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War in Ukraine: Ukraine’s monetary-financial vulnerabilities

The National Bank of Ukraine reacted decisively to Russia’s invasion, imposing capital controls and a fixed exchange rate regime. However, the country’s economy remains fragile and the battle to maintain monetary and financial stability continues. This column explores the growing risk of uncontrolled inflation in the country, what is causing it, and how it can be stopped. The unsatiated demand for foreign currency is putting pressure on the fixed exchange rate. In the longer term, the war has significantly increased the government budget deficit, raising concerns of monetary financing. Whether the war ends soon or not, the transition back to normality and stability is fraught with uncertainty.

Editors' note: This column is part of the Vox debate on the economic consequences of war.

The initial impact of the Russian invasion on the Ukrainian economy was devastating. A third of enterprises immediately ceased operations, caused by the destruction of production facilities and infrastructure, the disruption to supply chains, and dramatic increases in production costs. As a consequence, GDP fell 15% in 2022 Q1 and a staggering 37% in Q2.

Since then, the rebuilding of economic activity in the country has begun. However, high and uncontrolled inflation may yet prove a longer-term scourge for the Ukrainian economy. While rising inflation has become a global problem, caused by supply chain bottlenecks and rising world energy prices, the risk of high inflation in Ukraine is even greater. Figure 1A shows part of Ukraine’s troubled history with inflation, when it rose above 60% in 2015. However, after a period of relative stability, inflation has once again accelerated, to 24.6% in September, significantly above the National Bank of Ukraine’s (NBU) inflation target of 5%. 1 In the face of surging inflation, the NBU took the unusual step of hiking its policy rate by 15 percentage points in one move on 2 June, to 25% (see Figure 1B).

Yet, the policy challenge is more complex than a simple relationship between inflation and interest rates. In analysing the NBU’s policy response below, we look at the pressures on the national currency, the return of fiscal dominance, and support from the international financial community in gauging the severity of the inflation risk. 2

Figure 1 Inflation and the key policy rate

Figure 1 Inflation and the key policy rate

Source: National Bank of Ukraine.
Note: ‘Deposit rate’ and ‘lending rate’ are the interest rates on new deposits and loans in national currency to resident sectors (excluding deposit-taking corporations).

The exchange rate and demand for foreign currency

The Russian invasion generated a sharp increase in the demand for foreign currency in Ukraine. Initially, this was caused by Ukrainians seeking to move abroad and needing a means of payment. But, it was also caused by those wanting to protect the value of their liquid savings.

In the face of this pressure, the NBU acted decisively on 24 February by imposing capital controls (preventing the purchase of foreign currency) and a fixed exchange rate regime at 29.25 Ukrainian hryvnia per US dollar (UAH/USD).  However, the unsatiated demand for foreign currency caused the emergence of a shadow foreign exchange market. Figure 2 shows one such bilateral shadow market on the website, where individuals can post prices for currency they are willing to buy and sell. The gap between the official and shadow exchange rates is a good proxy of the pressure on the fixed exchange rate. From the onset of the initial fix, the shadow rate has been above the official rate. However, that gap steadily grew over the spring and summer, eventually forcing the NBU to announce a devaluation of the currency on 27 July (to UAH/USD = 36.57). Despite the interest rate hike and the revaluation of the currency, the gap between the official and shadow exchange rates continued to widen, with only a slight narrowing in recent weeks.

Figure 2 Official and shadow hryvnia exchange rate

Figure 2 Official and shadow hryvnia exchange rate

Source: National Bank of Ukraine and

The pressure on the NBU to devalue the currency can also be seen by the effect of the fixed exchange rate on its international reserves. Figure 3 shows that, in defending the fixed exchange rate, the NBU’s net stock of reserves fell almost 40%. The figure also shows the last large devaluation of the currency, in 2015, when the NBU depleted its reserves in an unsuccessful attempt to defend the currency. This time, the depletion of foreign currency reserves was partly reversed by the provision of international financial support and the devaluation of the exchange rate in July.

Figure 3 International reserves and the NBU’s purchase of foreign currency

Figure 3 International reserves and the NBU’s purchase of foreign currency

Source: National Bank of Ukraine.

The pressure on the national currency can be equally seen through the lens of the balance of payments. First, the stock of foreign cash owned by Ukrainians outside the banking system increased by almost $9 billion in January-September 2022 while trade credits rose by $11 billion. Second, trade volumes plummeted at the start of the invasion, and thereafter imports have recovered much faster than exports. As a consequence, Ukraine’s trade deficit was $15 billion (10% of GDP). While these two items were partially covered by remittances and military and humanitarian aid, Ukraine lost around $6 billion overall in international reserves.

A final important factor affecting foreign exchange has been the increase in excess liquidity in national currency in the banking system. This occurred because the NBU supported both the government to meet its expenditure needs and the banking sector to prevent a liquidity dry-up of financial markets. In the first two weeks of the invasion, commercial banks received 62 billion Ukrainian hryvnia of one-year maturity financing from the NBU at an interest rate of 11% and without needing collateral—approximately equivalent to the size of banks’ current accounts at the NBU before the invasion (see grey bars in Figure 4).

Figure 4 Banks’ current accounts at the NBU

Figure 4 Banks’ current accounts at the NBU

Source: National Bank of Ukraine (NBU).
Note: Total is the cumulative change in banks’ current accounts at the NBU since 1 November 2021. These changes split by four factors: two types of NBU monetary policy operations (‘Standing facilities’ and ‘Tenders’), ‘Cash’ (the effect of changes in the volume of cash in circulation), and ‘Other’ (dominated by the government expenditures). On 25 February, the tenders included unsecured funding with maturity up to one year.

Monetary financing of the budget deficit

While many of the factors described above may be temporary in nature, a more concerning long-term trend has been the monetary financing of the government’s budget deficit. The war has caused a significant increase in budget spending on defence and social security. As a consequence, the government budget deficit was 42% of GDP in 2022 Q2 (up from 3.6% of GDP in 2021). 3

To fund the deficit, the government issued bonds and called on the NBU to buy them. Figure 5A shows that the NBU is now the largest holder of Ukrainian government bonds. Moreover, Figure 5B shows a break-down of how the government’s budget has been financed since the start of the war. While significant support has been provided by the US, EU, and IMF, it has been insufficient to prevent the NBU from being the dominant actor in financing this increased spending. 4 If monetary policy continues to be subservient to fiscal policy, it becomes less credible that the NBU can act to prevent accelerating inflation. 5

Figure 5 Fiscal dominance returns

Figure 5 Fiscal dominance returns

Source: National Bank of Ukraine and Ministry of Finance of Ukraine.
Note: In panel (A), ‘Other’ includes resident households, resident firms, and non-residents. In panel (B), ‘Other’ includes other countries and international financial institutions.

In defence of the NBU, and as discussed at the start of the column, it did raise its policy rate sharply by 15 percentage points in June. However, the pass through to market interest rates has been meagre. As seen from Figure 1, which plots the average interest rate on new deposits and new loans, deposit rates have risen around 3 percentage points this year whereas lending rates have risen almost 6 percentage points. 6 This lack of pass-through, especially to depositors, has diminished the effectiveness of the policy in incentivising residents to hold national currency.

Part of the reason for the high inertia of deposit rates is that banks do not have strong incentives to raise external funds from the public. The NBU’s liquidity policies (see Figure 4) mean that Ukrainian banks experienced a structural surplus of national currency liquidity. 7 For the NBU, navigating the path between ensuring the banking system has sufficient liquidity to mitigate financial stability risks and ensuring that the monetary transmission mechanism from policy rates to commercial bank interest rates is working well, is a key challenge in the months ahead. 8

International financial support

Thus far, Ukraine’s stock of international reserves has been supported by comprehensive financial assistance from the international community. The total amount of international funding received by Ukraine since the beginning of the war exceeded $22 billion as of mid-October (above 75% of the pre-war stock of international reserves). 9 More recently, the US and EU have agreed to support Ukraine with $1.5 billion and €1.5 billion  per month in 2023, creating much needed stability and predictability in the financial support they are given.

Ukraine has also requested a full programme from the IMF in the hope of receiving $15-20 billion over two or three years in form of a Stand-By Arrangement (SBA) or an Extended Fund Facility (EFF). However, the decision to provide a programme and agree its design is complicated for two reasons. First, the IMF’s standard programmes require the sustainability of fiscal debt for three to five years, which is difficult to ensure since it will depend on the length and scale of the war. The war imposes uncertainty on the economic outlook, complicating macroeconomic forecasting and the predictability of timely repayments. Second, IMF support usually comes with structural reforms to ensure macroeconomic stability. However, it is again hard to say how structural reforms can be implemented while the war continues. The IMF is likely to want a return to pre-war conditions, including:

  1. Fiscal consolidation to ensure debt sustainability and its ability to repay external debt in the future
  2. Removal of the fixed exchange rate and foreign exchange market restrictions (if not to a fully floating regime, then at least to a managed float), since the fixed exchange rate is likely to lead to a further accumulation of macroeconomic imbalances
  3. Central bank independence to prevent long-term monetary financing of government deficits 10

While these aims are laudable in the long run, the transition back to normality and stability is fraught with uncertainty. Whether the war ends soon, or whether it continues to rumble on, the macroeconomic consequences are mounting for the country, creating both monetary and financial vulnerabilities. In addition to the challenges described above, it is likely that the banking sector is accumulating non-performing loans, the long-term consequences of which will probably appear once liquidity conditions in the banking sector normalise. The transition to normality will therefore require, not just financial support, but also the taking of wise and tough decisions by the NBU and related policy institutions.


Becker, T,  O Bilan,  Y Gorodnichenko,  T Mylovanov,  J Nell,  N Shapoval (2022), “Financing Ukraine’s victory: Why and how”,, 29 September.

de Groot, O and Y Skok (2022), “War in Ukraine: The financial defence”,, 17 March.

Fischer, S (2015), “Conducting Monetary Policy with a Large Balance Sheet”, Speech at the US Monetary Policy Forum.

Rogoff, K, B Weder di Mauro, T Mylovanov, M Obstfeld, S Johnson, S Guriev, Y Gorodnichenko, B Eichengreen and T Becker (eds) (2022), Macroeconomic policies for wartime Ukraine, CEPR Press, London.

Sargent, T and N Wallace (1981), “Some unpleasant monetarist arithmetic”, Federal Reserve Bank of Minneapolis Quarterly Review 5(3): 1-17.

Woodford, M (2003), Interest and Prices, Princeton University Press, Princeton.


  1. See the NBU Inflation Report (October 2022) for a more detailed discussion of the data.
  2. Becker et al. (2022) and Rogoff et al. (2022) provide a broad discussion of appropriate macroeconomic policies for Ukraine and how the international community should financially support them.
  3. The government debt-to-GDP ratio was 49% at the beginning of 2022, 58% of which was foreign-currency denominated. The debt-to-GDP ratio has risen to 71% at the end of 2022 Q3, a significant part of which was caused by the devaluation of the national currency.
  4. For the early rigorous analysis of fiscal dominance of monetary policy, see Sargent and Wallace (1981) and Woodford (2003).
  5. The effect of the NBU’s monetary financing of government expenditures can also be seen in banks’ current accounts at the NBU (see blue bars in Figure 4). The ratio of new money issued by the NBU to the volume of foreign currency sold by the NBU to banks was 3:2 in April and 1:1 in May. However, some banks hold excess liquidity in NBU certificates of deposit (enjoying high returns), the outstanding amount of which has increased substantially since the invasion (see orange bars).
  6. Average deposit rates declined by 1.6 percentage points from 6% to 4.4% between March and May before recovering to 6.9% in June.
  7. Even pre-war, the Ukrainian banking system operated under a structural surplus of liquidity.
  8. The US Federal Reserve faced a similar policy question with regards to its extensive QE asset purchase programme: Could they tighten policy (and control interest rates) while its balance sheet remained large and the banking system remained awash with liquidity? See e.g. Fischer (2015).
  9. In addition, international creditors allowed Ukraine to postpone repayment of about $20 billion of its debt for two years.
  10. Under the previous (pre-war) IMF programmes, the NBU also had an indicative goal for the growth of the monetary base. In addition, provision of refinancing loans to the financial sector was only short-term (up to 90 days) and with collateral.