Ukraine's central bankcut interest rates for the first time since August 2010 on Thursday, citing a slowdown in inflation and increasing confidence in the hryvnia currency despite growing pressures on its public finances.
The quarter point cut brings rates to 7.5 percent and could boost economic growth in the former Soviet republic as PresidentViktor Yanukovich’s partyprepares for October parliamentary elections.
Yanukovich has launched $3 billion in extra spending ahead of the polls but remains at odds with the International Monetary Fund, among other things over the state’s huge subsidies of prices of imported gas, which Fund officials say cannot last.
"We see positive inflation dynamics,"Ihor Shumylo, the head of the central bank’s economics department, told reporters.
"With lower (hryvnia) devaluationary expectations, increased liquidity will support economic activity and lending rather than flow into the foreign exchange market."
Inflation slowed to 3.0 percent in year-on-year terms in February from 7.2 percent in the same month of 2011. The bank has also said it "barely intervened" on the market to support the hryvnia last month.
The hryvnia, which is pegged at about 8 per dollar, had come under pressure in late 2011 but the bank intervened actively to support it and analysts say the peg is likely to remain in place at least until the October elections.
On Thursday, the central bank also said it would allow banks to hold up to 40 percent of their reserves in their regular accounts while the rest would be completely frozen. Previously, it had only allowed 30 percent of reserves to be used.
However, the bank increased reserve requirements – the proportion of money that has to be put away into reserves – on foreign currency deposits by 50 basis points, putting the figure at 8.0 percent for short-term deposits and 8.5 percent for call deposits.
Combined, these steps mean banks will have more liquidity, which could accelerate inflation. However, they will be less likely to change the released funds into foreign currency, allowing the central bank to maintain its dollar peg.
Shumylo said the bank expected a neutral balance of payments this year with capital account surplus covering the current account deficit, projected at about the same level as last year when it reached $9.3 billion.
CAMPAIGN COSTS
Ukraine’s economy, dominated by steel exports, is vulnerable to swings in global demand and the government expects growth to slow to 3.0 percent this year from 5.2 percent in 2011.
According to central bank estimates, growth eased to 2 percent in January-February 2012 from 6.5 percent in the same period of 2011.
That will put more pressure on the budget, but Yanukovich, whoseParty of the Regionshas seen voter support fall, announced a $3 billion package this month to boost pensions and other payouts as well as subsidising mortgages.
With poll ratings for Yanukovich’s main opposition growing, domestic political issues have already led to the suspension of the IMF’s $15 billion lending programme.
The IMF wantsUkraineto raise gas and heating prices for households which are currently heavily subsidised by the state.Kievwants to avoid the price hike and hopes to negotiate a lower price for Russian gas supplies. But the Fund says even that would not be enough.
"Heating companies and households (inUkraine) are paying 15 percent of the import price,"Max Alier, IMF resident representative inUkraine, told a financial conference on Thursday.
"Do you thinkRussiawill agree to an 85-percent gas price discount?"
Ukrainesaid last Thursday it wanted to restructure $3 billion in IMF debt falling due this year, jolting the debt market.
The government, however, has not submitted any formal restructuring request to the Fund and analysts saw the statement as an attempt to put pressure on the Fund to resume lending.
Ukraine, which has about $9 billion in outstanding Eurobonds, faces a heavy debt repayment schedule this year, including $3.1 billion to the IMF. (Reporting by Natalya Zinets; Writing by Olzhas Auyezov; editing by Patrick Graham)
