National Bank spends billions in hard currency reserves to beef up shaky hryvnya
With the outcome of the presidential elections uncertain, worried citizens and enterprises are dashing to convert their hryvyas to hard currency, triggering a dollar and euro shortage on the nation’s money market.
The government, headed by presidential candidate and Prime Minister Viktor Yanukovych, is struggling to keep the snowballing currency problem under control before the second round of voting, scheduled for Nov. 21. Rising inflation is complicating their efforts, economists say.
In recent weeks it has become increasingly difficult to buy U.S. dollars and other foreign currencies at exchange bureaus nationwide. In an effort to avoid panic and keep the hryvnya at around Hr 5.30 per U.S. dollar, the National Bank of Ukraine has dug deep into its reserves, in recent weeks selling about $1.5 billion of its nearly $11 billion in amassed foreign currency. The rising currency panic started about two months ago, but has escalated in recent weeks, forcing the NBU to sell $770 million in foreign cash reserves between Oct. 25 and Oct. 29 alone.
As of Oct. 29, the central bank’s foreign currency reserves stood at $9.15 billion.
The foreign currency buyers include ordinary citizens who doubt the stability of Ukraine’s currency, banks, and other enterprises that have accumulated foreign debt obligations through recent syndicated loans and Eurobond placements.
Serhy Tihipko, who took a leave of absence from his chairmanship of the NBU to lead Prime Minister Viktor Yanukovych’s presidential campaign, said the priority of the government and the Yanukovych campaign are to keep inflation and currency worries under control during the election campaign.
“We need to bring down prices for meat, for meat products, to bring down the cost of hard currency during this time, because there are no grounds for the high rate of the dollar,” Tihipko said during a Nov. 1 interview on the “Samy Toi” program, aired on the state’s national television channel UT-1.
Bankers say the panic is unfounded, but they also caution that the government’s response is too expensive.
“I don’t see a systemic crisis. What we have is a lack of confidence in the hryvnya,” one economist who advises the Ukrainian government said. “But it is damn expensive to defend that exchange rate this way for populist reasons. They are doing it only to keep confidence up ahead of elections,” the economist said. “If they didn’t spend all this reserve money, the hryvnya would depreciate and that would harm Yanukovych’s chances.”
Mel Brown, a former advisor to the NBU who resides in Kyiv, said the NBU’s currency intervention policy has been unnecessarily costly and the current rise in the exchange rates could have been at least partially avoided by adopting a more liberal currency policy. Brown said there is no need to panic for now and there shouldn’t be in the future as the economy is running smoothly. But things could get more complicated if the political situation in the country worsens.
“Historically Ukrainians have been hammered with a loss of savings through currency depreciation and inflation and their memories are strong. Many of them still remember how entire family savings were lost when the Soviet Union broke up and from the impact of the Russian financial crisis of 1998,” he said. “In reality, there is no reason for panic, as Ukraine’s economy is doing well, but this situation shows how fragile trust is in economies and banking systems.”
Jacques Mounier, head of Calyon Bank Ukraine, described the situation in a Post article last week as serious and unnecessary. He said a “snowball effect” had been created by poor management, including risky pension increases two months ago, bad NBU policies and growing public hysteria.
“Except for some panic on the population’s side, there is no reason at all to speak about hysteria or a banking crisis,” Mounier told the Post on Nov. 3. He said the turmoil was intensified by the government’s pre-election payouts, which added to inflation.
“The situation is still manageable, though harmful, in terms of general impact to the economy; we will see substantial CPI growth by the end of this year,” Mounier said.
Brown said the minor depreciation of the hryvnya exhibited in recent weeks is the result of the NBU’s longstanding currency policy, according to which reserves keep the hryvnya stable within a defined corridor. It has worked, but the strategy can fail under pressure, forcing the government to unnecessarily spend large sums of its reserves. Giving more liberty to the hryvnya would be a better monetary policy, according to Brown, but that policy could be risky for incumbent candidates during elections.
“People have believed in the hryvnya in recent years and started putting their money in the banks. Additionally, they have not, for the most part, put their savings in dollars or borrowed in dollars. But now they have jitters,” Brown added.
Brown said the NBU could, if it continues to sell dollars at its current pace, deplete reserves down to between $5 billion and $6 billion within a couple of weeks. That alone would pose no major damage to most Ukrainians, unless the rate of inflation skyrockets. But it could mean trouble for Ukrainian banks and companies that have tapped into the foreign debt market and have rising foreign currency obligations abroad.
“They need to pay these obligations in foreign currency,” Brown said, adding that they could end up defaulting on their debts if the panic persists. If that happens, their credit ratings would worsen, the cost of borrowing throughout the country would go up, and economic growth could slow down significantly.
“That is the spiral effect that happens if you get a financial sector meltdown,” he said. “They are not at that point yet, but it could go that way” if the government poorly manages the economy and political instability worsens.
“This situation is not unique to Ukraine. It happens in other countries; the only difference is that Ukraine is not a deep economy,” Brown said. “Little changes make quicker and more drastic changes. In the United States it takes months before an interest change affects an economy. In Ukraine, a shallow simple economy, it can happen quickly,” Brown added.
Mounier insisted the situation is manageable, as reserves are still large and the fundamentals of Ukraine’s economy remain strong.
Although it has not managed this situation well so far, the NBU has the capacity and the instruments to manage illiquidity in the hryvnya or in foreign currencies, Mounier said.
“More importantly, the balance of payment of Ukraine for the first nine months of this year is positive by $5.2 billion,” Mounier added. “Even if $1 billion or more disappeared in October, it is not a big deal.”
