You're reading: As devaluation pressure mounts, some call for scrapping fixed rate

Editor’s Note: This feature by the Kyiv Post explores the public and private financial forces that shape the economies of Ukraine and the world. Please email story ideas to [email protected].Ukraine’s central bank foreign currency reserves took another tumble in November, once again raising the question of why the country is desperately holding on to a currency regime that makes no economic sense.

Few things have aroused as much anxiety of late in the hearts of ordinary citizens as the hryvnia-to-dollar exchange rate. Indeed, the government introduced banana republic-style regulations in October, banning foreigners from selling hryvnias unless they could prove they had previously purchased a larger amount. (These have since been relaxed.

Meanwhile, Ukraine’s central bank spends cash from its coffers in costly currency market interventions to keep the hryvnia tightly linked to the U.S. dollar. With pressure on the hrvynia to devaluate, these policies continue to eat away at the country’s precious hard currency reserves and competitiveness.

Analysts from Troika Dialog investment bank say the dollar would cost around Hr 8.5 by now if a more flexible regime was introduced.

Ukraine fears being buffeted in the storms beyond its borders. Continuing a sharp decline this autumn, central bank hard currency reserves fell by more than 5 percent in November to $32 billion.

That’s a level supporting only 4.4 months of imports of goods and services, according to ING. The Dutch banking giant described the situation as a “clear mid-term risk for Ukraine’s balance of payments and the hryvnia.”

With fears increasing that another global recession is around the corner and trust in national leadership falling to record lows, the population’s appetite for foreign currency has not subsided. Citizens bought $1.4 billion of foreign cash in November, according to officials.

International financial authorities, above all the International Monetary Fund, have long called for a gradual liberalization of Ukraine’s currency regime – more towards a floating than a fixed rate, within an acceptable range.

This, they argue, would provide a buffer against external shocks and discourage dollarization (the use of dollars, rather than local currency, for transactions) and excessive risk-taking. It would also help the country reduce its current account deficit, boosting exports over imports.

Indeed, China has built its economic empire on keeping its currency artificially low to stimulate exports, a strategy followed by many countries. But not Ukraine.

The country, which claims its path to prosperity is based on selling steel and agricultural products abroad, has kept its currency artificially high for much of the past decade.

Some relief came from the sharp devaluation at the end of 2008, supporting an export-led recovery. However, according to a monthly report by Troika Dialog, the positive effect on export-oriented industries’ competitiveness “virtually ended in October 2011.” The investment bank described the current situation as “unsustainable.”

This loss of competitiveness is particularly visible in comparisons with Ukraine’s neighbors. While all the region’s currencies have lost significant ground against the dollar, making their exports 14 to 24 percent cheaper, Ukraine has barely budged.

From Poland’s perspective, the contrast is even clearer: Since the beginning of May, Ukrainian products have become 32 percent more expensive in zloty terms.
Some argue that a stronger currency makes imports and traveling abroad cheaper.

This, however, is hardly beneficial to the bulk of Ukrainian society. Instead, the main motive behind it may be habit and projecting stability, according to Oleksandr Zholud, senior analyst at the International Center of Policy Studies, a think tank.

Bank officials have a “fear of floating” the hryvnia, a policy which would help bring more balance to the nation’s economy, said Zholud.

He insists that a change is “long overdue,” most notably to cool down imports. He expects to see it in the next three to five years, but worries about half-hearted measures. “It is important to make a change in the policy and not just the figures,” he said.

Adapting may be initially hard, but it more than pays off later. If you want to swim, you must first learn to float.

Kyiv Post staff writer Jakub Parusinski can be reached at [email protected].