How to find additional financial resources for the further development of our state, given the difficulties associated with dependence on allied funds and limited government spending?
Banking sector
The activity of the banking sector for 11 months of 2023 was characterized by a decrease in the level of financial intermediation services and a high level of profitability. The banking system contains over UAH 2.2 trillion of deposits of legal entities and individuals. Free liquid funds of banks amount to almost UAH 1 trillion. But the redistribution of these funds to support economic development or finance the fiscal deficit remains very weak .
Thus, as of December 1, 2023, loans issued by banks amounted to only UAH 1 trillion, which is nominally 1.2% lower than the level at the beginning of the year (for business loans: UAH 751 billion and minus 2.8%, respectively).
In recent months, there has been some recovery in the level of lending: UAH 40 billion in the loan portfolio for July-November. But the increase in deposits over the same period was almost three times greater - UAH 107 billion.
Bank liquidity continues to increase progressively, as does the profitability of banking activities. Since the beginning of December, as of December 28, 2023, the total liquidity of banks (required reserves + certificates of deposit) has increased by UAH 115 billion (+14%), and since the beginning of the year - by UAH 424 billion (+80%). The main reason for the increase in bank liquidity is the fiscal deficit. The predominant part of banks' liquidity is in NBU certificates of deposit - 65%, or almost UAH 620 billion. In 2023, banks' investments in certificates of deposit brought banks a return of 15 to 25% per annum (with average inflation of 14%). Certificates of deposit form more than 30% of all interest income of banks, which exceeds other types of interest income (on business loans, consumer loans, government bonds, etc.). The net profit of the banking system for 11 months of 2023 reached UAH 131 billion (an increase of seven times compared to the previous year).
Bank investments in government bonds remain moderate. Banks' net investments in hryvnia government bonds have increased by UAH 171 billion since the beginning of the year (to UAH 575 billion). Benchmark government bonds on the balance sheets of banks increased by approximately the same amount after they were given permission to form their required reserves through special issues of government bonds. That is, in fact, there is no expansion of bank investments outside the framework of the factor of changes in regulatory regulation of liquidity . Banks mainly carry out rollover of redeemed government bonds into new issues of government bonds without expansion (not counting benchmark government bonds).
In general, the money supply multiplier (the ratio of the M3 money supply to the total value of the monetary base and certificates of deposit) is below 2.0, which characterizes a critically low level of financial intermediation in the economy . For comparison, at the end of 2022, the US money multiplier was 4.0, Poland - 3.2, Georgia - 3.3.
Thus, it can be stated that the activities of banks as financial intermediaries of the economy do not contribute to the effective redistribution of domestic savings for the purpose of investment development of the country .
Lending issue
The low level of bank lending is a significant obstacle to the economic recovery of Ukraine. The IMF clearly states this in its updated Memorandum. It is noted that during the war, the level of bank lending to the Ukrainian economy decreased significantly (from 18.8% of GDP in 2021 to 14.2% of GDP in 2023). And this despite the fact that about 13% of banks’ loan portfolio falls on preferential lending support programs. One of the reasons for the low level of lending is the channeling of bank funds into attractive NBU certificates of deposit.
The mobilization of credit resources should become an important driver of private sector growth and a source of meeting the economy's significant investment needs during the post-war recovery period. Therefore, according to the requirements of the same IMF, the NBU must develop a comprehensive strategy for expanding lending to the country’s economy. The deadline for completing this task is until the end of May 2024.
It is also interesting to note the rational position of the IMF on the possibility of attracting the NBU's emission resource to finance the state budget deficit . IMF documents indicate that the use of monetary financing of the budget is risky for maintaining stability. But in case of adverse shocks, such as an external financing gap, the option of monetary financing of the deficit can be applied. To do this, the NBU and the Ministry of Finance should develop frameworks that will regulate the conditions and timing of the use of such financing in accordance with the design of the IMF program and the recommendations of the recently completed NBU Safeguards Assessment.
The NBU must take into account that a point change in the key interest rate by 1–2 percentage points. won't change anything significantly. The slow movement towards lowering interest rates on loans and deposits will continue. Will this have any impact on financial stability and exchange rate stability? Definitely not!
Financial stability in the national economy is supported almost exclusively by sufficient amounts of foreign aid. The volume of this assistance not only covered the structural gap in the balance of payments (about 20% of GDP), but also made it possible to increase foreign exchange reserves to more than five months of imports.
An interesting point is that the IMF requires a package of tax measures worth 0.5% of GDP. Interest on 2023 certificates of deposit will be 1.5% of GDP. Reducing the key rate by half will already give 0.75% of GDP. The IMF is looking in the wrong place.
Resources
Tax and interest withdrawals from the economy doubled in 2022–23. Thus, tax revenues to the consolidated budget over two years increased by 2.1 times (mainly due to the personal income tax of the military), and interest income of banks - by 1.9 times (data for ten months of 2023 were used).
At the same time, nominal GDP over the same period grew by only 22%.
That is, a catastrophic situation has developed with the multiplication of funds withdrawn from the real economy. In the future, we will not be able to constantly increase withdrawals if we do not feel the opposite effect of productivity growth on the economy.
Consolidated budget spending on the real economy also increased very moderately: non-military and non-interest spending for 2022–2023 increased by only 44%. Money is circulated once through public finances, and then simply lies in the accounts of the banking system or is withdrawn into foreign currency outside banks.
It is necessary to expand fiscal and monetary instruments to support the real sector of the economy: business credit support programs, favorable monetary policies, and other grant and credit assistance programs.
About plans “B”, “C” and further in alphabetical order
Financing the Armed Forces costs us 20–30% of GDP. This is gigantic. Thus, state budget expenditures on the national defense sector in 2023, according to the revised annual plan, should amount to UAH 2.1 trillion (32% of GDP). For 2024, the state budget so far includes a significantly smaller amount - UAH 1.2 trillion. But still, in terms of GDP, this is also a lot - 16% of GDP. Such volumes cannot simply be additionally withdrawn from the economy through taxes or other mandatory payments. All tax revenues from the consolidated budget in 2024 will amount to 26% of GDP. Before the war, tax withdrawals amounted to 27% of GDP. That is, the resource here is small. You also need to keep in mind that an additional increase in the tax burden will depress economic activity.
Historical experience shows that the main financial resource of warring countries was not taxes, but loans, grants and cash assistance . The share of taxes in the financial resources of the US government during the Second World War accounted for only 30%, during the First World War - 20%. In Ukraine, tax payments formed 45% of all government resources in 2022–2023.
