Another "tax" on salaries? What's wrong with the idea of mandatory buybacks of government bonds?

After the tax increases, authorities are exploring new – sometimes "exotic" – ways to replenish the budget. One of these is the mandatory purchase of government bonds by citizens and businesses (OVGZ). Is such a decision justified even during wartime, and what do financiers and experts say about it? This is covered in the article by RBC-Ukraine journalist Ruslan Kislyak.

The uncertain prospects regarding the duration of the war in Ukraine, against the backdrop of changing geopolitical dynamics and unguaranteed volumes of financial assistance from partners, compel domestic officials responsible for financial matters to seek additional, and possibly alternative, methods to fill the state treasury.

Since Ukraine cannot use partner funds for military needs, it must rely solely on domestic sources of revenue. Among such sources, in particular but not exclusively, are – increases or the introduction of new taxes and fees, measures for the de-shadowing of the economy, the issuance of domestic government bonds by the state, and similar actions.

What is a mandatory defense loan

Recently, the head of the relevant committee of the Verkhovna Rada, Danilo Getmantsev, suggested publicly discussing yet another (quite exotic) method for budget replenishment during wartime – the so-called mandatory defense loan (defense loan). Its essence lies in the obligation for the population and businesses to direct a portion of their income (salary) towards the purchase of long-term government bonds. Getmantsev proposes to consider Israel's experience as a possible model.

“The experience of some countries that have gone through major wars indicates that mere market incentives may be insufficient to mobilize internal savings for the needs of security and defense. In Israel, which is often seen as a model of a country defending itself against superior enemy forces for over 70 years, a number of mandatory savings schemes were introduced in the 1970s, including for financing increasing security costs,” – reminds Getmantsev.

One such tool was the long-term mandatory defense loan. A mandatory 7% of the taxable income of an employee, self-employed individual, or enterprise was required to be spent on purchasing military bonds. The yield rate was 5%, and income from the bonds was tax-exempt. The principal of the loan was additionally indexed to the cost of living index.

The first loans (from 1970) were to be repaid in 1986, in 12 equal monthly installments. Interest was paid in equal tranches every three years starting from October 1977. The mandatory defense loan, which lasted just over five years, became an important source of funding for Israel's military efforts in the period leading up to and in the early years following the Yom Kippur War (1973).

Can a similar mandatory savings scheme be implemented in Ukraine (exclusively during wartime and solely for financing security and defense forces) is a question of deep political, public, and professional discussion, believes the people's deputy.

“I believe that state banks should transition to a certain format of mandatory military bond purchases based on individual plans to be developed by the Ministry of Finance and the National Bank. I will immediately respond to proponents of liberal ideas that I do not consider such proposals adequate for peacetime. However, the war continues, and no one knows how long it will last,” – argues Getmantsev.

Danilo Getmantsev suggests discussing the idea of a mandatory defense loan (photo: Vitaliy Nosach / RBC-Ukraine)

In his opinion, Ukraine still has the potential to further increase the volume of government bond placements both among banks and among legal and physical entities.

“In the context of the ongoing war, the activation of OVGZ placements is one of the few quick and accessible internal sources (the other method is increasing taxes), which can be used to partially cover the financing needs of the security and defense sector. Increasing domestic market borrowings is also a safeguard against emission financing of the budget deficit, which was used in 2022 and caused a spike in inflation among other reasons,” – summarizes Getmantsev.

Will mandatory defense loans appeal to Ukrainians

In the Ministry of Finance of Ukraine, in response to RBC-Ukraine's request for a comment on the idea of mandatory military bond purchases, they replied briefly and eloquently: "The ministry cannot comment on or assess political statements."

Danilo Getmantsev's colleague on the parliamentary committee, representative of the "Holos" party faction Yaroslav Zheleznyak noted in a comment to the publication that currently, investing in OVGZ is one of the best investment options, allowing Ukrainians to earn well while the state attracts additional funds into the budget. However, the people's deputy is convinced that this initiative should be voluntary.

Within the banking sector, the idea of additional obligations for the purchase of OVGZ (in addition to the existing ones) is met with expected ambivalence. However, acting executive director of the Independent Association of Banks of Ukraine Dmitry Glinski is quick to reassure that currently, it is only an attempt to start a public discussion on a complex issue, so the idea should not be viewed as a well-thought-out initiative.

At the same time, the interlocutor notes that the issue of sustainable funding for vital defense needs in Ukraine is indeed urgent. If we talk about introducing mandatory military bond purchases, it is necessary to carefully assess the possible risks for the state and weigh them against the potential for attracting funds through such a mechanism. And the risks, according to Dmitry Glinski, are significant.

“If the purchase of military bonds becomes mandatory, it will undermine the market motivation of internal investors and distort the state's motivation for debt management. The consequence may be an increase in the risk of default on such borrowings in the future and a lack of trust in OVGZ as a whole,” – warns the banker.

Moreover, the extraction of a portion of official income through mandatory bond purchases, in addition to existing taxation, will complicate the de-shadowing of the Ukrainian economy, thus limiting the potential for increasing tax revenues to the budget.

The head of the NABU notes that under the conditions of full-scale war, banks are gradually increasing lending to the economy and the state. At the same time, artificially accelerating banks' investments in OVGZ may, if not break, then significantly weaken the positive trends in lending and slow down economic growth.

For understanding. The volume of bank investments in OVGZ increased by 8.9% in the third quarter of 2024, while the annual growth reached 39%. Meanwhile, 74% of the entire bank portfolio of government bonds is concentrated in banks whose sole or primary owner is the state. The volumes of bank lending have also increased over the year. According to NBU data, the net loan portfolio to clients showed a growth of 6.8% in the last quarter and 22.4% over the year. At the same time, the volume of banks' investments in NBU deposit certificates shows a steady trend of decline.

Despite the fact that traditionally, the banking sector is the main investor in government bonds, lately, businesses and the population have been paying more attention to this instrument. Since the beginning of the year, Ukrainians have increased their holdings of OVGZ by 20 billion hryvnias to 73 billion, and further growth is expected. Among the reasons for the stable demand for government securities are relatively high rates (which reach 18% per annum), 100% state guarantee of return, a low entry threshold (the nominal value of military bonds is 1,000 UAH), and the absence of taxation on income from investments in OVGZ (unlike bank deposits, the income from which will be taxed at a rate of 23% starting this year).

“I consider the idea of a mandatory defense loan extremely harmful to the future of our state. Investments in bonds in independent Ukraine have always been voluntary. In 2022, Ukrainians purchased OVGZ to help their government withstand the aggressor. A large number of people experienced investing in securities for the first time. This provides opportunities for finally building a stock market in the country that will help finance post-war recovery,” – argues financial analyst of ICU group Mikhail Demkiy.

In his opinion, forcing Ukrainians to do so for generations to come will deter their willingness to trust the country and its debt obligations. As a result, in the future, there will be no one willing to invest in either government securities or private ones. There will only be one