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NBU Comment on Change in Real GDP in 2022

NBU Comment on Change in Real GDP in 2022

Real GDP fell by 29.1% in 2022, according to detailed GDP data from the State Statistics Service of Ukraine.

This was the deepest annual drop in GDP in Ukraine’s history. The plunge was primarily triggered by the full-scale war unleashed by russia on 24 February 2022, and its consequences. Those include the occupation of Ukrainian territory, the destruction of infrastructure and production facilities, the blockade of Black Sea ports, supply chain disruptions, and a huge wave of migration. A combination of these effects caused a sharp reduction in consumer demand, investment activity, exports, and harvests.

The economy sustained the most losses in the earliest months of the full-scale war. The slump reached 14.9% in Q1 2022 already. This was a result not only of the full-blown invasion, but also of a significant increase in risks in the lead-up to it. Those risks depressed consumer and business sentiment. In Q2 2022, real GDP shrank by 36.9% yoy. However, successful operations of Ukraine's Armed Forces, as well as emergency measures taken by the NBU and the government, which were supported by international partners, made it possible to gradually stabilize the macroeconomic situation. Ensuring the smooth functioning of the banking and payment systems and fixing the official exchange rate with the simultaneous imposition of FX restrictions on currency exchange transactions and capital movements were among the measures that restrained the spread of panic and significantly reduced uncertainty for households and businesses. Those efforts laid the groundwork for a revival of business activity after the first shock of the war. 

The first signs of recovery in economic activity emerged in the spring and continued throughout the summer and early fall. The revival was facilitated by the gradual removal of supply chain disruptions, the relocation of companies, the reorientation of a number of activities to military needs, the further liberation of russian-occupied territories, the return of some IDPs and forced migrants to places of permanent residence, and the launch of the grain corridor. As a result, the fall in real GDP slowed to 30.6% yoy in Q3.

At the end of the year, however, the economic recovery was interrupted by the fallout from russia's massive attacks on the energy infrastructure that created a significant shortage of electricity in Ukraine. Many companies were actually able to adapt to blackouts by purchasing power-generating hardware, but had to scale operations down to a lower capacity level. Other businesses found themselves unable to adjust to such conditions due to the special nature of their production processes and scarce financial resources. The shortage of electricity deepened the fall in GDP to 31.4% yoy in Q4.

The actual contraction of business activity in 2022 was less than many organizations predicted at the onset of the full-scale invasion, and came out better than the NBU's estimates released in the January 2023 Inflation Report. Improved economic performance, compared to initial forecasts, was made possible by a surge in budget expenditures, primarily on defense and security, which boosted public consumption and supported investment, as well as households' and businesses' quicker adjustment to wartime conditions, including power supply disruptions at the end of the year. 

Consumption declined by 16.9% amid a full-scale war  

This reduction occurred primarily because of a decline in private consumption, which is attributable to a fall in household income in real terms and to record-high migration fueled by high security risks. As a result, households’ final consumption expenditures fell by 26.7% in 2022.

At the same time, overall general government consumption increased by 18% over the year, driven by the surge in security and defense expenditures, social protection programs, and the relatively stable financing of other budgetary items (healthcare in particular).

What is more, final consumption expenditures of nonprofit institutions serving households (NPISH) went up significantly (by 37.7%) last year. This primarily reflects the rapid growth in the volunteer movement, as well as the work of other NGOs.

High security risks and deteriorating business expectations led to a significant drop in investment activity  

Gross fixed capital formation fell by 34.3% yoy in 2022. On top of security risks and the worsening of business expectations, the shrinking of investment activity was also driven by the overall deterioration in the financial performance of businesses.

At the same time, the supply of equipment and machinery to meet security and defense needs restrained the drop in investment.  

Exports plunged due to supply chain disruptions and russia's blockade of maritime transport, while the role of imported supplies increased 

As a result of the destruction of export-oriented companies' capacities and because of logistical hurdles as russia shut down Black Sea ports, the fall in exports deepened rapidly (to 42.4%). The launch of the grain corridor, and the development of transport routes that cross Ukraine's border in the west and facilitate the delivery of goods via railways and Danube ports, only partially made up for the closures of conventional pathways through which exports used to flow. 

Amid a slump in domestic production, imported supplies increased in significance, although the volume of imports also declined (by 18.5%) as domestic demand narrowed. Net exports made a negative contribution to the change in GDP (9.5 pp).

Performance indicators in most lines of business deteriorated significantly in 2022 

For every type of business activity during 2022, performance dynamics were primarily shaped by high security risks. 

Construction experienced the deepest decline as a consequence of reduced investment and a sharp drop in housing demand. To some extent, the sector drew on support from budget expenditures on infrastructure renewal. 

Industry's performance also deteriorated significantly as production facilities and infrastructure came under attack and consumer and investment demand flagged. Power outages at the end of the year, caused by russia's shelling of critical infrastructure, deepened the decline in industrial production. At the same time, certain segments of manufacturing, such as machine building, light industry, and food production, were supported by the state financing of military orders. The shift by agricultural producers away from fertilizers previously imported from russia and belarus and towards Ukrainian-made fertilizers propelled the chemical industry. Meanwhile, the uninterrupted production of energy resources supported the mining industry. 

The gross value added of trade also decreased significantly. There was also a deep drop in other types of services as a result of the sharp narrowing of consumer demand. Transport and wholesale trade were further impeded by supply chain disruptions, reduced export supplies, fuel shortages in the spring of 2022, and power outages at the end of the year.

The enemy occupation of Ukrainian soil and the laying of mines in sowing areas, as well as the decline in the yields of certain crops, were what brought about the significant decrease in the gross value added of agriculture. Agricultural production was driven by the switch of a number of agricultural producers from grains to oilseeds, and the opening of the grain corridor. 

The financial sector's performance declined at a considerably lower pace than that of other activities, primarily thanks to efforts to ensure the smooth operation of the banking system even as power outages impeded the conduct of business as usual. The fall in the gross value added of IT also came out smaller than elsewhere, as increasingly more people in this line of business opted to work remotely and companies promptly relocated to more peaceful regions.

The gross value added of public administration and defense grew rapidly due to their expanding role in conditions of full-scale war. Driven by budget expenditures, the financial performance of education and healthcare posted a slower pace of decline compared to many other segments. Overall, budget sectors' contribution to the change in real GDP was positive, unlike the impact of other industries. At the same time, the significant reduction in the tax base due to the slump in economic activity and the introduction of temporary tax breaks led to a material decrease in tax revenues, which had an adverse impact on GDP dynamics. 

At the start of 2023, the economy returned to recovery thanks to a much better situation in the energy sector, the further adjustment of businesses and households to wartime conditions, and international support. It is expected that the economy will continue to recover and that this year it will be possible to avoid a fall in real GDP. 

Expectations will improve, among other things, due to the NBU's efforts to ensure macrofinancial stability and reduce inflation. The slowdown in inflation will continue. At the same time, the recovery of the economy will remain subdued because of ongoing hostilities and high security risks. 

These and other factors will be taken into account in the NBU’s updated macroeconomic forecast, which will be presented at the 27 April 2023 press briefing on monetary policy and published in the Inflation Report on 4 May 2023.

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