Resilience Amid Conflict: Ukraine's Economy and Future Prospects

The domestic economy has faced extremely high risks over the last three years since the war began in Ukraine. Loss of territory, a tremendous increase in defense spending, damages to civilian infrastructure and production facilities, the blockade of traditional routes for external trade, almost daily air attacks on cities, and shortages in the supply of energy resources do not represent the entirety of the challenges the Ukrainian economy had to overcome. As a result, the initial shock amounted to a loss of almost 30% of Ukraine's GDP in the first year of the war, while the pause in business operations due to the start of the war lasted from a few days to several months for different sectors. However, the mentality of the Ukrainian population in response to external aggression, the adaptation of businesses to current circumstances, and resilience to major risks allowed the Ukrainian economy to demonstrate recovery just one year after the active stage of the war.

Adjustments to logistics routes, the relocation of business units to safer regions, the mobilization of internal resources, and a shift to alternative energy sources represent just a few examples of the Ukrainian economy's adaptation to current risks. Consequently, beginning in 2023, the economy has experienced moderate recovery rates of 3.0–5.5%, showcasing the implementation of innovative business models that are unprecedented on a global scale. While the defense sector's share has undoubtedly risen significantly, it is not the sole driver of the current recovery. Indeed, the Ukrainian economy operates concurrently with active defense operations conducted by its domestic army, which has effectively resisted a far more powerful aggressor. Furthermore, the resolute belief in protecting its territories and achieving peace has sustained a notably high volume of investments in the economy, with annual growth rates ranging from 10% to 50%. These figures far exceed GDP growth rates and starkly contrast the investment climate seen in most developed economies.

It is worth noting the implementation of an efficient pre-war banking system model in Ukraine and its resilience to significant risks at the beginning of the war. Indeed, the comprehensive cleanup of the sector between 2014 and 2017 (when nearly 100 banks exited the market) helped eliminate inefficient banks, strengthen capital reserves, and enforce stricter risk policies in operational activities. These adjustments, combined with the regulator's preparedness for a potential war and the rapid emergency measures implemented on the first day of the invasion, allowed the banking sector to remain operational. Furthermore, the war's impact on the banking system was relatively limited, avoiding mass bankruptcies within the sector or a dramatic deterioration in the quality of banking assets. Notably, the trajectory of non-performing loans (NPLs) in banking portfolios started to improve by mid-2023, currently standing at 30%, down from a peak of nearly 40% in mid-2023.

We understand that the outlook regarding the end of the war and the configuration of the peace mode and security guarantees are not clear yet. However, we are confident that it will take just a few months to begin an active rebuilding phase after the war ends. The length of the transition period before the active rebuilding stage will largely depend on the guarantees providing long-term peace and preventing the renewal of conflict in the medium term. These are the necessary conditions to switch from the current financial assistance—provided by our sovereign partners and mostly used to support the budget deficit during the active war—to real investments from international companies to support domestic business, rebuild and renew infrastructure, import new technologies, and apply new business standards. We also hope that the implementation of measures necessary for EU membership access will accelerate and guide this process more efficiently. If realized, these factors may drive GDP growth by 5-7% annually within three to four years.

We see several sectors as potentially attractive for international business, with high initial capacity for rapid development during the rebuilding stage and beyond. The defence sector is definitely at the top of this list, with new technologies proven in real conditions and products that strengthen domestic defence capabilities and have solid export potential. Historically, Ukraine has had a strong and efficient agriculture sector, so investments in food processing would be beneficial for investors in the medium to long term, allowing for a substantial increase in value-added from agricultural production. The significant damages caused by the aggressor to the domestic energy sector provide an opportunity to fully reshape it in response to new challenges and risks by moving more towards alternative energy sources, more dispersed generation, and integration with energy storage facilities.

The active rebuilding stage will rapidly raise the demand for construction materials. The limited capacity of the domestic sector will require a substantial increase in import flows and encourage new investments and the import of new technologies into the sector in Ukraine. Finally, Ukraine will benefit from its favorable geographical location, providing good conditions for the development of the transport and logistics sector.

Ukraine will need to address a significant number of serious problems caused by the war and its consequences, which have weakened economic potential, disrupted budget balances, and undermined the stability of the financial sector. In particular, the country must always be prepared to defend itself in the long term, while the government must find long-term sources to balance the budget. The necessity to bring Ukrainian citizens back and encourage their participation in the rebuilding stage is another challenging task. We anticipate uneven distribution of business and population post-war across Ukrainian territory, with regions closer to war zones being less attractive. Finally, de-mining Ukrainian territories after the war will require concentrated financial and technical resources, potentially a task spanning several decades.