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World Bank Economist Outlines Current, Prospective Support for Wartime Ukraine

In an exclusive interview with Kyiv Post, Karlis Smits, World Bank Lead Economist and Program Leader for Economic Policy for Eastern Europe (Belarus, Moldova, and Ukraine), explained the World Bank’s

Oct. 17, 2022

In an exclusive interview with Kyiv Post, Karlis Smits, World Bank Lead Economist and Program Leader for Economic Policy for Eastern Europe (Belarus, Moldova, and Ukraine), explained the World Bank’s ongoing support to Ukraine since Russia began its full-scale invasion. The focus so far has been on supporting the state budget and critical services, but future aid will depend on the extent of damage and on private foreign investment.

What assistance has the World Bank provided to Ukraine since the beginning of Russia’s full-scale invasion? Have the terms of cooperation with Ukraine changed?

First of all, the World Bank and its all staff are together with Ukraine in this difficult time. We have been fully engaged in helping Ukraine. Our terms have changed because of the urgency and critical essence of limiting the harm done to Ukraine, its people, and the government in these difficult times.

Our primary focus of assistance is continuity in providing government and public services. The government has continued to provide its functions based on the public sector, education, and health. Also, we understand the ability of the government to raise taxes and its ability to operate.

We provided budget support for government operations in the first week of Russia’s full-scale war. It is important to understand that people who have suffered as a result of the war and lost their homes require government assistance.

What projects in Ukraine are a priority for the World Bank? Is anything going on at the moment?

The priority is budget support operations and provision of resources to the government of Ukraine. With the help of donors, we mobilized $13 billion, and $ 11 billion has already been delivered to the Ukrainian government. It is very important to mobilize money and ensure that money gets to Ukraine on time to its Treasury Account. That throughout the Ukrainian budget, the government could fund the necessary needs.

So, our priority is to provide budget support and fund critical public services – public service, education, and health, because it is essential to maintain these functions.

How do you assess the Ukrainian economy? What are the forecasts?

There is an economic effect, but the most critical impact is on the people of Ukraine. There are no economic measures that can quantify people’s lives. The people of Ukraine are paying the highest price.

In terms of economic activity, the disruption of trade has affected the economy. The Ukrainian economy has been very severely hit. The first quarter has seen a very significant economic contraction of economic activity- around 45% in March. After the liberation of areas around Kyiv and Kharkiv, we observe signs of stabilization in large centers of economic activity. We thought the economy would contract by  about 45%, but we now believe it’s 35%.

No number can measure the loss, suffering, and pain of all of Ukraine. The most important thing is ensuring that Ukraine’s productive assets are preserved. The impact of the war is that Ukraine’s production assets, its capital, have been destroyed and will be replaced. The second important element of economic activity is the labor force. We have seen displacements internally. Once you have this disruption of capital, it is important for the ability of people to innovate and adapt.

Ukraine has demonstrated, despite these diversities, courage in economic activity in the business sector. Try to restore what you have in delivering services in this time of adversity —a lot of digital services that Ukraine provides, and it this important to maintain the continuation of these services.

The recovery process will be long, and it’s vital to restore internal and external access to the markets. Also, that it’s important to note that the economic war did not start in Ukraine on Feb. 24. There is a continuation of continuous economic deterioration from November of last year. Loss of confidence and access to the insurance market significantly impact the economy through difficulty in accessing capital.

Once the insurance market was dysfunctional, airlines couldn’t fly even before the war. The economic infrastructure was under stress even before the full-scale Russian invasion.

Are there special programs to cover military risks associated with doing business in Ukraine?

Insurance and de- risking are vital. If you are a business owner, then you have insurance, and these risks associated with the war are uninsurable. This market failure will need to be addressed because the private sector cannot price those risks. At the World Bank, we have the Multilateral Investment Guarantee Agency, which deals with these insurance issues. They are trying to help because it is an important issue in the shipping industry. Ukraine is shipping its grain and needs to have insurance. The insurance premium is high because of the increased risk. This is an example where there is a need for an innovative solution. There were many examples in the U.S. after the 9/11 terror attack, when the government stepped in to address a terrorist risk.

Is there any timeline yet for a solution to this?

We have to prioritize what stages are the most important at the moment. The primary focus is to provide budget support to ensure that the government functions.

Once the recovery and reconstruction start, insurance and de-risking would become the primary things that need to be addressed. Now there is time to think about this solution, because it requires time.

50 percent of the Ukrainian state budget for next year is based on international aid. Is the World Bank ready to support the Ukrainian government?

The World Bank is ready to support, and already supporting the Ukrainian authorities. The main issue for the next budget is that the needs of Ukraine are significant to finance and those of the government because income tax received is low due to the obvious reason [of war]. There is a huge budget deficit.

So, six months after the full-scale invasion started, Ukraine can cover that gap: by cutting government services, monetizing the Central Bank, and increasing taxes, but the price for that will be paid by the people of Ukraine. If you print money – there will be inflation, and if you cut government services, it’s a cut in critical support. Our message to the donor countries has been that “this is not a time to cut support for people of Ukraine, who are already paying a terrible price.” It is crucial to have donor support to limit the harm to the people of Ukraine.

This year donor support has been very significant –in the form of grants from the U.S. It is essential. For Ukraine to have additional debt is complicated because it has to be repaid. We have a challenge for next year to mobilize resources. It’s an important message that Ukraine needs resources now, not tomorrow.

Huge resources will be needed for reconstruction, but a lot of resources are required today for the government to finance critical public services. It remains significant, by our estimation, $3 to $4 billion every month in 2023. We’ve seen the first draft of the budget submitted to the Parliament, and it envisages 50% donor financing. We are working and advocate that these resources must be committed and disbursed on time.

If the resources are not committed, as I have said, the Ukrainian authorities will start printing money, which will cause inflation. The government has already made significant spending cuts since the war began, to cut more will result in a cut in critical support.

Do you have donor coordination? The U.S. government, the EU support Ukraine, the World Bank and other International Financial Organizations are willing to help. Is there mutual cooperation?

Yes, we do cooperate, and I will provide you with examples. The U.S. has committed a significant amount of resources, but the challenge to mobilize these resources from the U.S. Congress is the law to approve it and deliver to the budget. A lot of democratic countries that provide these resources require accountability that these resources are allocated to budget articles – health care, education, etc. The World Bank helps providing the channel for the resources from the U.S. to all existing projects where we finance health, education, and public administration in Ukraine.

We coordinate with the Ukrainian government to ensure that every dollar is spent efficiently – that gives comfort and confidence to donors and helps to mobilize additional resources.

It is very important to share information between donors about your needs and this conference in Lugano – a kind of coordination. It’s very important for donors to meet and talk to Ukrainian authorities because the government knows what particular needs are required.

Today (Sep.12), we will have a second-round table in Washington DC with the Ukrainian government to mobilize additional support to fund budget expenditures for next year. Reconstruction needs will also be discussed.

We want reconstruction to start on day two after the war ends. That is why we have to create a background for providing these funds.

Which reforms should, in your opinion, Ukrainian authorities implement?

Ukraine has a path to becoming a member of the EU. That is the anchor of how you do  reforms. The Ukrainian government should reform the economy to fully comply with EU norms. It has to be Ukraine’s driving force for reform.

Once we get to the post-war recovery period, we will see market failures because of the high risks for investors. Also, there will be an issue that the private sector will not be able to restore fully destroyed assets. For example, utility companies working on the market have their pricing, and costs and would need support.

There will be a certain period after the war when the government should step in and help the private sector. Also, when the government becomes bigger, it has a lot of risks in terms of corruption and efficiency. The goal of the reforms should be [provision of] efficient government services. Ukraine is already benefiting from the reforms of digital services implemented earlier. This is an excellent example, because it let the government continue to provide services to the population despite the war.

The reforms cannot be implemented from the outside. The driver should be the people of Ukraine and the government to implement it. It is not working when some from outside tell you what you have to do. Ukraine has made reform commitments for a long period, but it is not easy to achieve.

What about Ukraine’s recovery plan? Is the World Bank going to support Ukraine after the war?

If you look at history, what the World Bank established at the end of the Second World War with the unique mandate to help post-war reconstruction, it includes many things. The major one is reconstruction and development. These words are a priority for Ukraine – reconstruction and development.

We’ve already done the preliminary work, and for reconstruction, we need a damages assessment report, a kind of snapshot of what damage has been done. We don’t know what the nature of the recovery will be.

First of all, the private sector has to recover, and this is a priority. It is difficult because  domestic demand will be depressed after the war, so having external demand to support the private sector is critical. If you look at the Marshall Plan as an example, it consisted of many resources. Still, another essential element was providing access to markets and developing markets for export capacity.

The reconstruction recovery would need a lot of foreign savings from the government sector and official donors. Western balance sheets would be limited in providing many resources. Private sector help through foreign direct investments will be very critical. Ukraine’s accession to the EU will provide a path for foreign direct investment.