Supporting Small- and Medium-Sized Enterprises for Ukraine’s Recovery and Reconstruction

Prior to Russia’s war of aggression, since 2014 the Ukrainian economy grew at a rate of 2.9 percent on average per year, disregarding a slight dip in 2020 as a result of the Covid-19 pandemic. Small- and medium-sized enterprises (SMEs), particularly those in the wholesale and retail sectors, were key drivers of this growth, including the rapid development of Ukraine’s IT sector. As in other countries, SMEs in Ukraine play a critical role in economic growth and job creation.

Due to the war, in 2022 Ukraine’s GDP fell by about 35 percent and the International Labor Organization (ILO) reports that about five million jobs were lost. If the conflict continues, the United Nations predicts that around 90 percent of Ukrainians could fall into poverty. Although the war caused significant property damage, business interruptions, and logistics and supply chain restrictions, Ukrainian SMEs have demonstrated significant resilience. A European Bank for Reconstruction and Development (EBRD) survey found that, by the end of 2022, business activity levels for most Ukrainian SMEs had stabilized. During this critical time, it is imperative to support Ukrainian SMEs so that the economy stays afloat and Ukrainians remain employed. Moreover, there are concerns that SMEs will be inadvertently excluded from the reconstruction process. SMEs will need a lot of support, including in financing and capacity building, to ensure a level playing field and a seat at the table in reconstruction plans.

The Current Landscape of Ukrainian SMEs

Ukraine is host to a vibrant business sector comprised of approximately 1.6 million individual entrepreneurs, 500 large enterprises, and 400,000 SMEs. In 2019, approximately 7.4 million people were employed in the SME sector and 65.5 percent of sales of goods, works and services, and 64 percent of value added in Ukraine was attributable to SMEs. Retail and trade formed the largest part of the SME sector, roughly 46 percent in 2019, followed by agriculture and industry, at around 14 percent and 12 percent respectively in 2017. The share of SMEs in the IT sector has been growing steadily, accounting for almost 11 percent in 2019.

The Covid-19 pandemic and subsequent war have disrupted and rerouted global supply chains, negatively impacting Ukrainian SMEs. Migration of the workforce and a reduction in consumer demand have dampened business activity and economic growth across the country. SMEs, particularly those located near conflict zones in the eastern, southern, and western regions, have been hit particularly hard, and many have been forced to relocate their operations, either to other parts of Ukraine or neighboring countries.

Despite these limitations, Ukrainian SMEs have demonstrated resilience, and business activity levels for most Ukrainian SMEs had stabilized. Of the 166 businesses surveyed by the EBRD at the end of 2022, 57 percent were able to maintain their prewar activity, 37 percent were operating at reduced capacity, and only 6 percent had suspended their operations.

Immediate and Medium-Term Challenges for Ukrainian SMEs

Before the war, SMEs faced barriers, preventing the Ukrainian business sector from flourishing despite relatively free market conditions. This suboptimal business environment reduces Ukraine’s attractiveness for foreign investors, hampering the inflow of private capital. Rampant corruption, a cumbersome tax process, a weak judiciary system, and lack of sufficient protection mechanisms for property rights all negatively impact SME growth potential and productivity. While most of these issues were identified prior to the war and have been eclipsed by more urgent needs, they are likely to remain relevant after the war.

SMEs are facing added challenges due to the war, including physical damages, obtaining financial support and insurance, getting advice, learning from the experience of international companies, and facilitating international partnerships. According to a study done by the Centre for Economic Policy Research, although 79 percent of SMEs report being able to maintain operations should the war continue for another six months, that number drops down to 62 percent if the war were to persist for an additional year or more. In a survey commissioned by the EBRD in partnership with the United States and Sweden, low demand and depressed market activity is listed as the largest reported problem by 77 percent of the SMEs, followed by cost increases at 70 percent. There is currently limited availability of liquidity and credit and 36 percent of businesses in Ukraine are left searching for funding options. The uncertainty caused by the ongoing conflict hampers companies’ ability to forecast or build long-term strategies.

At the same time, labor shortages prevent companies from maintaining their operations. Approximately 5.1 million Ukrainians were forced to move abroad in 2022, and nearly a quarter remain uncertain as to whether they will return. This severely impacts the availability of skilled workers and many SMEs cannot offer financial incentives to attract and retain employees. The loss and or damage of key infrastructure, particularly logistics infrastructure, as a result of the conflict.

Ensuring Ukraine’s Reconstruction Creates Inclusive Growth for SMEs

The international community is providing much needed finance via budgetary support directly to the government of Ukraine in order to keep the lights on. Unfortunately, there are very few touch points to integrate the broader business sector into this support. The Ukrainian government has launched initiatives, including the Small and Medium-Sized Enterprise Development Office (SMEDO), to support entrepreneurial capacity, and facilitate access to finance. Digitalization of the economy has made the process of launching a new business much simpler and quicker. Yet without proper financing and technical capacity, many of the newly registered companies will not survive. While government support is valuable, the involvement of private capital and international support is necessary to ensure long-term growth of these companies and the Ukrainian economy. Private capital will be crucial for the reconstruction and sustainable development of Ukraine.

There are concerns that reconstruction plans may unintentionally exclude SMEs from direct or even second- or third-order participation. Many efforts are ongoing on the smaller scale, but larger scale reconstruction plans, worth hundreds of billions of dollars, often do not have space for smaller players. Generally speaking, reconstruction processes tend to involve large companies and contractors that possess both capacity and sophistication, a global footprint or presence, and have significant international connections. However, reconstruction should work to reorient the economy so that it is not just centered around those companies with the strongest connections and reinforce a system wherein established players have the loudest voice. Large-scale projects will need to include SMEs too.

As the conversation of Ukraine’s reconstruction develops, the international community working with the Ukraine government should work to include SMEs in the process, and keep in mind the following points:

• There is a need to focus on capacity and skill building of current internally displaced persons (IDPs) and refugees so that they reintegrate seamlessly into the Ukrainian economy upon returning. Many refugees will eventually go back to their homeland, so it is important that during this time donors and companies abroad help Ukrainians maintain and gain new skills, so they are “work ready.”
• As Ukraine descales their military economy during the peace process, the reintegration of the veterans back into civilian life and the labor market will be an important consideration.
• While there are some programs that are dedicated to women and young entrepreneurs, both within and outside Ukraine, there is an opportunity to promote startups and equity investments in companies. Initiatives by the EBRD and other MDBs include start-ups and SMEs in procurement processes, with changes in procurement rules.

While war creates uncertainty on the battlefield, the international community can help provide more predictability and stability for companies operating in Ukraine. Collaboration with the Ukrainian government and donor community should be ongoing to ensure effective SME engagement. In the long term, Ukrainian SMEs need to have a seat and the table and be fully included in the reconstruction of their country. The international community, aid agencies, and implementing partners must work together to deliver on the promise of a better future for Ukraine.

Romina Bandura is a senior fellow with the Project on Prosperity and Development and the Project on U.S. Leadership in Development at Center for Strategic and International Studies (CSIS) in Washington, D.C. Madeleine McLean is a program coordinator and research assistant with the Project on Prosperity and Development at CSIS.

This commentary was made possible by the generous support of the Mastercard Center for Inclusive Growth.