Sergiy Nikolaychuk on the Economics of War

By Harry Clynch

By Harry Clynch

Staff Writer


Sergiy Nikolaychuk

Sergiy Nikolaychuk has served as a Deputy Governor at the National Bank of Ukraine since July 2021 and is responsible for maintaining monetary stability. Of course, his job got a lot more complicated after Russia invaded Ukraine this February. Since then, he has played a key role in running Ukraine’s wartime economy. Sergiy spoke to us from Kyiv to discuss the economics of war.


This interview has been lightly edited for clarity.


Rabbit Hole: Could you start by telling us about the challenges of running an economy during a war for your country’s existence?


SN: The war has inevitably affected the country in multiple ways: falls in economic activity, human deaths, mass migration abroad, damage to physical infrastructure, and bottlenecks in export logistics. Estimates for the damage already done to Ukraine’s civilian infrastructure already exceed $100 billion. Other economic losses, including unrealized economic growth, should also be added to that number, not to mention the compensation owed to refugees and abandoned investment projects, and so on. There are different estimates of how much these economic losses total: hovering from around $500 billion to $1 trillion. The war is still ongoing, and the full losses are yet to materialize fully.

This definitely creates a lot of challenges for policymakers trying to stabilize the situation, minimize the disruption to economic activity, and minimize the impact on the civilian population. In terms of the central bank, we are trying to keep prices and finances as stable as possible in the current environment.


Rabbit Hole: The war has doubtless wrought immense damage on Ukraine’s economy. What percentage of Ukraine’s economy is currently operational?


SN: Nowadays, we have to rely on different estimates, based on the results of our surveys and indicators which show the dynamics in different sectors of the economy. For example, according to our surveys, around one third of enterprises were not operating completely at the beginning of March. When we observed this again at the end of May, this number had decreased to 14%.

However, more and more businesses are adjusting to the new reality – particularly in sectors like hospitality. At the beginning of the war, restaurants’ turnover fell to about 20% of the pre-war level. But now this figure is back up to 75-80% of the pre-war level. So we’re seeing some steady rebalancing in this sector. But looking more generally, we assess that in the second quarter, GDP fell by 40% compared with the second quarter last year.


Rabbit Hole: The key role of a central bank is usually to keep inflation under control. Presumably, now, you also have other priorities. What are those priorities?


SN: Actually, frankly speaking, our main priorities remain unchanged. Our job is still to ensure price and financial stability in the country. However, the methods needed to achieve those goals have changed dramatically. Prior to the invasion, we followed an orthodox approach based on an inflation-target regime, which is similar to the approach used by the Bank of England. I’m confident that our post-war policy will not differ a lot from this one, as we stay committed to traditional monetary instruments and market principles.

However, since the invasion, we understood very clearly that it’s impossible for us to follow this orthodox approach. We shifted from operating on market-driven principles to manual management in order to meet these unprecedented challenges. We moved to a completely different type of monetary policy. We fixed the exchange rate, and we started to rely very heavily on intervention as one of our main policy tools. We also introduced a number of capital controls, and restrictions on the banking system.

When the war broke out, we froze our decision on the key policy rate. Interest rates stayed at 10%. However, as the economy is gradually adjusting, and we begin to move past the psychological shock from the outbreak of war, we are pushing to switch policy back to more market-driven mechanisms. At the beginning of June, we raised our interest rate to 25% – moving towards more orthodox ways for navigating the economy.

“[O]ur main priorities remain unchanged. Our job is still to ensure price and financial stability in the country. However, the methods needed to achieve those goals have changed dramatically.”

Rabbit Hole: In macroeconomics, there’s the classic trade-off between “guns and butter” – between spending on defense versus spending on civilian goods. In wartime, of course, the pendulum swings more towards guns. But how are you balancing between the two now?


SN: The task of budget management lies with the minister of finance, the government in general, and with the parliament. Military expenditure is definitely their major priority, and all sources of the economy are being directed to this area, as is needed. Meanwhile, we also understand that we have to support the population and maintain social expenditures. We also need to try and launch the economy in areas where it is possible – in relatively calm regions. We rely heavily on international support to accumulate resources and finance these expenditures. But of course, military expenditures are currently the main priority.


Rabbit Hole: How are you allocating the foreign aid Ukraine is receiving?


SN: First of all, this crucial financial support helps us to fill the budget gap. The deficit has expanded given very, very high military expenditures and the sizeable drop in revenues. During the last few months, our budget deficit was close to $5 billion, around $1.5 billion per month, and we finance this with the support of our international partners. Some of this support is also targeted to social needs. Usually, our partners do not want to finance military expenditures because of difficult geopolitical considerations. So we try to finance our military expenditure from internal sources, as much as possible.


Rabbit Hole: In an interview in this magazine, Israeli military expert Azar Gat spoke of the importance of economics to war. He said: “The winner in all the great power wars over the past two centuries was the richest. It is the economy that determined the winner in all of them. The ability to produce weapons fast, in large quantities, and high quality, was the decisive factor.” Do you agree with this assessment?


SN: I would agree to an extent, but I also believe that other factors are important. First of all, there is the moral motivation and the values of the military forces. In our case, it’s very clear that Ukrainian forces are extremely motivated in defending their own lands. But Russian troops are fighting mostly because of the orders of their leadership. That difference in motivation could be crucial.

However, coming back to the question of economics, international financial support is very important. Frankly, at the start of the war, our forces were not compared as well as the Russians. But every day we see that international support for Ukraine and our forces is growing. We are very thankful for that. If we just compare Ukraine and Russia, Russia definitely has a bigger economy and much higher potential when it comes to military spending. But with international support, and our high levels of motivation, I believe we will win.


Rabbit Hole: How is the central bank supporting the war effort?


SN: There are a few ways that we can support the budget directly. Actually, before the war, during the pandemic crisis, many emerging market central banks joined the central banks of advanced economies to provide quantitative easing and support budgets. In the past, we have had very bad experiences with such mechanisms: our crisis of 2014-15 was partly caused by helicopter money from the central bank to the budget, so we are usually afraid to do that. But the war changed everything. We have to balance the need to achieve financial stability with the need to support the government’s crucial expenditure. Since the beginning of the year, we have provided the government with 225 billion Ukrainian hryvnias, which is something like $7.5 billion, to cover around a month and a half of budget deficits. Our response to the war is designed to help fund military expenses.


Rabbit Hole: Accordingly, do you see yourself as squared-off against the Russian central bank, and, if so, how do you plan to beat it?


SN: Nowadays, I don’t think we can compare ourselves to the Russian Central Bank. In our view, the Russian state is now the main terroristic organization in the world – and the Central Bank is definitely part of this state. Before the war, we considered Russian central bankers as very experienced, professional, and technocratic. But since the war, we now believe Russian central bankers to be part of a terroristic state.


Rabbit Hole: The World Bank has projected Ukraine’s economy will shrink by 45.1% this year, and that Russia’s will shrink by 11.2%. How would you assess the relative strengths and weaknesses of the Ukrainian economy and the Russian one?


SN: First of all, I must emphasize that we are not fighting with economic figures, but with military forces. Of course, our economy is struggling a lot because of the invasion, and even more so because of terroristic actions – like bombing civilian areas, or shelling shopping centers. Given this destruction, the destruction of infrastructure and loss of revenue, our economy is definitely suffering a lot. But we are completely sure that, with international support, it will ultimately be Russia that has to pay for these disruptions. In the longer-term, with economic reforms anchored in membership of the European Union, our economy will be able to regrow. Russia, on the other hand, now faces a decade of regression. The next 10 years will be dedicated to a complete regress from globalization as its economy is forced to localize. These are our main strengths compared with the Russian economy.

“In the longer-term, with economic reforms anchored in membership of the EU, our economy will be able to regrow. Russia, on the other hand, now faces a decade of regression.”

Hole: What more should other countries be doing to sanction the Russian economy? 


SN: A lot has been done already, but we still see some loopholes that allows Russia to fund its military expenditure. Firstly, some Russian banks still remain in the SWIFT payments system. Secondly, we still think that action is required in energy and gas markets. There are ongoing negotiations to determine how countries can at least minimize their future use of Russian energy, or set limits on the prices that are paid to Russia – money that funds their war against Ukraine. It’s important that these loopholes are closed, as we consider this conflict to be between Russia and the entire civilized world.


Rabbit Hole: Finally, you’ve called for Russia to be expelled from international organizations like the International Monetary Fund (IMF) and the Bank for International Settlements (BIS). How would this help Ukraine?


SN: It’s very clear. Russia is fighting not just against Ukraine, but the entire democratic and free world. Because of this, [Russia should not be] allowed to engage with international organizations like the IMF and BIS in the same way it did before the war. We are pleased with the progress we have made so far: just recently Russia has been suspended from participating, for example, in different IMF committees and working groups. That is a very important sign for us and shows how isolated Russia is becoming.