Serhiy Marchenko: “The military budget makes up three quarters of the entire budget of Ukraine”
Minister of Finance about Western financial and business aid in wartime
For more than three months now, the war has been inflicting not only significant human losses, but also damage to the Ukrainian economy. As a result of the war, business suffers, customs revenues are reduced, and therefore Ukraine's GDP suffers. The country has difficulty with exporting grain and other foods as well due to the blockade of Ukrainian ports. The authorities are reassuring that there is no reason to worry: they say that it's a really tough situation in the country now, but everything is under control.
Mind has discussed with the Minister of Finance of Ukraine Serhiy Marchenko forecasts for Ukrainian GDP and the hryvnia exchange rate, problems with filling the state budget and tax revenues, as well as the effectiveness of economic sanctions against Russia.
On Western financial assistance and its use
Interviewer: Since the beginning of the war with Russia, you have repeatedly said that you are dissatisfied with the speed with which Ukraine receives financial assistance from abroad. Has the situation changed?
Mr. Marchenko: The Minister of Finance cannot be satisfied at all, especially in wartime. After all, I understand the price of each hryvnia, and the flow of funds is now a priority for us.
From May 1 to May 20, we were financing our needs without external assistance. We proceeded from our available opportunities, attracting funds from military bonds and resources of the National Bank of Ukraine. We passed this period with dignity. On May 20, we converted the first amount – 504 million euros. Later that day, another € 600 million of macro-financial assistance was received. Therefore, it is possible to fully finance the needs that have accumulated over the past period of time.
On May 24, we received $100 million from Japan. We expect more than $4.8 billion in June. In particular, through the mechanism of the World Bank, the United States, Britain, Canada, Germany, Japan, Italy, the Netherlands, Lithuania and Latvia.
If we talk about the funds received, since the beginning of the war, Ukraine has received more than $6 billion of external aid in the form of grants and loans. Grants are provided by the United States, and we have already received $1 billion of them. Also in the form of grant aid 110 million euros were received from the Italian government and more than 120 million euros from the European Union. Non-grant funds are provided mainly at 1% per annum and for a period of 10 to 30 years.
Interviewer: And what are the priorities for spending the received money and in what proportions?
Mr. Marchenko: At the beginning of martial law, we adopted a government decree, which provided for the procedure of treasury services, which indicated the top-priority expenditures. That means, there are expenditures of I, II, III stages.
The first stage is for pensions and military benefits; as well as law enforcement, security and defense sector. Then there are all other expenses, including social payments, salaries of educators, doctors, and the public sector. We also have the opportunity to restore critical infrastructure (if necessary); there are expenditures on humanitarian needs. At present, we conduct almost no expenditures for other categories.
Interviewer: That means that the financial assistance of our Western partners is not used to restore the affected settlements of Kyiv and other regions?
Mr. Marchenko: These funds are used mainly to cover our needs in the humanitarian and social spheres. According to the terms set by our international partners, their funds are definitely not spent on military needs.
1.5 billion hryvnias were allocated from the reserve fund for Irpin, Bucha, Borodyanka, etc.
Interviewer: How much has the state spent on those who lost their jobs, as well as on IDPs and the army?
Mr. Marchenko: I can talk about the monthly expenses. On average, they constitute over UAH 200 billion a month. For example, in April the amount reached UAH 206 billion. It included payments to IDPs, the army, and so on. In April, about UAH 14-15 billion ($400 million – Mind ed.) was spent on IDPs and food programs. In May, the figure was higher – about 16-17 billion UAH. If we talk about spendings on social protection in general, they are estimated at 34 billion UAH, on education and medicine – at 31 billion UAH, on salaries in the budgetary sphere – at 5 billion UAH.
Of course, the lion's share of funds goes to financing of the army. In general, the military budget makes up three quarters of the entire budget of Ukraine.
Is there any hope for a “helping hand” for businesses from the state?
Interviewer: So, what about business support from the state?
Mr. Marchenko: Honestly, I am not an adherent of supporting business at the expense of the state, except for creating conditions for soft loans. Besides, the country is in no state to afford such a luxury now. Decisions on payments in the size of UAH 6,500 to those, who lost their jobs or were unable to work in the occupied territories, were made. I believe that these funds sufficiently covered the country's needs during the first month of the war.
And now our message for business is quite simple: resume your activities, keep working, pay taxes. And this aspect is very important, because taxes paid will be used, first of all, to support the Ukrainian army. If we want to win the war with Russia, business should be in solidarity with the state and perform this function.
At present, we collect UAH 54-56 billion from received taxes, and these funds cover only 1/3 of the needs for our expenditures. Of course, this situation is forced, because we are at war and our international partners understand this and are ready to help us. However, sooner or later, we have to restore balance. That's why I'm inclined to continue doing businesses and paying taxes. I am not in favor of changing the tax regime in any way – neither in terms of easing nor in terms of strengthening. I believe that the tax system should be stable – and all the changes we have today should return to those that had been functioning until February 24, 2022.
Interviewer: That is, the state is not going to help even big business – for example, through giving loans?
Mr. Marchenko: We are helping in that way. Lending under the Affordable Loans 5-7-9% program is currently underway. According to the program of loans under state guarantees on a portfolio basis, the budget provides UAH 23 billion to cover 80% of portfolio risks. In particular, for the period of martial law we compensate loans at 0%.
So, from this point of view, the state is ready to help businesses. And those who are willing to take a loan to provide liquidity or other needs, can do so. During martial law in Ukraine, 6,726 loan agreements totaling UAH 24.38 billion were concluded within the framework of the state program Affordable Loans 5–7–9%.
Interviewer: And what kind of support from the state can farmers expect (credit agricultural programs)?
Mr. Marchenko: The government decree has been in force for two months now: conditions have been created for sowing, when money under the Affordable Loans 5–7–9% program can be used not only by small and medium-sized agribusinesses, but also by large agribusinesses (as a part of sowing campaign). The government did so in order to launch and ensure this year's sowing.
Interviewer: What percentage of domestic business today has stopped or reduced production due to hostilities?
Mr. Marchenko: If we focus on the internal survey of business, which data are used by the National Bank as well, 17% of businesses in Ukraine have suspended their activities. And up to 30% partially lost activity compared to the pre-war state.
In March the situation was much worse, in April and May we have seen that business activity in the country is reviving and business is gradually resuming its activity. Currently, small and medium-sized businesses (groups I-III) may not pay taxes. For example, group III pays 2% instead of 5%. In addition, this group is maximally expanded – and such a turnover tax can be paid by almost the entire business.
I believe that the state now supports business more than ever. And so it needs the same support from the side of business to win this war as soon as possible. This should be a bilateral process, in terms of joint liability.
Today there is no need to review our tax system in terms of stricter conditions or vice versa. But in my opinion the pre-war tax system should keep working.
Moreover, businesses should trust the state, because the army is financed through the state mechanism. Volunteering and volunteer programs are great, but they are not enough, compared to the funds we allocate to the Armed Forces every day. Therefore, if we want to live in a free and peaceful country, we must be able to finance our own army. And this is expensive, especially when the country is at war.
Interviewer: Will Ukraine have enough money to fight and rebuild at the same time?
Mr. Marchenko: Only critical infrastructure can be rebuilt at the same time. In the liberated territories of Kharkiv, Sumy, Kyiv and Chernihiv regions. We have the funds for these purposes. And we should talk about a broad rebuilding, we should talk about it with our partners, probably after the victory. Of course, we are still talking about it today, but the program can start only when hostilities on our territory cease.
On GDP during the war
Interviewer: Due to the loss of economic and industrial potential – east / south, port closures, logistical and fuel problems, obstacles on the railway – a number of experts predict at least 70-80% of GDP decline. If in 2021 it was almost $200 billion, by the end of 2022 it will be only $30-50 billion, provided that agricultural products are available and sold en masse to the EU. How considerable will the fall in GDP be in 2022? What consequences will it cause? And how long will it take to reach the pre-war level?
Mr. Marchenko: I don't know where “expert” opinions about 70-80% of GDP fall are generated…
I tend to trust the calculations of the NBU, the Ministry of Economy and structures such as the World Bank, which have not yet changed their forecasts: the most pessimistic of them is a fall of 4445%. However, now they tend to change these figures for the better ones.
After all, business activity is resuming in the country after the first shock in March and part of April. Of course, there are difficulties in the mining and processing industries, in trade and other areas. But in general, I see no reason to think that 80% of the Ukrainian economy will “vanish”.
For example, the information I have about paying taxes does not indicate this at all. If we take the possible fall of our GDP by 25-30%, it is normal for a country at war. The fall of the UST by 17% in April and the personal income tax with the military tax by 19% is also a normal situation.
We are currently collecting UST almost at the same level as last year (only half a percent less). This shows that business and the state are socially responsible and pay their workers.
That's why I do not understand what are the reasons to believe that there will be an 80% drop in GDP? The Ministry of Finance does not have its own base for calculating the fall in GDP, but we have calculations of collected taxes and I would not make any pessimistic forecasts. The latest information I have received is that GDP could fall by up to 20%. So, there is no reason to believe that it will be bigger yet.
As for the consequences of GDP falling and the achievement of pre-war indicators, I am not inclined to make forecasts and this is not a function of our ministry. First of all, this is a question to the Ministry of Economy. Of course, the economic downturn caused by the war is enormous, and this question makes sense. After all, this is the loss of de facto infrastructure, buildings and structures, shortfall in GDP, loss of supply chains and so on. But I think we will be able to get through this crisis: we have banking and budget systems, treasury, tax and customs working like clockwork. We perform all the government functions.
Throughout the war, there were no delays in the payment of pensions and military payments. Therefore, there is no reason to think about the catastrophe.
However, neither am I optimistic in this case, because the war is not over yet. And everything will depend on the consequences of hostilities by the end of the year and how quickly we will win. Of course, all these derivatives can affect the forecast about 80% of GDP decline as well, but today I do not see such grounds.
How quickly we will recover from the war depends on how quickly we can get the resources and funds that allow us to do so. Ukraine is not able to recover on its own, because we have huge losses, and it will take decades. If we have the support of the G7 countries and European partners (EU structural funds, US assistance in various forms, seized financial assets of Russia and Russian oligarchs) it will take much less time. There are many options, but the main and key one: how to make it profitable, interesting and gainful to run business in our country.
On filling the budget, the state of affairs within the tax and custom systems
Interviewer: You noted that during the first days of the war the NBU transferred to the budget a part of the profits for 2021, received dividends from state banks, many companies paid taxes in advance – thanks to them it became possible to reimburse VAT and provide social payments and debt service. How is the budget filled today?
Mr. Marchenko: It is too early to report about May, the figures will be in early June. But in April the 70% of the planned tax revenues were sent to the general fund of the State Budget. In April, about UAH 45 billion was received from the Tax Administration and UAH 8.3 billion from the State Customs.
However, we should take into account that the Tax indicators should be adjusted in view of the fact that VAT was not refunded. And this is also a problem, but I hope that we will solve it soon and resume the process of VAT refunding.
Losses from customs are estimated at 73% of previous targets, and losses from taxes – 25-30%. If we talk about customs, since the payment of taxes on most goods was canceled (import duty – 0%, VAT – 0%), how can we collect taxes when there are none of them? In addition, imports fell by 46% and that is only in March. So, now we are preparing a decision to return taxes to customs, because the country cannot live without taxes. The relevant government bill will be introduced in the near future.
Interviewer: A month ago, in one of your speeches, you said: “Our debt is now very large, and we are discussing with donors different ways to finance it.” At the expense of what are you going to reduce the deficit of the budget/debt? What volume of money is needed?
Mr. Marchenko: The budget deficit is estimated at $5 billion a month. But this is a deficit that we potentially could cover with foreign financial aid. But it should be borne in mind that we still have domestic bonds worth one billion hryvnias plus borrowings of the NBU worth up to 1.5 billion hryvnias.
That means that the total planned deficit for May is about $6 billion.
If we talk about reducing costs, we have already done sequestrations several times and reduced them to UAH 180 billion. Capital expenditures were almost completely reduced by UAH 72 billion, salaries of employees of budgetary institutions were reduced by UAH 20 billion, social protection expenditures by UAH 22 billion, and other expenditures by UAH 40 billion. There is nowhere to cut further.
On the possible unpopular measures of the state in case of a protracted war
Interviewer: In an interview with The Economist, you said: “If the war drags on, the government will have to take “painful measures” to cut budget spendings, including salaries, pensions, social security, as well as to raise taxes and resort to nationalization.” Did the authorities start gently preparing the population for the total crisis in autumn?
Mr. Marchenko: To properly assess what I said in an interview with The Economist, it should be read in the original. Because all the quotes that have been made so far are not true. And I keep saying that all the time.
I meant if the war dragged on, we would need to return our tax system to the pre-war level. And I did not say a word about the increasing taxes – what all the media were actively reporting about. It was not a matter of that speech.
Interviewer: But this information could not be mistranslated from English by all the mass media at the same time.
Mr. Marchenko: I just emphasized that recently we had made too many benefits, opportunities for non-payment of taxes and so on. And this should be finally stopped. Therefore, we will talk about the return of the tax and customs regime to the pre-war state.
Regarding expenditures: the question arises in which direction to reduce them. After all, without cutting expenditures, we now actually do not have any budget financing if we do not take into account external assistance (our budget is not balanced). So it is logical that such a question may arise – although I did not talk about any specific directions. But when we feel that we do not have external help, we will sometimes have to make painful decisions. And this is normal.
You know, a country cannot live when 2/3 of the budget is financed by foreign aid. In any case, it may not last long.
Interviewer: For whom exactly will these decisions be painful, who will be the first in line? Because after your interview with The Economist, there was active talk about increasing the tax burden and it was said that the Bill №7311(“On Amendments to the Tax Code of Ukraine and Other Laws of Ukraine on Peculiarities of Collection of Certain Taxes and Fees in the Period of Martial Law or State of Emergency” – transl.) is just the “first swallow”.
Mr. Marchenko: I support Bill №7311 in terms of VAT refunds and import duties on goods. This is an opportunity for domestic businesses to protect themselves from imported analogues. As for painful decisions, they will apply to everyone except people who need help from the state.
In general, the state will determine the priorities of its own expenditures. The least socially vulnerable categories are usually the first ones to experience the cut of expenditures. For example, it is possible to reduce the number of civil servants, review their functions – because the war has shown that the staff of ministries and departments are working at 30–70% of the workload, while the functions are performed quite well. So, now there is a question of reduction of state apparatus. Unfortunately, such measures will not save much.
It is also important to optimize spendings in various spheres. We will talk about this later, but so far, given that we are supported financially by international partners, I would not focus on this. In any case, the reduction of even government consumption is a reduction in the economic capacity of the state. So let's wait until we win the war. I have more hopes for this than that we will cut something.
Interviewer: OK, so, we figured out the reduction of costs and taxes. And what about your words to The Economist about nationalization? Were they also mistranslated from English?
Mr. Marchenko: It was a separate question from the correspondent. He asked: “Are the nationalization measures possible in a country at war?” And I said they were possible. For example, such a decision was made on Russia's Sberbank. I don't have any other examples yet though.
But it is a typical situation, when the belligerent country has additional forms of intervention in economic processes. As much as I would like it. However, I did not say, I was for nationalization.
Literally, I said: “Since the mechanisms of a market economy have been introduced in Ukraine, it is very difficult for us to take the steps that are usually taken by belligerent countries, including nationalization. This can only be an extreme forced step from the side of the government.”
In general, the Ministry of Finance does not have nationalization functions, and I, as a Minister, do not have such a desire. On the contrary, before the war we wanted to privatize a part of the banking system (50% of which is now owned by the state), but transferring private business to state ownership is not a current priority of the government. And I'd like to advise all the businesses only one thing – pay taxes and help us win the war.
On the fate of the national currency
Interviewer: And what will happen to the hryvnia exchange rate if the war drags on for more than 3-4 months (it is believed to reach at least UAH 100 per dollar in winter)?
Mr. Marchenko: It is difficult for me to comment on such speculations. Instead, I will form my own position. The National Bank is responsible for exchange rate policy. And I believe that since the beginning of the war, the NBU has made a very logical and correct decision, having fixed the hryvnia exchange rate and introduced currency controls and other restrictions.
Now the NBU has made another decision that changes the currency market. The logic of this decision should be commented on by the NBU. However, now we have an understanding that Ukraine will receive funds from borrowings – the inflow on the foreign currency account should be significant (I have already mentioned the figure of $5 billion).
Given that the reduction of imports is higher than the reduction of exports, our only channel of currency outflow from the country (except imports) is our citizens who currently live abroad and buy goods and services. That means that now it is the largest channel of currency turnover – about $2 billion a month.
And if the NBU sees an opportunity to block these channels of supply and demand factors of currency at the expense of external revenues, and has analysed all the risks, then I see no reason for fluctuations in the hryvnia exchange rate. And the speculative trends that exist today can very quickly go the other way. So, I see no economic reason for the devaluation of the hryvnia, except for speculative panic, temporarily caused by certain factors.
Interviewer: In 2014, it was also said so, but everyone remembers what happened to the hryvnia…
Mr. Marchenko: In 2014, there were other people, they made other decisions on certain grounds. Institutionally strong systems of the National Bank and the Ministry of Finance have already been formed, and now other people are working there and making other decisions. The war in Ukraine has been going on for three months now, and we have a practically stable hryvnia exchange rate. I think the NBU has calculated all the risks.
Interviewer: You have mentioned that the current speculative trends may quickly go the other way. Doesn't that mean that the hryvnia exchange rate can return to its previous position, that was before February 24?
Mr. Marchenko: Everything is possible, because Ukraine receives international funding.
On the “effectiveness” of anti-Russian sanctions
Interviewer: How do you assess the losses of Russia from the new packages of Western sanctions in the medium and long term? Will they be long-lasting and not just “decorative”? As the US and EU economies have already experienced the “boomerang effect” – and we see how sanctions are being successfully circumvented.
Mr. Marchenko: It is difficult to talk about sanctions, being the Minister of the country where the war is taking place and which has revenues that cover only 1/3 of the needs and expenditures. Although the aggressor country that started this war has a budget surplus and receives a billion euros a day from the sale of oil, gas and other goods.
These sanctions do not work fully, because there are still ways to avoid them. In addition, there are countries that do not support anti-Russian sanctions. Therefore, we call for the introduction of secondary sanctions on countries that support Russia in its efforts to circumvent sanctions. We call for a full trade embargo on oil and gas and the import of any goods from Russia. Because while Ukraine is losing 300 million euros every day, Russia is gaining 1 billion euros. We do not have equal and fair conditions for this war.
There should definitely be more sanctions. In particular, more Russian banks need to be sanctioned, and Russian businesses that continue to support their government by paying taxes need to be properly sanctioned. This is my position as Minister of Finance.
The objective reality is that anti-Russian sanctions have a too mild effect on the Russian economy and budget – just look at how quickly the ruble has recovered. Therefore, I do not believe that the sanctions will have an impact on Russia either in six months or later. We need tougher and faster sanctions as soon as possible.