Economist Oleksandr Zholud tries to make sense of what’s going on with the hryvnia.
Ukraine’s national currency, the hryvnia, tumbled in recent weeks and flirted with its record lows of Hr 9.5-Hr 10/$1 before strengthening in recent days. Naturally, this sharp and sudden depreciation stirred anxiety and prompted worries that the much-dreaded “second wave” of the economic crisis has hit the nation.
On the interbank currency exchange, where banks trade, the money slid from a rate of Hr 8.35/$1 to Hr 8.88/$1 in early September. At streetside currency exchange booths, it even exceeded Hr 9, for a drop of 15 percent in two months.
No wonder citizens are rattled. Politicians point the finger at opponents, hoping to score points. Uncertainty is a given. What’s happening and why? Most economists expected the hryvnia to weaken this fall after its 40-plus percent plunge in the last four months of 2008. Political infighting has exacerbated the situation, but the underlying reasons are based on macroeconomics.
Ukraine is experiencing massive demands on its supply of hard, foreign currency as companies and citizens struggle to pay non-hryvnia denominated loans amid a deep recession. As exports and foreign direct investments fell, the country’s main sources of foreign currency earnings went dry. It’s a sharp contrast from the trends of 2006-2008, when a booming economy helped boost central bank reserves from $19.4 billion to $35.4 billion. Money was pouring into Ukraine then, fueling a credit and consumption boom that concealed the underlying dangers.
During the boom times, Ukraine had a substantial inflow of foreign capital in the form of direct or indirect foreign investment and loans. This infusion was abruptly cut off when the global financial crisis spread. Ukraine’s economy proved resilient, surviving the initial shock of such imbalances last fall. The adjustment came in the form of the sharp currency devaluation. Yet, the external debt did not disappear and needs to be repaid. This means dollars will continue seeping out of the nation. This is a big reason for the pressure on the hryvnia as dollars remain in high demand.
While Ukraine’s current-account deficit – a measure of its import-export trade balance – has narrowed in the past year, to $1.2 billion recently, it remains in negative territory. Part of this deficit is attributable to payments for natural gas pumped underground in summer and stored for winter.
Some $4.5 billion in foreign debt payments and an increase of $5.4 billion in foreign-currency cash holdings by the population have not helped the financial picture. People distrust the hryvnia and a shadow economy is flourishing again, as businesses seek shelter from tax authorities desperately trying to cover budget deficits.
But why the sudden and sharp drop? The answer is a combination of negative news caused by Ukraine’s political instability, high demand for hard currency and general nervousness.
An International Monetary Fund bailout – with more than $10 billion lent in the last year – has improved the hryvnia’s stability. But in late August, speculation that the IMF may cut off lending caused a panic. Foreign companies withdrew their earned incomes as they feared yet more currency depreciation losses and a possible doomsday scenario. To pay Russia for gas imports, Naftogaz is also driving up demand for hard currency. Meanwhile, the main suppliers of hard currency, exporters, held on to their earnings.
In the midst of all this, central bank policy became erratic. The National Bank of Ukraine stayed outside the market for a few days and refused to sell dollars. Then suddenly, the NBU injected some cash. However, these brief and ill-planned interventions just whetted the appetite for hard currency and indirectly confirmed suspicions that the hryvnia was falling, leaving the NBU with no means to prevent the devaluation.
This episode clearly showed that, while underlying fundamentals will set the course for Ukraine’s currency, market panic and speculation fueled by politicians and alarmist reports can cause dangerous fluctuations if the central bank fails to step in effectively.
With all the variables, predicting the end-of-September exchange rate is difficult. It will likely head towards Hr 10/$1. As the global economy pulls out of recession and exports pick up, the hryvnia should strengthen up a bit. Much also depends on the ability of companies to refinance debts. Intervention by the central bank could temporarily prop up the hryvnia. But if done ineffectively again, it will be just another waste of precious and dwindling hard-currency reserves.
Oleksandr Zholud is an economist at the Kyiv-based International Centre for Policy Studies. He can be reached at [email protected].
