Analysis-Ukraine's huge financing gap set to widen as war heats up and reforms stall

By Olena Harmash

KYIV (Reuters) -Ukraine's financing gap will widen significantly next year if Russia keeps up its intense attacks across the country and the government fails to act on demands for reform from foreign lenders, analysts say.

The government spends most state revenues on the army and finances social and humanitarian spending with foreign aid, which state data shows has totalled $139 billion since Russia launched its full-scale invasion in February 2022.

Central Bank Governor Andriy Pyshnyi said that only about a third of the $65 billion needed for both 2026 and 2027 had been pledged, with talks underway on the rest.

A poll of eight economists by the Centre for Economic Studies, a Kyiv-based think-tank, showed Ukraine will need between $39 billion - this year's sum - and about $58 billion in external financing for next year alone. The task is urgent.

"A key challenge for the government now is to look for $10-15 billion in addition to that volume of aid which partners have already pledged for 2026," ICU, a Kyiv-based investment house, said in a research note.

Those negotiations may become more difficult after Ukraine missed key targets agreed with lenders - including the appointment of judges and other key officials - and the president tightened control over the two main agencies investigating corruption.

The move by President Volodymyr Zelenskiy sparked Ukraine's biggest wartime street protests and prompted strong criticism from Kyiv's European allies, who made it clear that strong anti-graft measures were key to the country's EU aspirations.

Zelenskiy backtracked and has submitted a new draft law to parliament, vowing to restore the independence of institutions set up to root out corruption, even at the highest level. The vote on the draft bill is set for later on Thursday.

But some damage has been done already, experts say.

"Although Europe is unlikely to walk away from Ukraine, future financial and military support will likely come under much more scrutiny, leading to delays that Ukraine can ill afford," said Evghenia Sleptsova, senior economist at Oxford Economics.

STALLED REFORMS

To unlock the next tranches of multi-year lending programs from the European Union and the International Monetary Fund, Ukraine needs to make various reform steps which include hiring more judges to the highest anti-corruption court, overhauling the agency tasked with managing nationalised assets and appointing a head of the bureau for economic security.

In the first quarter of this year, Ukraine failed to meet several funding targets under the four-year 50 billion-euro Ukraine Facility approved by the EU last year, two officials with knowledge of the matter said. In June, Ukraine requested 3 billion euros instead of the 4.5 billion euros it was meant to receive for the second quarter, they said.

The economy ministry, a coordinator for the facility, said Ukraine was meeting all its obligations despite wartime challenges and expected a tranche worth about 3 billion euros in August. The ministry said it hoped to receive a 1.45 billion euro tranche at a later stage.

Ukraine also has a $15.5 billion support program with the IMF and plans talks on a new lending program, officials say.

Danylo Hetmansev, a lawmaker from the ruling party and the head of parliament's committee for taxes and finances, said the delays in meeting key reform targets were baffling.

"I cannot say that among the uncompleted tasks there was anything extremely difficult or unmanageable," he said on the Telegram app.

Officials say that the government is working to implement all required reform steps but some more complicated tasks require more time.

Ukraine overhauled its government on July 17, appointing experienced technocrat Yulia Svyrydenko as the first new prime minister in five years to revitalise economic management.

The economy grew 2.9% last year but for this year, the central bank has cut its forecast to 2.1% as hopes for a quick end to the war as predicted by U.S. President Donald Trump have faded.

"While many of us have previously assumed that 2026 would be easier, we now anticipate that the war will continue into next year," said Oleksandra Betlyi, researcher from the Institute of Economic Studies in Ukraine.

She cited mining and agriculture among economic weak spots.

As Russian troops advance in the eastern Donetsk region, Ukraine has lost key assets, including the country's only coking coal mine near the besieged city of Pokrovsk. Russian strikes have also damaged Ukraine's gas production, Betlyi added.

Trump set a new deadline on Monday of 10 or 12 days for Russia to make progress toward ending the war in Ukraine, threatening to impose new sanctions if it failed to do so.

Analysts pointed out that Ukraine would be unable to cut its defence spending significantly next year, even if a ceasefire was agreed this year, given that its much larger neighbour Russia has hiked military spending to record levels.

Ukraine will spend a record 2.6 trillion hryvnias ($62 billion) or about 31% of GDP on defence this year.

($1 = 0.8725 euros)

(Reporting by Olena Harmash; Editing by Mike Collett-White and Philippa Fletcher)