Forex News: Currency Briefing: Ukraine in the hands of politicians
The political crisis in Ukraine since last November has had a serious impact on UAH. The escalation of street protests has particularly increased uncertainty among investors. USD/UAH is not only trading at levels last seen 5 years ago, but the Ukrainian central bank (NBU) has since had to abandon its exchange rate target. On Feb 7, it fixed USD/UAH at levels above 8.0000 for the first time since 2009, at 8.7080 to be precise. This step reflects the fact that the NBU is no longer able to defend the USD/UAH exchange rate of 8.0000. Since early 2012 its foreign exchange reserves have eased by almost 40 per cent, so it has no other choice but to give in to the depreciation pressure.
The central bank is nonetheless trying everything to prevent a rapid collapse in the UAH. Recently it even introduced capital controls. First, private FX purchases for foreign transactions with some exceptions are limited to an amount of UAH 50,000 per month. Second, the purchase of foreign currency for early repayment of foreign currency loans and for investments abroad is prohibited. Finally, foreign currency purchases can only be realized with a 6 day lead time, i.e. a company that wants to convert UAH into foreign currency has to transfer the corresponding amount to a so-called “special analytic book account” and apply for the conversion with the NBU. The bank will only be allowed to convert UAH into foreign currency after 6 days and then transfer it to the respective company.
But why does the NBU not allow UAH to depreciate further in view of the now unsustainable current account deficit of approximately 9 per cent of GDP? Analysts at Commerzbank explained this yesterday in a research note with the following two reasons. First, energy import costs are already at high levels, but following any UAH depreciation they would rise even further. As Ukraine’s largest energy importer is state owned, this would be a significant burden for national finances. Moreover, foreign currency indebtedness is high, which means that a depreciation of the UAH is a double burden for the finance ministry. Second, the central bank wants to prevent the flight of capital and a resulting current account crisis. If it allows UAH to depreciate too quickly this could lead to a confidence crisis, that is investors and the population might lose confidence in the currency and no longer invest capital in the country or try and move the capital abroad. That would mean the country would no longer be able to finance the current account deficit leading to a collapse of imports and consumption. That in turn would drag the economy deep into recession.
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Obviously, the capital controls are only a temporary fix. The more difficult it becomes to move capital abroad, the less attractive it becomes for investors and companies to invest in Ukraine. It seems questionable that investors would be interested in investing their funds in Ukraine even now. The NBU is only likely to ease the capital controls if it can assume the country can finance the current account deficit, i.e. that capital will continue to flow into Ukraine.
International aid could ride to the rescue to finance Ukraine’s fiscal and current account deficit with a fiscal aid package. It is absolutely necessary for the Ukrainian government to secure such an aid agreement to prevent the country from defaulting. Last December, Russia had agreed to provide financial aid worth USD 15 billion to Prime Minister Azarov’s government. After Azarov had to step down, Russia froze the payment of the second tranche of the payment until a new government has been appointed. President Yanukovych signaled that he will announce a new candidate for the office of Prime Minister this week. The Russian government immediately announced that it would pay the second tranche. This is likely to calm the fiscal situation for the time being, but it does not mean the crisis has been averted.
Ukraine is currently in recession, and it suffers from a wide current-account deficit, which means it buys more goods from abroad than it sells. The Ukrainian government said one reason it turned down the EU deal was that it needed to repair relations with its former Soviet master to avoid significant economic hardship. This week, the country’s finance ministry said its ability to meet its external debt obligations in 2015 will be largely “dependent on relations with Russia.”