OUTLOOK 2023: Ukraine

OUTLOOK 2023: Ukraine
Ukrainian President Volodymyr Zelenskiy has been adamant that no talks can start until Russia quits Ukraine’s territory entirely / bne IntelliNews
By Ben Aris in Berlin January 31, 2023

This outlook is part of bne IntelliNews' annual series of reports looking ahead to what 2023 holds for the countries in our region. Read the full report here or download the pdf at the bottom of this article.

Since the war began, Ukraine has collected about $32bn in macro-financial aid. According to Prime Minister Denys Shmyhal, Ukraine needs $38bn in 2023 to cover the budget deficit and another $17bn to implement rapid reconstruction projects. He added that the EU has promised €18bn in macro-financial aid, and the US will allocate €13bn. Also, the start of the IMF programme to finance Ukraine is anticipated by the end of the first quarter. 

Attracting macro-financial aid is one of the main directions of diplomatic work to strengthen Ukraine's internal capacity, the prime minister of Ukraine added. 

Shmyhal also emphasised the need to create the diplomatic corps to expand Ukrainian exports, which have decreased by more than 30% in 2022. He believes that it is necessary to strengthen work with traditional export markets and to expand the geography of trade and economic co-operation with the countries of Africa and Latin America.

In December European Commission President Ursula von der Leyen accidently revealed the cost to Ukraine of the war in a speech. “It is estimated that more than 20,000 civilians and 100,000 Ukrainian military personnel have died to date,” she said. The comment drew a sharp backlash and the EC later deleted the comments from video recordings of the address. Bankova has made casualty figures a state secret, but von der Leyen’s comment shows just how much Ukraine is paying for Russia’s invasion. Prior to the war, in the eight years of fighting in Donbas against separatists Ukraine had lost a total of some 14,000 people.

Despite the death toll, Ukrainians remain almost universally committed to continuing the war until they win. Ukraine has some million people (many women have also volunteered, and for frontline duty too) in uniform, with several hundred thousand in active service in the fight. They face around 400,000 Russians serving in the Russian army, but with a new mobilisation being prepared – probably for around April when the weather improves – this war could last for years.

Ukraine has lost an estimated 20% of its territory. At least 22% of Ukrainian farmland is under Russian control. These areas are a large part of the territories identified in the Minsk II agreement that would have been governed as autonomous districts. Due to the failure of the Minsk II agreement, Russia launched its “special military operation” to free these areas from the grip of the Ukrainian government. As of today, it appears Russia has come close to achieving some of its initial goals.

Leaders in the West are starting to wake up to the fact that this war could drag on for years.

Ukraine’s economy has been devastated by the war with Russia and at the start of 2023 the situation has only been getting worse as Ukraine’s power and heating infrastructure have been targeted.

Economic forecasts have steadily worsened in December. Mid-year forecasts for an economic contraction of 30-35% have been increased following the disabling of the power sector, with some economists forecasting a 50% contraction and another 10% next year, depending on the development of the war.

However, the official forecasts are slightly less apocalyptic: Ukraine's GDP will grow by 1% in 2023, according to an IMF’s macro forecast. “Economic activity is expected to stabilise in 2023, with economic growth of 1% under the baseline scenario after the economy contracted by 33% this year," IMF mission chief Gavin Gray said. In addition, the fund predicts that the annual inflation rate in Ukraine will remain at an average of 25% next year.

In its forecast in September, the EBRD also thought Ukraine’s economy would shrink by 30% this year but would grow by 8% next year; but that was before the Russians started bombing the power plants.

The Bloomberg consensus says Ukraine will have -34% growth in 2022, which makes sense given the Q2 GDP collapse. It also says 2023 growth will be +5%. For that you need +33% Q4/Q4 2023 growth, i.e. immediate end to war and then a big boom to overcome a huge negative base effect.

Estimates of the cost of physical damage have also risen from around $100bn mid-year to some $400bn in November and new forecasts of up to $630bn by some analysts in December.

There is no way that Ukraine can pay for this reconstruction and currently it can’t even pay for the maintenance of its own economy. The government forecast revenues of some $36bn equivalent in 2023, but that is only a third of what it has as budget spending. The forecast deficit is $38bn, which the West has promised to cover. Finance Minister Sergey Marchenko has said just one-third of Ukraine’s budget revenue comes from domestic sources, while the rest consists of foreign grants and loans. Even if the war were to end soon, Ukraine will be heavily dependent on international aid for years to come. A new comprehensive IMF programme is due to be agreed in the spring but even this will be a moving target.

Poverty due to the collapse of the economy was already in double digits in the second half of 2022 and the World Bank estimates it could rise to 50% in 2023.

Labour shortages were already an issue after some 3mn Ukrainians left the country prior to the war to look for better paid work in neighbouring countries such as Poland and Romania. However, after the war broke out an estimated additional 7mn people have left and recent polls say that a third of them don’t intend to return. On top of that, Ukraine was already suffering from a demographic crisis that will only get worse now.

The economy is struggling with a massive trade deficit, reliant on international aid to shore up its FX reserves, which had fallen to $25.2bn in December. The hryvnia has already been heavily devalued, but analysts expect the National Bank of Ukraine (NBU) to allow further depreciation of the hryvnia in the first half of 2023 as the financial crisis deteriorates.

With business on its back the budget is now entirely dependent on external aid. The Ministry of Finance estimates next year’s deficit will reach $38bn and Ukraine’s Western allies have said they will cover all of this. But again, as the economic situation continued to deteriorate further in December, bigger estimates of the deficit were already appearing, with some saying the deficit could reach $50bn in 2023, creating the need for more funding to be raised from partners.

Public expenditures have been driven by defence and essential social spending and have led to an unprecedented fiscal deficit of about 20% of GDP in 2022. Since the war began until the end of October, Ukraine has disbursed $23bn in financial assistance to the population.

The EU has confirmed it will provide Ukraine with €18bn in 2023, distributed in tranches of €1.5bn per month, according to Prime Minister Denys Shmyhal. At the same time, the USA has promised to match the EU and send $9.8bn in 2023, bringing a combined $28.7bn. Other donors like the International Monetary Fund (IMF), World Bank and other multilateral agencies have all promised more funds.

There is still no sign of peace talks starting any time soon. The initial attempt in March and April came close to striking a deal, but after that failure the two sides have too much distance between them to be able to come to the table. In November and December the Kremlin signalled that it was ready to start talks, but Ukrainian President Volodymyr Zelenskiy was adamant that no talks could start until Russia had quit Ukraine’s territory entirely – a position the Kremlin rejected out of hand.

Negotiations could start in the New Year as a certain Ukraine fatigue was appearing in November, according to the US, as the cost of the war and the associated polycrisis it has fuelled start to weigh on Europe. The cost-of-living crisis in the West has already spurred demonstrations, although the energy crisis in 2022 seems to have been contained as Europe’s gas tanks were filled to the brim by the start of the heating season. However, energy analysts are already warning that the energy crisis in the winter of 2023 could be even worse. Russia sent the EU 60bn cubic metres of gas in the first half of 2022, but since the two Nord Stream pipelines were blown up in September the volume of gas Russia can send will be dramatically reduced. The International Energy Agency (IEA) forecasts that Europe will go into next year’s heating season with a 30 bcm deficit that will cause an even bigger energy crisis.

Political outlook

There is little in the way of politics at the moment as the situation is politically frozen by the war. Ukrainian President Volodymyr Zelenskiy is fully focused on keeping the aid and arms from donors flowing. The population is solidly behind the president and determined to fight to the bitter end to expel the Russians, come what may.

Bankova’s main worry is if the Ukraine fatigue increases during 2023 as the economic impact of the war starts to do more damage in the West, stoking opposition to the war.

At the same time, the sanction efforts on Russia are running out of steam as differences within the EU become more apparent. A ninth package of sanctions was approved on December 16, but it contained little of effect, focusing mostly on personal sanctions on some 200 government, media and business personalities. Sanctions on fertiliser exports were specifically watered down to allow Europe to continue to import Russian fertilisers. The Hungarian delegate to the negotiations said that energy issues – including the price caps on oil and gas – were taken off the table at the start of the talks as they were too divisive.

It is hard to see how much more the West can do to harm Russia. Most of the sanctions being imposed now boomerang back on the EU and can do more damage to Brussels than they do to Moscow. However, in the long term the sanctions already imposed on Russia are going to be devastating. The problem is they need time to take effect, and that is time that Ukraine, being pounded every day by Russian missiles, doesn’t have.

As up to now the West has mainly sent Ukraine defensive weapons, especially air defence, the chances of a victor currently seem slim unless Russia’s morale collapses and it withdraws. The chances of that also look slim following the appointment of General Sergey Surovikin in October, who is taking a much more defensive approach and has been digging in for winter. Moreover, in December half of the new 300,000 conscripts from September’s partial mobilisation had arrived on the front line and the other half were being kept as reserves.

One possibility that could end the war is if both sides come to see it as unwinnable by military means. Then diplomacy is the only way out. By November it seemed that the Kremlin was starting to think this way as it signalled it was ready for talks. However, with the liberation of Kherson still close in the rear-view mirror and the stunning successes of the Kharkiv offence in September, neither Zelenskiy nor the people are close to giving up on the fight.

Russia’s tactics to take out the power and heating as winter closes in are clearly designed to demoralise the population and push Bankova towards coming to the negotiating table. But at the time of writing making any sort of prediction remains impossible.