In 2025, the Ukrainian government plans to allocate 2.2 trillion hryvnias to defence—around 26% of GDP. However, only about 2.5% of that, roughly 55 billion hryvnias, is set aside specifically for arms production. That’s roughly the same amount Poland, which isn’t involved in active fighting, is spending. Meanwhile, President Zelensky said earlier this year that Ukraine now covers 40% of its own weapons needs.
Illia Neskhodovskyi, head of the analytical division at the National Interests Advocacy Network (ANTS), spoke to The Ukrainian Week about the challenges in defence funding, the advantages of restarting arms exports, and the damage caused by recent tax hikes.
— How would you assess the situation now? Has there been any progress since 2022, and can we say that Ukraine is becoming more capable of meeting its own defence needs?
— There’s definitely been progress. Throughout 2022 and early 2023, the defence sector saw virtually no investment and faced numerous challenges. Funding was often delayed, forcing companies to rely on commercial loans—despite interest rates spiking to 25% at the end of 2022. Meanwhile, the so-called “Affordable Loans 5–7–9%” programme existed, but the defence industry couldn’t access it. Key areas, like missile production, were basically left unfunded, and drones weren’t even part of the conversation.
It wasn’t until late 2023 that things started to change. Direct funding to the defence sector improved, and the system began evolving to better align with the actual needs on the front line.
It’s important to remember that supporting the defence sector and the military isn’t just about weapons—it also involves supplying clothing, food, and other essentials. In 2023, procurement scandals rocked the sector, with inflated prices and a lack of transparency. Instead of placing state orders with Ukrainian companies capable of meeting demand, contracts were often handed off to firms with questionable reputations and opaque ownership—based in Poland, Turkey, and China. This seriously undermined the ability to properly fulfill defence contracts.
The situation is slowly improving today, but many issues remain unresolved. A major hurdle is funding: building a full-scale Ukrainian defence industry requires significant investment. Yet in 2022 and 2023, the state failed to adequately finance the creation of relevant enterprises or the development and upgrade of domestic weaponry. Even the orders that were placed were often paid with substantial delays.
The impact has been severe. Allocating just 55 billion hryvnias (approximately $1.4 billion) for arms production is barely a drop in the bucket for a country at war.
— With such a huge defence budget, why was the money allocated so inefficiently?
— The priority was on supporting mobilisation and ensuring payments to those on the front lines. However, the military’s staff was—and still is—significantly overstaffed, leaving the Ministry of Defence bloated. This bloating drives up overhead costs, diverting funds away from effectively equipping every soldier.
Our international partners stepped in with crucial aid—providing weapons, training, and supplies. While most countries legally cannot directly fund the Ukrainian army, they have supplied arms and ammunition that help us defend ourselves, alongside training our troops.
It wasn’t until 2024 that we started to see real changes in our defence industry. The scandals from before, while damaging, did have one silver lining: they spurred the creation of the Defence Procurement Agency, which has generally improved the procurement process. Overdue debts were finally reduced, and during contract negotiations, opaque intermediaries—who had previously tacked on markups of nearly 100% to weapons sold to Ukraine—began to be cut out.
Our defence enterprises started receiving consistent orders. By 2024, funding had become more stable, allowing development efforts to accelerate. For example, if the state had financed the missile sector like this from the outset of the full-scale invasion—or at least since late 2022—we would already have the long-range missiles we need, like the Neptunes capable of striking deep into enemy territory.
— Is the state doing enough?
— It’s still not enough. The system remains heavily bogged down in bureaucracy. Despite the urgent demands of wartime, crucial reforms to procurement procedures and the adoption of new technologies—especially drones—were delayed for far too long.
Another key issue: in 2023, the government effectively launched criminal cases against our own defence enterprises over a vague regulation that limited their profit margins to 15%. One of the Cabinet resolutions was legally unclear, which only made things worse. On that basis, the Accounting Chamber of Ukraine began audits and ramped up pressure on these companies. Heads of enterprises faced criminal liability. It was a disgraceful situation—and the government only managed to fix it a full year later.
One major misstep by the state was the prolonged delay in granting tax exemptions on components used for unmanned systems, including FPV drones. It took a full eight months before the relevant law was passed, finally allowing components to be supplied at cost without hefty import duties.
On the positive side, 2024 brought a significant breakthrough with the so-called Danish Initiative. Instead of buying weapons from third-party countries, Denmark opted to place orders directly with Ukrainian manufacturers. They calculated this approach would cost half as much as purchasing equivalent equipment elsewhere—and they followed through with those orders.
One of the earliest contracts was for the production of the Bohdana self-propelled artillery system, which gave a much-needed boost to Ukraine’s defence industry. Since then, other countries have started to follow suit. Today, many are placing substantial orders directly with Ukrainian companies to supply our armed forces.
— You mentioned that real progress in domestic arms production only started in 2024. Yet, back in August, Minister of Digital Transformation Mykhailo Fedorov claimed that 96% of the drones the government purchased were made in Ukraine. How accurate is that figure?
— That figure is entirely plausible. It’s important to remember that drones vary widely in type and price. In theory, hitting that percentage is possible, but in about 90% of cases, these weren’t fully developed systems—they were assembled from Chinese components shipped to Ukraine and put together locally.
By 2024, the situation improved dramatically, with roughly 70% of components for various unmanned systems, including FPV drones, being produced domestically.
— In recent months, there’s been a lot of talk about how the ban on arms exports is holding back Ukraine’s tech defence manufacturers. Do you think allowing Ukrainian weapons to be sold abroad could actually help our military?
— The ban isn’t official in a legal sense, but in practice, it’s very much in place. Exporting these products requires special permits, but the authorities simply aren’t issuing them. So, the process could start at any time — it’s just not happening.
That said, it’s a sensitive issue. Our international partners are supplying us with large amounts of weapons free of charge, and understandably, they question the idea of us selling our own arms while they’re providing support. It doesn’t sit well, especially during wartime.
There’s also concern about Ukrainian weapons ending up in enemy hands—but that risk is often exaggerated. Take FPV drones, for example: they can be shot down and recovered, but all that gives enemy engineers is access to the final product, not the underlying technical documentation. The real threat is limited. What we need is a clear framework and strong rationale to present to our international partners—an explanation of why allowing Ukraine to export weapons makes sense. After all, many of our defence companies are still operating well below capacity.
But that argument alone hasn’t been enough. The counterpoint is that defence funding should actually be increased, with parts of the budget reallocated from other areas if there’s a genuine need for more weapons but not enough money.
Right now, there are a few potential paths forward. The first one is to grant export permits for specific types of weapons. But this risks becoming a classic corruption scheme, where only certain companies get permits while others are shut out—effectively deciding who profits and who just works in the defence sector. That’s why I believe the Cabinet of Ministers’ current proposal isn’t the right solution.
The second, more reasonable option would allow any enterprise to export up to 50% of the volume of its Ministry of Defence state order. This ensures domestic orders are met first before exports happen. But even this approach has flaws. If a company has a large state order and is operating at full capacity, it physically can’t export anything. Meanwhile, other companies with smaller orders might have idle capacity going unused.
For the past six months, I’ve been advocating for what I believe is the optimal model: introducing a 10% special export duty on arms exports. Hetmantsev has proposed 20%. Considering the profit margins in this sector run high—between 50% and 100%—this duty wouldn’t be a major deterrent to exporting weapons. Instead, it would allow the Ministry of Defence to channel additional funds back into purchasing the most urgently needed arms.
Put simply, if a company isn’t operating at full capacity but gains the ability to export, the export duty would generate extra revenue for the state budget, which could then be reinvested in new orders for that very company. This model creates a win-win: manufacturers get to expand their markets, the government secures more funding for military procurement, employment and wages rise in defence enterprises, and tax revenues increase accordingly.
At the same time, export prices aren’t capped by the state, so companies can use part of their profits to invest in research and development, enhancing their products.
Most importantly, this provides a straightforward explanation to our international partners: yes, we sell weapons abroad, but thanks to the export duty, for every four or five FPV drones sold, one goes directly to our army. This helps improve funding for our military. Of course, certification and preparation will be necessary. However, companies ready to enter the export market are already working today to ensure their products meet international standards.
— According to Prime Minister Denys Shmyhal, the government plans to secure \$39 billion in external financing in 2024. At the end of last year, several tax changes were adopted, including a hike in the military levy on salaries from 1.5% to 5%. Is there currently any alternative to plugging the budget deficit with foreign funds? Do you see a path for Ukraine to eventually reduce its dependence on external support?
— If we manage to secure some form of ceasefire, defence spending would drop significantly—probably by at least half. That would free up funds currently earmarked for the military to support the civilian budget instead. In that scenario, the need for external financing would shrink considerably, as domestic revenues would start to cover more of the budget. Of course, this all depends on a lasting ceasefire.
Looking ahead to 2025, we expect to receive 20 to 30% more than originally planned—around $55 to $60 billion—while the actual need is only about $39 billion. It’s crucial, then, that the funds we receive now are used wisely: either to secure victory or as reserves to meet budget needs in the following year.
As for the tax increase—that wasn’t an ideal move. It has hurt purchasing power, especially for those earning salaries. As it stands, the minimum wage is about $200 a month. Of that, the state takes $46 in taxes, leaving someone with just $3 to $5 a day to live on — essentially at the poverty line. According to UN estimates, this level of income already falls squarely into poverty.
So, this approach is flawed. Economists raised concerns and urged officials to consider raising other taxes, like value-added tax, instead of hiking the military levy. But those warnings were largely ignored, and the decision went through.
On top of that, taxation on small businesses increased. You mentioned the military levy on salaries, but it also applies to sole proprietors on the simplified tax system. This has led to a 44% rise in the number of sole proprietors closing shop compared to last year — and that trend shows no signs of slowing.
The government’s move was misguided. Beyond boosting state revenues, it needs to focus on jumpstarting the economy — figuring out how to get it moving and generating tax revenue without squeezing people who are already struggling.
The real key is growing the number of operating businesses, creating jobs, and raising wages. That’s the sustainable way to increase budget revenues over time.
One effective approach is for the government to place consistent orders with Ukrainian companies, ensuring stable sales volumes. This stability enables businesses to raise wages, pay more taxes, and create a positive feedback loop: the more spent on local manufacturers, the higher the state’s tax revenues—funds that can then be reinvested into defence contracts.
Right now, international aid remains essential. We’re at war, facing an adversary that spends over \$100 billion annually on its military. There’s no way we could sustain this defence effort solely on our own finances. That’s why the European Union’s initiative to channel funds directly into military aid and orders for Ukrainian defence firms is such a crucial step.
This initiative deserves full support, but it must be paired with a government commitment to create favourable conditions for Ukrainian enterprises. Businesses need to operate in a stable, supportive environment at home. If we get this right, EU funds earmarked for defence procurement could provide a major boost to our industrial development.
Unfortunately, we’re not seeing those results yet. The government’s lack of initiative is holding us back, dimming the outlook for sustained economic growth.
— Do you think the boost in revenue from higher taxes might be outweighed by their negative effects on the economy?
— Not yet. We haven’t reached the tipping point on the Laffer curve where raising taxes actually reduces total revenue.
It’s important to remember that most wage taxes come from public sector employees. So, when taxes go up, it mostly cuts into the real incomes of people working in government roles—and those taxes then cycle back into the budget. That’s why I don’t buy the argument that higher taxes automatically hurt revenue. But, if the government focused on stimulating economic growth, tax revenues would naturally increase as the economy expands.
On top of that, the budget lost billions because the president didn’t sign a tobacco tax increase on time—a move that could have compensated for the revenue lost from sole proprietors paying the military tax. In this light, the government’s approach seems erratic, lacking a coherent strategy, and ultimately doing more harm than good for economic growth. Instead of raising taxes, the focus should be on making the economy stronger.
— What steps are needed to improve budget policy to strengthen Ukraine’s defence capabilities? Is there anything we can learn from Russia’s approach?
— It’s always important to study the enemy’s experience, but I wouldn’t say we should simply copy their playbook. I don’t support handpicking which enterprises get orders. That said, how Russia manages state orders—supporting and financing defence enterprises—is definitely something worth considering.
— What needs to be done?
— First and foremost, we need to significantly increase state orders for Ukrainian enterprises. This might even mean revising legislation to give our companies better access to sales markets. Another crucial element is allowing Ukrainian weapons exports—the model I mentioned earlier could have a strong positive impact here.
We also have to boost support for scientific research focused on weapons development, since right now, enterprises are funding these efforts themselves. Beyond arms, increasing state orders for items like clothing and footwear made in Ukraine makes sense—it’s far better than relying on Chinese imports. If there’s domestic demand for certain products, why not produce them here?
Ideally, we should back companies ready to start production of needed goods within six months by providing loans and investment. These enterprises should profit directly, rather than outsourcing production to intermediaries or foreign manufacturers.
On tax increases, while I’m firmly opposed to raising them, I would support increasing import taxes—similar to the approach former President Trump took in the U.S.—to ease the burden on domestic producers.
At the same time, cracking down on tax evasion schemes is critical, especially in sectors like tobacco sales, where significant revenue is lost. We also need to address other areas of the economy rife with underreported income, such as the gambling industry, which has reportedly shortchanged the budget by billions in recent years. This remains a pressing issue.
The focus should be on those who aren’t paying their fair share, rather than squeezing those who already do. A system like this would level the playing field, foster economic growth, boost state revenues, and create a more sustainable business environment overall.
