Russia’s invasion has created enormous challenges for Ukraine, the surrounding region and globally. Development banks are balancing the need for a short-term crisis response with support for longer-term infrastructure and transition aspirations. By Nick Herbert.
The humanitarian impact of Russia’s war in Ukraine has been, and continues to be, calamitous. For one, the United Nations Office for the Coordination of Humanitarian Affairs reports that the military offensive has displaced nearly 30% of the Ukrainian population.
Ripples from the conflict have been felt far and wide with higher energy and commodity prices stoking inflation and precipitating a round of rapid and drastic interest rates hikes. Financial stability has been compromised.
A joint assessment from the Government of Ukraine, the World Bank Group, the European Commission and the United Nations, estimates that the cost of reconstruction and recovery in Ukraine grew to US$411bn over the one-year period to the first anniversary of the war. The cost of reconstruction and recovery is expected to stretch over 10 years and combines both needs for public and private funds.
As well as strikes to Ukraine’s infrastructure, considerable damage has been inflicted on the country’s private sector. Businesses have closed or are operating below capacity, yet many firms continue to provide jobs and services. They need finances to keep going.
Near-term support to help keep Ukraine’s businesses and economy functioning continues to flow into the country.
The European Bank for Reconstruction and Development – the largest institutional investor in Ukraine – committed to providing €3bn of financing over 2022-2023, deploying €1.7bn during 2022. In addition €200m was also directly mobilised from partner financial institutions.
In December 2022, IFC announced a US$2bn package to help build resilience in the Ukrainian private sector and help prepare the country for reconstruction.
Yet development partner support needs to be complemented by private investment.
Private potential
Attracting private investment into keeping economies going in a region with a war ranging nearby is not easy. The volatile backdrop arguably makes it even more difficult to attract the type of investment required to finance the longer-term objectives of net zero. It might even be a distraction.
“There has already been a standstill in many of the investments in the capital markets side,” said Melis Ekmen Tabojer, director of the EBRD's EU banks and structured finance department. “High volatility in the business environment caused by Covid turned into a severe disruption on the back of the war on Ukraine. Investor confidence is further shaken by the deteriorating macro backdrop.“
Even before the war, the region had well-known structural laggards in terms of capital markets, energy infrastructure, and the regulatory environment that made infrastructure projects sufficiently bankable to attract private investors.
And with the private sector understandably more cautious in the current environment, then the nature of development bank activities becomes more important in supporting the region’s economies and capital market issuances.
“The need for EBRD support has increased tremendously over the last year and a half,” said Ekmen Tabojer. “We supported the issuers as an anchor investor and crowded in private investors.”
The need for a countercyclical investor has seen the EBRD increase its presence and focus on Ukraine and the surrounding area, something that is illustrated in its bond-investing activity.
“We’ve increased how much we would normally invest in corporate bonds from the region, trying to bring private investors along with us by becoming a core investor, giving confidence to the issuers and scaling back to make further space for private investors,” said Ekmen Tabojer.
Playing a bigger role in the capital markets represents an example of an immediate response to the financial dynamic. It is, nevertheless, a stopgap to the major task that awaits. The long-term rebuilding process is going to take place once the war is over.
Big infrastructure investments have taken a hit due to the heightened geopolitical risks and the weaker macroeconomic environment, but the topics of energy security and food security highlighted by the invasion only increase the need for such long-term investments. And those long-term investments will, increasingly, be guided by the net-zero agenda.
“Our current and future investments will be in line with our green economy transition objectives,” said Ekmen Tabojer.
Changing perceptions
A heavy reliance on Russian energy supplies throughout Europe prior to the war has amplified the issue of energy security, particularly in those countries on the Eastern border of the European Union where there has been the greatest dependence on Russia’s oil, gas and coal. This is a short-term and long-term challenge.
“Countries are trying to find an alternative to their previous reliance on Russian energy sources,” said Grzegorz Zielinski, head of Energy Europe for EBRD. “Some have managed to effectively diversify completely away from Russian gas thanks to the construction of LNG terminals before the war but also by opening new pipelines and connecting with Norwegian gas fields.”
It is more of a struggle for other countries that do not have the opportunity to import gas from elsewhere.
Likewise for electricity. Some countries in the region were synchronised with the electric power systems of Russia and Belarus. Ukraine and Moldova managed to connect to ENTSO-E (the European Network of Transmission System Operators) in March 2022, just before the invasion, while the Baltic states have set 2025 as a target to begin disconnecting from Russia.
For the long term, the war has effectively given a boost to the decarbonisation and renewable energy agenda across the region.
“Energy security changes everything,” said Zielinski. “It gives policymakers a totally different perception on the subject and how to tackle it. It's not just about independence from Russia and fossil fuels, it's also about energy transition, it's about cheaper electricity. The authorities and regulators now believe renewables is the way forward.”
Renewables energised
The perception of energy security in the region has changed, not just from the viewpoint of a reliance on Russia but in terms of developing sustainable sources of power. There was already a regional push to decarbonise but implementation of those plans is being accelerated because of the conflict.
“It wasn't just Russia's invasion of Ukraine that triggered conversations around the energy transition; there was already a need to address energy needs,” said Rana Karadsheh, regional director at IFC Europe. “But what it has done is accelerate the movement towards not just the transition but the creation of energy resilience within each economy.”
Energy resilience is achieved by diversifying the energy base and moving towards renewable energy.
“There’s a sense that if we don't move forward in some of these key areas, then our ability to navigate future crises – this is unlikely to be the last to come – is diminished,” said Karadsheh. “A greater focus on energy resilience will help countries and companies become more able to adapt.”
Achieving greater energy security and resilience requires an environment that attracts private capital. A more accepting approach towards renewable energy has seen a marked change in discussions with regulators.
“We’ve been promoting relevant support schemes for renewables for years,” said Zielinski. “It's easier for people like EBRD to do our policy engagement work now. We just get much more buy-in from the authorities.
“They may not necessarily be sufficiently convinced to implement changes overnight, but at least they want to talk and develop adequate renewable energy support schemes relevant to each country’s requirements.”
Creating the right investible environment is key to nurturing the involvement of the private sector in infrastructure and the kind of renewable energy technology that has already been tried and tested in the rest of Europe. There is growing interest in the region.
“Over the long term, the trend towards private finance has been increasing and we're seeing the private sector – whether through equity or debt – exploring opportunities in this area,” said Karadsheh. “In the immediate situation, it’s true that we’re seeing a bit of a capital flight, but that's where we can step in. We can fill some of the financing gaps that currently the market is not willing to.”
Renewable energy is acknowledged as an increasingly cheap and more secure alternative than a previous reliance on fossil fuels, and there is a growing resolve to encourage the participation of the private sector in its development as well as development of infrastructure more generally. There is still work to be done, however.
“A couple of big things need to be addressed in the region,” said Karadsheh. “State-owned enterprises still play a relatively outsized role in the region. And this is one area where the strategic and conscious introduction of the private sector can help increase competition.”
Encouraging the introduction of public-private partnership frameworks also has the potential to attract private capital.
“It'll look different in each country,” said Karadsheh, “and will depend on the sector and the extent to which each government needs to play a role in the assets.”
While power generation is not the only consideration in realising net-zero targets, the change in perception towards renewables as a result of Russian aggression is likely to accelerate rather than hamper the transition.
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