You're reading: Business Sense: Sink or swim – Hryvnia decline will usher in second wave of crisis

Until the Ukrainian national currency started to weaken towards the middle of last week, it was beginning to seem like just a bad memory. While there are, indeed, more “for rent” signs around Kyiv, the hryvnia’s stability over the last several months had provided a reason for hope. The stock market also more than doubled from its lows, there is still nowhere to park a car and you still can’t get a table at a good restaurant on a Friday night.

But the most visible cracks in the fa?ade occurred last week, as the currency slipped to Hr 8.2 on the interbank exchange. While the currency managed to stabilize at around Hr 8 to the dollar by the end of the week, thanks to intervention by the National Bank of Ukraine, the reality of an impending second wave of the economic crisis hit home. This was compounded by the Cabinet of Ministers’ announcement that it would like Naftogaz and the Finance Ministry to discuss the prospect of restructuring the state energy giant’s external financing obligations, including a $500 million Eurobond due at the end of September.

The hryvnia’s decline was a serious cause of concern for average Ukrainians, who still vividly recall last year’s dramatic 50 percent decline in the currency. Meanwhile, Naftogaz shareholders watched the price of their bonds drop from $92 to $71 and then ratchet back into the high $80s as debts remained a hot political topic.

Prime Minister Yulia Tymoshenko promised a stable hryvnia and President Victor Yushchenko promised Naftogaz would not restructure its debt. But many economists view a second wave of the crisis as increasingly likely as we close out the summer. The additional $3.3 billion the International Monetary Fund provided Ukraine last week will help pay its external debts, but we may be in for a bumpy autumn.

Three major factors loom large on the horizon for Ukraine’s currency reserves and the exchange rate, which is the most visible sign of the macroeconomic situation to the average Ukrainian.

First is Ukraine’s external public debt payment, which totals $1 billion, combined with a corporate sector that owes about $10 billion, based on June’s external debt figures. Second is Ukraine’s need to pay a growing gas bill, which will total $1.8 billion in the third quarter as Ukraine continues to fill its gas reserves ahead of the winter. Last is the fact that households are already switching to foreign currency, a situation likely to worsen should the currency continue to slide, as households tend to chase momentum.

If Ukraine’s roughly 34 million working age people decide to hit up currency exchange windows for $200 each, it would equal an additional $6.8 billion. This begs the question of how Ukraine’s foreign reserves will hold up in the wake of these payments.

Upon receipt of the latest IMF tranche, the National Bank and government will together have a de facto war chest of $30 billion. Ukraine’s government and corporate debt total roughly $2 billion for August and September, compounded by a roughly equal payment for gas over the period. If households decide to further switch savings into dollars, the currency will slip more.

Given that we are on the cusp of an election campaign, the NBU will be asked to fight tooth and nail to defend the currency, protecting hryvnia savings and bank balance sheets. But it is hard to see how they can prop it up at targeted levels of less than Hr 8 per dollar. It would not be unrealistic to expect the currency to slip further, re-testing last year’s weakest point above Hr 9.

This is an unfortunate scenario for the average man in the street, and could delay real economic recovery in Ukraine for months. However, there is a silver lining in the clouds looming overhead.

This may represent the opportunity of a lifetime for Ukrainian investors. The equity and real estate markets may pull back as recovery from the crisis is delayed. Individuals and companies will be cash-short and real estate prices could reach more reasonable levels after the excesses of the past several years. Also, brokers and bankers will be forced to give up blocks of Ukrainian shares, pushing stock valuations back down to levels that will entice foreign investors back into the market.

But the ultimate beneficiary will be Ukraine’s current account.

The country is a heavily export-driven economy and the steel sector is its most important engine. A cheaper hryvnia will mean lower wages and costs for producers, allowing them to benefit from lower expenses and the prospect of higher prices for steel in the second half of the year, as consumer-related imports become relatively more expensive and continue to tumble.

Machine builders and other industrial producers will also gain from this medicine of more-competitive exports and reduced import substitution. In fact, industrial production halted its decline lately, rising 3.1 percent month-on-month in June, after rising 1.3 percent in May.

The most serious concern is that political maneuvering ahead of the election will prevent the government and central bank from addressing the imbalances that are causing this macroeconomic weakness, preferring back-room deals and populist measures to cement positioning ahead of January. This will only prolong the suffering.

We are in for a long and difficult fall and winter. But if Ukraine takes its medicine, we can begin the process of healing next year.

Lucas Romriell is a managing director at Kyiv-based investment bank Galt & Taggart Securities. He has lived, worked and traveled in the former Soviet Union for more than 10 years. He holds a bachelor’s degree in Russian studies from the University of Colorado. He can be reached at [email protected].