KYIV – When Russian forces closed in on Kyiv at the start of their invasion in 2022, the staff at Zavertailo, a popular bakery in the Ukrainian capital, shut up shop and began preparing free salads for soldiers defending the city.

Supplies dwindled as fighting raged around Kyiv, and the bakery’s finances collapsed as managers continued to pay staff salaries.

“Business completely came to a halt, and there were no revenues expected,” said Ms Anna Zavertailo, the bakery’s founder. “It took a lot of work to slowly restart the business.”

But it paid off. This spring, Ms Zavertailo opened a second bakery in Kyiv, encouraged by growing customer demand as life in the capital gradually adjusted to wartime conditions and returned to some semblance of routine.

“New opportunities opened up to us,” said Ms Viktoriia Kolomiiets, Zavertailo’s chief operating officer.

The bakery’s expansion is part of a wider, albeit modest, economic recovery in Ukraine.

Although Ukraine’s economic output is still considerably smaller than before the war – the economy shrank by one-third after Russia’s full-scale invasion – it will grow an estimated 3.5 per cent in 2023, the World Bank predicts.

The expansion is driven by a pickup in domestic spending and underpinned by a steady flow of foreign financial aid.

Economists say it will take many years for Ukraine’s economy to return to its pre-war level, and forecasts in a time of fierce fighting are bound to be uncertain.

Enormous challenges lie ahead, including the costly rebuilding of the country’s devastated cities, a government deficit that will continue to balloon as the war drags on, and labour shortages caused by an exodus of Ukrainians fleeing the war and the mobilisation of working-age citizens to fight it.

Still, local analysts and business people say, a sense of resilience and relative stability has taken hold after 20 months of war, improving confidence among consumers and investors.

“Ukraine’s economy is adapting to the war,” said Ms Olena Bilan, chief economist at the Kyiv-based investment bank Dragon Capital. She added that people had moved from a “savings mode” to a situation where they now “feel more relaxed and start to spend more”.

The World Bank estimated in a recent report that private consumption in Ukraine would grow 5 per cent in 2023, after contracting by more than a quarter in 2022. In cities such as Kyiv and Dnipro, which are far from the combat zone but remain under threat from Russian air attacks, customers are returning to reopened restaurants and resuming shopping.

“Today, most Ukrainians understand that the war may be prolonged, and they need to continue living in these new circumstances,” said Mr Andriy Cherukha, founder of Etnodim, which produces vyshyvankas, the traditional embroidered Ukrainian shirts.

He said sales in his shop has tripled in 2023 compared with the year before, driven in part by a rise in patriotism.

Ukrainians, Mr Cherukha added, “continue to work and purchase clothing and other items that may not be considered essential but are a way to maintain a sense of normalcy”.

Ms Olga Kustenko, a co-owner of the First Point Espresso Bar in the trendy Podil neighborhood of Kyiv, said people needed routines to cope with the war.

Customers have returned to her cafe, she said, because they look for a familiar place to spend time. She opened a second cafe this spring to meet growing demand.

The stronger-than-expected spending has prompted financial institutions to upgrade their economic forecasts.

Last week, the International Monetary Fund predicted that the country’s total output would rise 2 per cent in 2023, slightly less optimistic than the World Bank’s forecast but a significant upgrade from an initial forecast for a 3 per cent decline.

To be sure, Ukraine’s economy is growing from a low base, after the first year of the war devastated the country’s main economic assets. The Azovstal steelworks, which accounted for a fifth of Ukraine’s steel output, was destroyed in the fighting for Mariupol in 2022.

Growth rates can also be a poor indicator of a country’s economic health in wartime, as output is often inflated by military production, which is ordered up by the government. Ukraine’s government has devoted much of its budget to cover the army’s payroll and support arms production.

But economists say Ukraine’s ability to adapt to wartime challenges, such as keeping the electricity flowing despite Moscow’s winter campaign against its energy infrastructure, has helped put the economy on a stabilising path.

Ms Maria Repko, deputy director of the Kyiv-based Centre for Economic Strategy, noted that the opening of new trade routes to circumvent Moscow’s Black Sea blockade was also helping a rebound in agricultural exports, which made up the bulk of Ukraine’s pre-war income.

The World Bank estimates that Ukraine’s overall exports will continue to shrink in 2023 before growing 15 per cent next year and 30 per cent in 2025 – a potential economic lifeline if the war drags on.

Much like Russia’s, Ukraine’s economy is increasingly being restructured around war. More than half of the government’s 2024 spending, roughly US$46 billion (S$63 billion), is expected to be devoted to defence.

But with little tax revenue to finance this spending spree, Ukraine’s budget deficit will reach 21 per cent of the country’s total output in 2024, Prime Minister Denys Shmyhal said last week. He added that his government would need US$42 billion in financial aid to cover this shortfall.

That sum may prove difficult to secure as support for Ukraine wanes in the United States, by far Kyiv’s biggest financial backer, and as the world’s attention is diverted by the war between Israel and Gaza.

“The situation looks really worrisome,” said Ms Repko. NYTIMES