A 180° ex­change course

What’s go­ing to hap­pen to the hryv­nia on the cur­rency mar­ket

The Ukrainian Week - - ECONOMICS - Lyubomyr Shava­lyuk

“When’s the dol­lar fi­nally go­ing to go up again?” asks a friend, ner­vously pulling on his cig­a­rette. He started build­ing, some­thing that needs con­stant fund­ing, more­over in hryv­nia. But he’s been keep­ing all his sav­ings in dol­lars, so the last few months, as the hryv­nia slowly picked up strength, he has con­stantly been faced with a choice: keep up the dol­lars or the pace of con­struc­tion. And with trem­bling heart, he has cho­sen the lat­ter, changing the big­ger part of his hard­earned bucks into hryv­nia and buy­ing build­ing ma­te­ri­als.

My friend’s sys­tem for mak­ing fi­nan­cial de­ci­sions is part of the arse­nal of mil­lions of Ukraini­ans. The en­tire pe­riod of in­de­pen­dence has shown that our cur­rency sooner or later loses value. The NBU re­cently cal­cu­lated that the hryv­nia has de­val­ued to the dol­lar some­thing like 15 times since it was first in­tro­duced in 1996. Even a brief pe­riod of reval­u­a­tion, such as in the spring and sum­mer of 2008, was in­evitably fol­lowed by a much longer and steeper de­val­u­a­tion. Peo­ple who have got­ten used to this tend to keep sav­ings in hard cur­ren­cies, es­pe­cially those who hang on to sav­ings over the longer term and have nei­ther the time nor the skills to reg­u­larly track the dy­nam­ics of the hryv­nia’s ex­change rate and pro­jec­tions for it.

Over the last three years, the hryv­nia has been float­ing al­most freely. In this sit­u­a­tion, the dol­lar has tended to re­coup its records ev­ery fall and win­ter. This has only con­firmed for or­di­nary Ukraini­ans that the hryv­nia will only con­tinue to lose value. Th­ese days, even house­wives can be heard to say, “The dol­lar’s go­ing to go up.” More­over, they say this in a tone much like that of the old prophets when they pro­nounced their vi­sions.

Un­der the cir­cum­stances, the slow and steady, if not overly sig­nif­i­cant—un­der 10%—strength­en­ing of the hryv­nia this year was an un­pleas­ant sur­prise for many. The nadir came on Jan­uary 1, when the hryv­nia fell to UAH 28.80 to the dol­lar—a hryv­nia cheaper on the in­ter­bank cur­rency ex­change. Af­ter that, the hryv­nia grew in value all the way to the end of Au­gust. Many of those who de­cided to buy dol­lars last fall or win­ter re­gret­ted it. Some lost their pa­tience and even fell into a panic: th­ese were the ones turned in their dol­lars or eu­ros, fear­ing that they would grow even cheaper. But is there an eco­nomic ba­sis for this kind of worry? What’s go­ing to hap­pen with the hryv­nia’s ex­change rate in the next while?

A SHAKY FOUN­DA­TION

When a na­tional cur­rency has a float­ing ex­change rate, its value is de­ter­mined by the mar­ket and it’s de­ter­mined by in­come and pay­ments in for­eign cur­ren­cies. The Na­tional Bank of Ukraine reg­u­larly tracks th­ese flows and con­sol­i­dates th­ese fig­ures in the bal­ance of pay­ments, which it pub­lishes monthly. The num­bers that are in­cluded in the bal­ance of pay­ment are di­rectly con­nected with fun­da­men­tal trends in the do­mes­tic econ­omy and are es­sen­tially its nu­meric rep­re­sen­ta­tion. Given that trends gen­er­ally last more than a month and of­ten even longer than a year, an­a­lyz­ing them makes it pos­si­ble to fig­ure out where in gen­eral the cur­rency mar­ket is likely to go and, with it, the hryv­nia ex­change rate.

To­day, there are sev­eral key trends. One of them is the grow­ing cur­rent ac­count deficit or CAD, whose main com­po­nents are the ex­port and im­port of goods and ser­vices, wages and salaries, in­ter­est and div­i­dends to for­eign­ers, and mon­e­tary trans­fers (see The Price of Growth). In the last 12 months to the end of July, the CAD has grown US $4.6 bil­lion, higher even than it was in 2014, although GDP is con­sid­er­ably smaller now. The pace of growth of the deficit is strik­ing: just a year ago, it was one third of what it is now, while one or two months ac­tu­ally posted a sur­plus. This trend is wor­ry­ing, be­cause if a coun­try has a deficit on its cur­rent ac­count op­er­a­tions, it means it’s tak­ing in less hard cur­rency than it is spend­ing. At that point, the coun­try ei­ther finds sources for fi­nanc­ing this deficit, usu­ally for­eign in­vest­ment or cred­its, or the deficit leads to a lack of hard cur­rency on the do­mes­tic mar­ket and slowly ex­erts down­ward pres­sure on the lo­cal cur­rency. If the CAD grows too quickly, the need for ex­ter­nal fi­nanc­ing be­comes ur­gent and there is a grow­ing risk that that in­vestors and cred­i­tors will refuse to pro­vide cap­i­tal. In other words, a high deficit goes hand-in-hand with a cur­rency cri­sis and of­ten turns into one.

Again, the key fac­tors in a cur­rent ac­count deficit are ex­ports and im­ports. Ex­ports are in a healthy state in Ukraine right now: in the first half of 2017, ex­ports of goods grew 24.2% and ex­ports of ser­vices grew 9.6%, although their to­tal vol­ume is con­sid­er­ably smaller. Ex­ports of goods grew thanks to grow­ing prices for key prod­ucts, an av­er­age of 1015% al­most ev­ery month for the pre­vi­ous half-year. Phys­i­cal vol­umes grew as well, es­pe­cially for agri­cul­tural prod­ucts. In other words, ex­ports grew not only be­cause of bet­ter prices on world mar­kets for raw ma­te­ri­als, but also in higher de­mand for Ukrainian-made prod­ucts. In short, it’s pos­si­ble to ex­pect ex­ports to con­tinue to grow, which, in and of it­self, is a good thing.

Un­for­tu­nately, against this ac­cel­er­ated growth in ex­ports, im­ports grew even more quickly: In the first six months, im­ports of goods jumped 29.9%, plus ser­vices an­other 7.1%, although here, too, vol­umes were rel­a­tively small. This is what de­ter­mined the sharp growth in the CAD.

What’s im­por­tant is that Ukraine be­gan to im­port much more, not in the way of con­sumer goods, but of goods that are used for pro­duc­tion and man­u­fac­tur­ing, from fu­els and min­eral fer­til­iz­ers, to var­i­ous kinds of machin­ery and equip­ment. This has two pos­i­tive as­pects to it. Firstly, an eco­nomic re­cov­ery de­mands that busi­nesses re­plen­ish stores of raw ma­te­ri­als and sup­plies. Be­cause many of th­ese are im­ported, the in­flow of such goods grew. But the minute the vol­ume of in­dus­trial sup­plies is re­stored and be­comes enough for the planned vol­umes of out­put, im­ports of those cat­e­gories of goods will be­come stead­ier. This could even­tu­ally lead to a re­duc­tion in the cur­rent ac­count deficit.

Se­condly, a sig­nif­i­cant share of th­ese im­ports is in­vest­ments. For four quar­ters in a row now, start­ing in QIII of 2016, cap­i­tal in­vest­ments in Ukraine have been grow­ing 20% and more. It’s clear that most equip­ment and machin­ery is not made in Ukraine and needs to be brought in. The neg­a­tive im­pact of this kind of im­ports on the CAD is tem­po­rary and limited, given that cap­i­tal in­vest­ments gen­er­ate pro­duc­tion, and this pro­duc­tion will ei­ther in­crease ex­ports or re­place im­ports. This is why the hard cur­rency spent and the goods im­ported for in­vest­ment pur­poses soon pay them­selves off be­cause the cur­rent ac­count will im­prove per­ma­nently.

It fol­lows from this that, although the CAD has been grow­ing sharply and putting pres­sure on the hryv­nia, it is a pos­i­tive trend and thus, un­likely to re­main at this high level for too long. If this is in­deed the case, then this will not jeop­ar­dize the sta­bil­ity of the hryv­nia and Ukraine will be eas­ily able to fi­nance it.

A MAT­TER OF FI­NANCES

Re­gard­less of the na­ture of the CAD, how­ever, it has to some­how be fi­nanced. In other words, the coun­try needs to at­tract money to its bal­ance of pay­ments ac­count, and that means get­ting money from eq­uity or port­fo­lio in­vestors and lenders—not a sim­ple task. Over the last three years, when Ukraine’s econ­omy was in the dol­drums, the main sources of ex­ter­nal fi­nanc­ing were IMF lines of credit and as­sis­tance from other in­ter­na­tional donors. This was enough for a while, when the CAD was not overly large and re­struc­tur­ing gave the coun­try breath­ing space on pay­ing back its debts. But time stops for no one and the sit­u­a­tion has changed.

Over 2017-2019, the Gov­ern­ment alone will have to pay back US $8.9bn, not even count­ing the “Yanukovych debt” of US $3bn. The peak of pay­ments comes in 2019, an elec­tion year. Pay­ments are also go­ing to go up in the pri­vate sec­tor, where a slew of busi­nesses re­struc­tured their ex­ter­nal debts to­gether with the Gov­ern­ment. Given the growth of the CAD, there al­ready isn’t enough to even cover in­ter­na­tional donors dur­ing this pe­riod—even if Ukraine keeps re­ceiv­ing fund­ing in the planned quan­ti­ties, which no one can guar­an­tee. The ques­tion arises whether there are al­ter­na­tive sources of ex­ter­nal fi­nanc­ing that might sup­ple­ment in­ter­na­tional fi­nan­cial as­sis­tance or even sub­sti­tute the lion’s share of it? In­deed, there are some hy­po­thet­i­cal op­tions.

Tra­di­tion­ally, the health­i­est source of ex­ter­nal fi­nanc­ing is for­eign di­rect in­vest­ment (FDI). In 2016, Ukraine re­ceived US $3.4bn. But most of this sum was only on pa­per be­ing ac­tu­ally the trans­fer of the for­eign debts of banks into cap­i­tal as part of NBU’s re­quire­ment to re­cap­i­tal­ize fi­nan­cial in­sti­tu­tions. Very lit­tle came in as live money. More­over, this can be seen in the indi­ca­tors for 2017, re­flect­ing the low level of re­cap­i­tal­iza­tion this year: for the first 7 months, US $1.3bn in FDI came to Ukraine, not even close to enough to cover the coun­try’s needs. This is fully 48% less than FDI for the same pe­riod of 2016, but this time there’s more “live” money. It’s a seem­ingly pos­i­tive trend, but the quan­tity of high cur­rency gained through FDI is im­mea­sur­ably less than what is ac­tu­ally needed. Even if this amount grows steadily over the next few years—and there’s no guar­an­tee it will—, it will still be too lit­tle. Ukraine needs to be look­ing for other source of fi­nanc­ing.

The sit­u­a­tion with pri­vate cred­its is very sim­i­lar. Over Jan­uary-July, net in­flows of hard cur­rency from the is­sue of eu­robonds to non-fi­nan­cial cor­po­ra­tions added up to US $283mn, with an­other US $322mn from other ex­ter­nal cred­its. Th­ese sums are much larger than in 2016, when al­most noth­ing was drawn on. But this is minis­cule com­pared to what Ukraine needs to pay back. It’s im­por­tant that this year, Ker­nel and My­ronivskiy Kh­li­bo­pro­dukt both also placed eu­robonds that gar­nered them US $500mn each. But this money does not fig­ure in the bal­ance of pay­ments, mean­ing that this money went to man­ag­ing com­pa­nies reg­is­tered some­where on Cyprus. If th­ese kinds of place­ments were to grow and the money came to pro­duc­tion com­pa­nies lo­cated in Ukraine, the coun­try’s bal­ance of pay­ments would be far health­ier. Right now, this isn’t the case, so the risks re­main.

Fi­nally, state bor­row­ings on global fi­nan­cial mar­kets might also help en­sure sig­nif­i­cant hard cur­rency in­flows. In its April me­moran­dum, the IMF pre­dicts that this item will bring Ukraine a bil­lion dol­lars this year and two bil­lion each in the next two years. Again, how­ever, things are not so sim­ple. Ukraine has not gone to in­ter­na­tional lend­ing mar­kets since the Euro­maidan revo­lu­tion. Mean­while, the va­pid pace of re­forms has be­come a real stop­light for many po­ten­tial in­vestors and will com­pli­cate this op­tion for the fore­see­able fu­ture. Ex­perts say that real de­mand for gov­ern­ment eu­robonds is not es­pe­cially high to­day. Although an­nounce­ments by MinFin of­fi­cials sug­gest that the Gov­ern­ment is pre­par­ing for an­other eu­robond placement and has al­ready hired a num­ber of big name in­ter­na­tional banks to han­dle it, there’s se­ri­ous doubt that this will at­tract the bil­lions that the IMF has pro­jected.

In short, it turns out that Ukraine does not have iron sources of fi­nanc­ing to­day, sources that would al­low it to smoothly go through the next two years of in­creased ex­ter­nal debt pay­ments, in com­bi­na­tion with a se­ri­ous CAD. Un­der the cir­cum­stances, the only sure thing, re­al­is­ti­cally, is IMF cred­its. But even to get them, the gov­ern­ment will have to put in some sweat eq­uity.

All this comes down to the re­al­ity that this year of­fers only a mis­lead­ing, even false, im­pres­sion of hard cur­rency sta­bil­ity. On one hand, the peak of ex­ter­nal debt pay­ments has not started yet, and although Ukraine paid the IMF back US $500mn in Au­gust, this did not place much pres­sure on the FOREX mar­ket. In a sense, this makes 2017 a mere con­tin­u­a­tion of the pre­vi­ous few years.

On the other hand, a cer­tain in­crease in in­flows from di­rect, port­fo­lio in­vest­ments and pri­vate debt did have a pos­i­tive im­pact on the bal­ance of pay­ments. For one thing it cre­ated a sur­plus of hard cur­rency on the mar­ket, which lasted for sev­eral months (see Watch the in­ter­ven­tions). As a re­sult, the NBU

The con­fis­ca­tion of US $1.4bn of the Yanukovych Fam­ily's money that was on Oschadny Bank ac­counts was a pleas­ant sur­prise for the Bud­get

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