financial account balance of USD 11.9 billion formed a negative overall balance of payments of USD 3.4 billion. This balance was covered by net IMF loans (USD 0.8 billion) and foreign exchange interventions from Ukraine’s international reserves (USD 2.6 billion). Furthermore, the decrease in international reserves was not critical, as of December 1, the international reserves amounted to USD 28 billion. This volume provides financing for the import of goods and services for 3.5 months, but is insufficient according to the IMF composite criterion.    

In 2023, the stabilization of Ukraine’s balance of payments and the reduction of the external vulnerability of the economy will require the state and the private sector to consolidate efforts to restore economic activity and export capacity, reduce the outflow of resources for purchasing cash currency by residents and providing trade credits to non-residents, as well as to continue their cooperation with international partners on financial assistance.    

The fixed exchange rate from the beginning of the war played a constructive role in maintaining macro-financial stability and preventing the devaluation-inflationary spiral. In 2023, maintaining the fixed exchange rate regime with the possibility of a one-time revision of the hryvnia exchange rate fixation parameters seems reasonable. Preventing the loss of price competitiveness of Ukrainian producers and suppliers requires taking into account the fact that inflation rates in Ukraine are still significantly higher than in the USA and the EU.   

Tetiana Bogdan, Scientific Director at the Growford Institute