Dragon Capital Analysts Update Macroeconomic Forecast Through 2026
Key events affecting the economy
Against the backdrop of unsuccessful U.S. efforts to push Russia toward peace negotiations, there has been an important shift in the European Union’s approach to using frozen Russian state assets for Ukraine’s benefit. Since mid-September, discussions in the EU have intensified regarding the potential establishment of a “reparations loan” mechanism, secured by immobilized Russian assets. This primarily concerns €185 billion ($215 billion) frozen in the Belgian depository Euroclear, although other countries may also join the mechanism. It is expected that part of this amount, approximately €45 billion, will be allocated to compensate ERA loans, the current support mechanism for Ukraine financed by frozen asset revenues, while €140 billion in the “reparations loan” could be available as early as the first half of 2026.
Although some EU countries remain cautious about using Russian assets, the EU has made a political decision to provide Ukraine with sufficient resources in the coming years. We therefore expect the “reparations loan” mechanism to be approved by the end of this year.
Meanwhile, as we had anticipated, the Ukrainian government has submitted an official request to the IMF for a new program, since the current four-year Extended Fund Facility (EFF) program, launched in 2023, does not provide sufficient financing if the war continues beyond 2025. The new IMF program is also likely to be four years in duration and will assume that the war lasts until the end of 2027. The “reparations loan” will form a significant part of Ukraine’s new external support package for 2026–2029, estimated by the Ministry of Finance at $150–170 billion, and will ensure full financing of the new IMF program.
Taking into account existing external budget financing programs such as ERA loans and the Ukraine Facility, and assuming that military aid from partners does not decline, we estimate that $75–95 billion of the “reparations loan” will need to be allocated for budget purposes in 2026–2029. The remaining funds will likely be used for arms purchases from the U.S. and/or to expand military production in the EU for Ukraine’s needs.
Thus, thanks to the “reparations loan,” Ukraine could receive $96 billion in external budget financing in 2025–2026, compared with $87 billion in our previous forecast, including $52 billion this year (unchanged) and $44 billion next year (significantly higher than the $35 billion previously projected). Despite its name, the “reparations loan” will not create an additional debt burden for Ukraine, as repayment will come from Russian reparations.
The second significant development was the resumption of targeted large-scale attacks by Russia on Ukraine’s critical infrastructure at the end of September, which led to reduced gas production, electricity shortages, increased energy imports, and higher costs for industrial consumers. While in our previous baseline forecast, we assumed that the “energy truce,” which had lasted since March this year, would end at the end of 2025 – beginning of 2026 due to the lack of progress in diplomatic peace efforts, the attacks resumed noticeably earlier than expected.
In light of these events, we have adjusted our macroeconomic forecasts for 2025–2026, focusing on a “prolonged war” scenario, as its likelihood has increased substantially in recent months.
Economic Growth
Ukraine’s economy continued to grow in the first half of 2025, supported by resilient consumer demand, further expansion of domestic military production, and the “energy truce.” However, growth slowed due to losses in productive capacity, exhaustion of previous growth drivers (macroeconomic stabilization and full recovery of Black Sea port operations), and a high labor shortage. Additionally, from June onwards, the harvest delay for grain due to adverse weather negatively affected real GDP growth. As a result, real GDP growth slowed to 0.8% y/y in H1 2025, compared with 2.9% in 2024 and 5.5% in 2023.
The resumption of Russian attacks on critical infrastructure will be the main negative factor for the economy over the forecast horizon. Meanwhile, economic activity will be supported by additional budget stimulus made possible by higher external financing. In our updated forecast, the general government budget deficit is expected to reach a record $50 billion this year and likely remain at a similarly high level in 2026, compared with $44 billion in the previous forecast. Temporary support for real GDP growth in Q4 2025 will also come from the agricultural sector due to the acceleration of the harvest.
Taking these factors into account, we have revised our 2025 GDP growth forecast down by 0.3 pp to 1.7% y/y and the 2026 GDP forecast down by 0.5 pp to 1.0% y/y. However, due to significant uncertainty regarding potential destruction of critical infrastructure, downside risks to the forecast remain high.
We confirm our previous assessment of 5% y/y GDP growth in 2026 in the event of a stable truce at the beginning of next year, driven by consumption growth and recovery of investment activity amid declining security risks, partial return of refugees, and the start of reconstruction, supported by sufficient external resources. According to our estimates, these factors will outweigh the negative impact of reduced defense spending from the budget.
Inflation
Annual consumer inflation has slowed as expected over the past months, falling to 11.9% y/y in September from 15.9% in May, following fifteen months of acceleration. The slowdown in inflation was driven by easing fundamental pressures, normalization of vegetable supply after the weak 2024 harvest, and stable electricity tariffs for retail consumers following last July’s increase.
Weakening of underlying inflationary pressures was supported by the exhaustion of last year’s effects of rising business electricity costs, a stable foreign exchange market, and tighter NBU monetary policy. However, rapid wage growth in the private sector amid a growing labor shortage continued to feed production costs.
We expect underlying inflationary pressures to intensify in the coming months due to further increases in business energy costs and higher budget expenditures, but to ease again in 2026 as the labor deficit is expected to stabilize, slowing wage growth in the private sector. Considering also the high base effect in the raw food segment and assuming utility tariffs remain unchanged, we expect consumer inflation to continue slowing, albeit at a more moderate pace. We forecast that by the end of 2026, consumer inflation will decline to 6.0% y/y (0.7 pp higher than previously expected), down from 9.3% this year.
Against the backdrop of rising inflation risks from both supply and demand sides, the recent NBU decision to keep the key policy rate unchanged at 15.5% and postpone the start of its reduction cycle until January 2026 appears logical. We see scope for a rate cut at the beginning of 2026, but do not rule out further postponement by the NBU if inflationary pressures continue to build due to significant infrastructure damage or other factors.
Balance of Payments and NBU Reserves
Among the unexpected trends in recent months has been the rapid expansion of the external trade deficit, which reached a record $35 billion over the first nine months of 2025, up $12 billion y/y. The main reason for the widening deficit was a sharp increase in imports by $11 billion y/y to $63 billion, while exports slightly declined to $28 billion.
The significant increase in imports was largely driven by goods required by the wartime economy, including the replacement of lost assets. These include weapons, dual-use goods, natural gas, coal, other fuels, energy equipment, and other investment goods. We estimate that imports of such goods rose by $6 billion y/y to $30 billion over the first nine months of 2025, accounting for nearly half of total imports. Consumer goods imports also rose actively, adding $5 billion y/y (to $22 billion), mainly due to increased shipments in individual consignments (estimated +$3 billion, to $5.2 billion), which are currently almost tax-exempt, and active imports of cars ahead of the expiration of tax benefits on EV imports from January 1, 2026.
Meanwhile, agricultural products continue to dominate exports, shaping their dynamics. Agricultural exports fell 11% y/y over the first nine months of 2025 due to a high base at the start of 2024, delays in shipments caused by cyberattacks on Ukrzaliznytsia, and late harvesting of this year’s grain.
The worsening trade balance this year has been accompanied by a reduction in private sector capital outflows to $1.5 billion over eight months of 2025 from $8.8 billion over the same period in 2024 (excluding NBU reserve revaluation effects). The primary reason for this change is difficult to isolate, but possible factors include more active financing of private and state companies by international financial institutions (notably for gas and energy equipment imports), improved export revenue repatriation, and reduced unproductive outflows due to targeted government measures.
International budget support increased significantly to $29 billion over the first nine months of 2025, up from $24 billion over the same period in 2024. Thus, despite the record external trade deficit, NBU reserves remained high at $44 billion at the end of September, compared with $31 billion before the full-scale invasion.
Assuming our estimate of international budget support at $52 billion this year, we expect NBU reserves to rise to a record $54 billion by the end of 2025, slightly above our previous baseline of $52 billion due to currency revaluation and higher gold prices.
We expect the external trade deficit to narrow to $45 billion in 2026 from a record $49 billion this year, due to reduced EV imports, import substitution in military production, and delayed grain exports. Assuming private sector capital outflows do not rise significantly and considering higher-than-expected international aid inflows ($44 billion vs $35 billion), we have raised our forecast for NBU reserves at the end of 2026 to $50 billion from $42 billion previously.
Exchange Rate
Under the current flexible inflation-targeting framework adapted to wartime realities, NBU’s exchange rate policy remains subordinate to achieving the 5% inflation target, with the UAH/USD rate determined by the NBU. In setting the optimal trajectory of the UAH/USD rate, the NBU considers multiple factors, including consumer inflation risks, public expectations, balance of payments, and USD movements against major currencies globally, especially the euro. In the short term, the NBU aligns the currency rate with interbank market conditions, except for specific transactions.
During January–September 2025, the NBU strengthened the hryvnia by 1.5% against the USD, after a 10% weakening in 2024. This shift likely reflects the NBU’s response to high inflation, satisfactory balance of payments, and a significant USD weakening against the euro and other currencies. Consequently, the hryvnia weakened 9.3% against the euro, supporting the competitiveness of Ukrainian goods in the EU, Ukraine’s largest trading partner.
We believe the combination of economic factors shaping NBU’s outlook currently favors a relatively stable UAH/USD rate. As infrastructure losses from attacks intensify fundamental inflationary pressures, NBU’s reserves are expected to remain at record levels despite the widening trade deficit, while consensus forecasts anticipate continued USD weakness against other currencies.
We expect that by year-end, the NBU will allow the hryvnia to weaken slightly against the USD amid seasonal demand for foreign currency, but will avoid significant devaluation. In our updated forecast, the UAH/USD rate will reach 43.0 by the end of 2025 and 44.0 by the end of 2026, compared with previous expectations of 43.5 and 46.0.