SOURCE: https://www.msn.com/en-us/money/markets/ukraine-battles-to-avoid-hyperinflation-as-war-costs-soar/ar-AA119Iix?ocid=msedgntp&cvid=c2615d36284c057833bcfd520f8afdbc

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Ukraine battles to avoid hyperinflation as war costs soar

Nik Martin, Deutsche Welle, Deutshe Welle, 8/27/22

Ukraine’s central bank has been de facto printing money to pay its troops, but the measure is unsustainable. More international support is vital, but how much new cash could be raised domestically?As the war against Russia enters its seventh month, Ukraine is stuck between a financial rock and a hard place as it seeks to stay afloat while fighting off Moscow’s invading forces.

Tax revenues have plummeted due to an economy in free fall while military spending has skyrocketed, leaving the government facing a budget shortfall of $5 billion (E5.02 billion) per month.

To make up for the lack of cash, the country’s central bank has effectively been printing money — buying government bonds to the tune of $7.7 billion over the past six months. The Financial Times reported that the printing presses effectively created $3.6 billion in June alone.

Runaway inflation could ‘destroy the economy’

With the war now likely to drag on indefinitely, the country faces the prospect of runaway inflation and possibly even hyperinflation — very high and accelerating inflation.

That would further erode the value of Ukraine’s currency, the hryvnia, which has already dropped by about a third. Inflation is up to 20% and is on course to hit 30% by the end of the year.

Earlier this month, a report by the London-based Center for Economic and Policy Research (CEPR) urged a “decreasing reliance” on money printing, or seigniorage, warning that Ukraine would likely face much higher inflation, a currency crisis and even a banking crisis if it continued.

“Money printing makes sense at the beginning of the war, when there is a lot of chaos, and allows you to raise money very quickly,” report co-author, economist Yuriy Gorodnichenko from the University of California, Berkeley, told DW. “But it’s not a sustainable solution. If you keep doing this, you’re going to destroy the rest of the economy.”

In 1992, shortly after the country’s independence that followed the collapse of the Soviet Union, the measure of price rises reached 2,000%. The country became the first in the world to witness such a massive inflation spike that didn’t result from conflict. Inflation also soared to 50% in 2014, when the war in eastern Ukraine broke out.

The CEPR report advised the Ukrainian government to raise taxes and seek additional foreign aid while reining nonmilitary spending — a policy that Kyiv implemented from the outset of the war. It also called for strict controls on capital outflows, restrictions on imports and more flexibility in the exchange rate.

Tax revenues have collapsed to about a fifth of their pre-war level and now cover about a third of the government’s expenditures. Money printing currently supports another third or so, while foreign loans, grants and local bond issues help meet the rest of the spending.

Faced with the prospect of further hiking taxes and import duties, Kyiv is mindful that businesses and consumers are already under a huge strain.

Economy hit hard by Russian invasion

Firms have been forced to close down in conflict areas and the flight of 5 million Ukrainians and military conscription for men has caused a brain drain, while unemployment has already hit 35%. Those remaining in war zones, displaced internally or suddenly made jobless also require financial support.

The prospect of an ever-weakening economy, along with fuel shortages, power or heating cuts this winter, could force many more firms out of business while testing public support of President Volodymyr Zelenskyy’s government.

The World Bank has predicted that 55% of Ukrainians will be living in poverty by the end of 2023, compared with 2.5% before the conflict.

Ukrainian government must make ‘painful’ choices

Gorodnichenko acknowledged that the recommendations would be “very painful,” but would be better than a lengthy war “creating high or even hyperinflation.”

The CEPR report said it was “wishful thinking” to expect Western countries to meet most or all of the government’s budget shortfall. But it also said support from Ukraine’s allies remained critical, “not only for the survival of the country but also for the future of the global order and security.”

Around $38 billion in financial support has been pledged by foreign governments and international organizations over the past six months, the Financial Times reported, citing Ukraine’s Finance Ministry.

A separate tracker by Germany’s Kiel Institute for the World Economy (IfW-Kiel) showed some E84.2 billion ($84.9 billion) in military, financial and humanitarian aid has been promised by around 40 countries.

The United States alone has pledged more than E8.5 billion in humanitarian and financial aid, while European Union institutions have made commitments to send E12.3 billion. But actual payments have been slow to arrive.

Only a quarter of the EU’s aid commitmenthas been dispersed, according the the IfW-Kiel tracker. Media reports say the delay is due to discussions about whether the aid should be in the form of grants or loans.

“The European Union is worried that Ukraine will be unable to repay the loan, which is a legitimate concern, but it should not be a loan, it should be a grant,” Gorodnichenko told DW.

War bonds could prove profitable

As Ukraine negotiates a fresh program of loans worth $15 billion to $20 billion with the International Monetary Fund (IMF), the government is also raising money from the public through war bonds — a measure that could be easily ramped up.

Ukrainians have already donated around $1 billion for the war effort from a fundraising drive without interest or any other incentive, Gorodnichenko said. Noting how Ukraine has a large shadow or unofficial economy, he said that too could be tapped.

“While it’s hard to know how much money is there, I imagine it is a significant amount and, in principle, people may be willing to pull money from under their mattresses to help to pay for this war,” the economist told DW.

While some Ukrainians have hidden wealth stashed away offshore or outside the banking system, millions of people are barely surviving on their remaining savings. Faced with soaring prices, unemployment and looming poverty, they may have no alternative than to hang on to their cash.