The Crisis of Military Keynesianism: Ukraine's economy, after a phase of military adaptation, faces almost the same problems as Russia's

Slowdown on the frontlines

Western aid, the ERA mechanism, a partial recovery in exports, and the effect of 'military Keynesianism' ensured relatively stable performance of the Ukrainian economy in 2023–2024. However, as previously noted, the fiscal stimulus linked to expanded military production has a diminishing effect and inflationary consequences (→ Re: Russia: Resilience). As a result, as in Russia, the impressive growth of Ukraine’s economy throughout 2024 gave way to a rapid slowdown by the end of the year. Although Ukraine’s situation, having suffered Russian aggression and lost up to 30% of its GDP in 2022, is incomparably more severe, the economic trajectories of the two warring countries are in many respects similar. After a phase of military adaptation, both are facing structural challenges and the threat of accelerating inflation. Additional, and also 'parallel', challenges include a sharp drop in export revenues for Russia and a reduction in foreign aid for Ukraine.

Ukraine’s economy continues to grow, but its recovery is weaker than expected. In 2024, according to the Ukrainian State Statistics Service, GDP increased by just 2.9%, although the initial estimate in February was 3.4%. Moreover, in the fourth quarter, the economy actually contracted by 0.1% year-on-year. The shortfall relative to forecasts is attributed to damage from Russian attacks on energy infrastructure, a worsening labour shortage, and a sharp downturn in the agricultural sector, according to analysts from the National Bank of Ukraine (NBU). In the fourth quarter, output in the agricultural sector was 30% lower than a year earlier. For the year as a whole, gross value added in agriculture, which accounts for nearly two-thirds of Ukraine’s export revenues, declined by 7.3%. In the energy sector, which was heavily affected by attacks, gross value added fell by 2.7% over the year, which was worse than the 1.8% drop recorded in 2023.

Ukraine's GDP growth in constant 2021 prices, 2022–2024, Ukrainian hryvnia

In its May review, the National Bank of Ukraine (NBU) downgraded the growth forecast for this year from the 3.6% expected at the start of the year to 3.1%. The IMF, in its spring World Economic Outlook, offers an even more modest figure, at just 2%. Both the NBU and IMF cite the same reasons: externally, a worsening global economic environment; internally, a labour shortage and damage not only to energy infrastructure but also to industrial facilities. A major blow to the economy came from the closure of the country's largest coal mine, Pokrovska, caused by the approach of Russian troops. Pokrovskaya is the only domestic supplier of coking coal for the Ukrainian metallurgical industry. While enterprises could switch to imported raw materials, analysts at GMK Center warn this would significantly raise production costs, reduce demand, and lead to lower output.

In addition, as in Russia, weak performance is expected this year in the agricultural sector. The harvest of grains may fall by 10%, and oilseeds by 5%, Ukraine’s Minister of Agrarian Policy and Food, Vitalii Koval, warned in a recent interview with Reuters. In addition, the EU intends to revise the terms of access for Ukrainian agricultural products to the European market in order to protect its own producers. Poland, in particular, has succeeded in pushing for the cancellation of Ukrainian trade preferences, said Prime Minister Donald Tusk. Since 2022, Ukrainian goods have been imported duty-free – now duties will be at least partially reinstated. According to government estimates cited by Forbes Ukraine, this could cost Ukraine’s economy €2.9 billion annually.

The main factors that supported the economies of both Ukraine and Russia last year were similar. In 2024, private consumption made the largest positive contribution to Ukraine’s real GDP growth, according to NBU analysts. Households increased their final consumption spending by 6.8%, driven by rapid growth in real wages. As in Russia, this growth is due to an acute labour shortage – but for obvious reasons, the problem is even more acute in Ukraine. According to estimates by the Ukrainian Ministry of Economy, average real wages rose by 13% in 2024. At the same time, government spending in real terms has begun to decline. The NBU estimates a reduction of 4.3% in 2024, with this trend expected to continue into 2025.

As in Russia, Ukraine saw inflation return to double digits at the end of last year. Price growth continued into the beginning of this year. On a year-on-year basis, inflation accelerated to 15.9% in May, up from 15.1% in April. The main underlying factors, according to NBU analysts, include rising costs for electricity and labour, along with strong consumer demand. Additional pressures stem from a poor harvest and increased excise duties. In response, Ukraine’s central bank, like Russia’s, raised its key interest rate, although only to 15.5%. The NBU forecasts a decline in annual inflation by summer 2025, when the comparison will no longer include June 2024, the month in which electricity tariffs for households were increased. By year’s end, annual inflation is expected to reach 8.7%.

A positive element for the economy and macroeconomic stability is that external financing needed to cover the budget deficit in 2025 is fully secured by international partners, note analysts from the Bank of Finland Institute for Emerging Economies (BOFIT). Ukraine is set to receive around $39 billion from G7 countries under the Emergency Revenue Acceleration (ERA) Loan Programme. This will be sufficient to fully cover budgetary needs for 2025. The Ukrainian Ministry of Finance also plans to reserve part of these funds for 2026. Importantly, interest payments on loans provided through the ERA programme are being covered by income generated from frozen assets of the Russian central bank. As a result, Ukraine’s financial outlook for this year is more confident. In the early years of the war, there was no such level of predictability.

Ukraine’s Plan B 

However, the outlook for 2026 and beyond appears highly uncertain and unfavourable. The likely economic trajectory in the event of a war ending under terms acceptable to Ukraine is reasonably clear. International aid volumes would be sharply reduced: while Ukraine may receive up to $41 billion in 2025 through the ERA programme and other mechanisms, only $34 billion is planned in total for 2026–2027, according to analysts from the Kyiv School of Economics. This allocation is based on forecasts that the war will end by 2026.

As military spending declines, government consumption will begin to have a negative effect on GDP growth. At the same time, the contribution of private consumption will weaken as real income growth slows. Investment activity should become the main source of growth, both from domestic investors and, primarily, from foreign investors. The latest forecast by the World Bank promises that, if the war ends, Ukraine’s economic growth could accelerate from 2% in 2025 to 5.2% in 2026 and 4.5% in 2027, supported by robust investment: 'The tailwind from the end of hostilities could accelerate capital inflows, productivity gains, and labour supply expansion’.

However, hopes for a cessation of hostilities this year have, by now, all but evaporated: Donald Trump’s contradictory and inconsistent peace mission has ended in complete failure. For Ukraine, the prospects of securing meaningful security guarantees — even in the event of a ceasefire — also remain extremely vague. As a result, the continuation of the war amidst declining volumes of Western assistance is becoming an increasingly likely scenario. In this context, Ukraine will be forced to make a series of painful decisions in order to maintain macroeconomic stability, warns a report from the Centre for Economic Policy Research (CEPR), authored by a group including Barry Eichengreen, Yuriy Gorodnichenko, Kenneth Rogoff, Sergei Guriev, among others. In 2022, the same group authored a report entitled ‘Macroeconomic Policy for a War-Torn Ukraine,’ which influenced the Ukrainian authorities' policy in the early stages of the war, and in 2023, a report on the macroeconomic policy of post-war Ukraine, which, unfortunately, remains irrelevant.

The latest report is entitled ‘Replacing Foreign Aid: Plan B for Ukraine and Europe.’ The authors of the report began from the premise that the current level of output in the Ukrainian economy is close to its potential.

This means that further demand-side stimulus is unlikely to produce meaningful growth in production without exacerbating inflationary pressure (a scenario that has already played out in the form of economic overheating in Russia). As a result, economic policy must shift focus towards supporting the supply side.

According to the experts, the government's priorities should prioritise addressing logistical bottlenecks (including modernisation of ports and border crossings), ensuring a stable electricity supply (through repair and protection of infrastructure), supporting labour mobility (via training and retraining programmes), increasing female participation in the workforce (through tax incentives and childcare development), and reducing business risk (by means of war insurance, public-private partnerships, and joint projects with foreign investors). They also advocate relocating production to relatively safer regions, pursuing deregulation and digitalisation, and improving the governance of nationalised assets.

The reduction in external assistance will necessitate tax increases, particularly indirect taxes such as VAT and excise duties, as well as broadening the tax base by tackling the shadow economy, and cutting non-military expenditure. It may become necessary to suspend indexation of pensions and other social benefits (with support for vulnerable groups becoming more targeted), and to delay the implementation of various infrastructure projects. Another important objective will be the expansion of domestic debt, through broader distribution of government bonds among citizens and the diaspora, automatic investment of part of individual income, and extension of loan maturities. Maintaining or even tightening capital controls and the gradual depreciation of the hryvnia to improve the trade balance are also proposed.

From Europe, the authors expect continued short-term support for Ukraine. In the medium term, a key factor in reducing fiscal and trade-related risks could be a decision to confiscate frozen Russian assets – a move that, once again, depends entirely on Europe.