UKRAINE BATTLES FOREIGN EXCHANGE CRISIS.

Downward pressure on the hryvnya has led the National Bank of Ukraine (NBU) to clamp down on the foreign exchange market and to raise interest rates sharply. While these developments are linked to the general instability currently afflicting international capital markets, they could exact a particularly high price on Ukraine’s economic prospects.

Ukraine’s foreign exchange crisis became news on November 15, when the NBU raised its annual refinancing interest rate from 15 to 25 percent in order to stem the outflow of capital that had been scared out of emerging markets by developments in East Asia. (Russian and Ukrainian agencies, November 15) The rate hike apparently did little to calm the Ukrainian stock and foreign-exchange markets: the hryvnya by November 19 had depreciated to 2 hryvnya per dollar, above the maximum rate of 1.9 hryvnya per dollar set in the NBU’s currency corridor. The NBU’s handling of the market was viewed by many observers as clumsy, and it prompted a forex dealer at one large Moscow bank to tell the press that a "crash had started." (Kievskiye vyedomosti, Nov. 20)

The NBU counter-attacked on four fronts. First, it stepped up the pace of its interventions on the foreign-exchange market in Kyiv, selling dollars in order to keep the hryvnya from depreciating further. (Russian and Ukrainian agencies, November 26) Second, the NBU further tightened money-market conditions. In addition to again raising the annual refinancing rate on November 24 from 25 to 35 percent, the NBU increased commercial bank reserve requirements from 11 to 15 percent. (InfoBank, November 25) These moves helped to push annual yields on treasury bills to 40 percent, up from only 22 percent in September. Third, the NBU slapped administrative controls on foreign-exchange trading: Ukrainian banks are now prohibited from offering hryvnya-denominated credits to non-residents.

Finally, NBU president Viktor Yushchenko went on a public-relations offensive. Describing these developments as nothing more than "disproportions on the foreign-exchange market due to factors of a speculative nature," Yushchenko on November 26 claimed that the crisis was over and that the NBU’s foreign-exchange reserves remained unchanged at a healthy $2.4 billion. Moreover, those responsible for the "factors of a speculative nature" would not escape unscathed: Yushchenko said the NBU is currently examining the behavior of commercial banks that have been heavily engaged in foreign-exchange trading this month, in order to uncover transactions "that may have been inconsistent with the appropriate legislation." (Russian and Ukrainian agencies, November 26)

While these developments may not bode well for liberalization of Ukraine’s banking system, the NBU has in the past responded to monetary instability by slapping administrative restrictions on the foreign-exchange market, and then removing them shortly thereafter when the threat had passed. (This occurred, for example, during the hryvnya’s introduction during the summer of 1996.) Moreover, the NBU had by November 26 managed to force the exchange rate back down below the corridor’s maximum level of $1 = 1.9 hryvnya. More serious damage may have been done to Ukraine’s macroeconomic and fiscal prospects, however. The sharp increase in interest rates is likely to both drive up the cost of servicing Ukraine’s public debt and push private borrowers out of the credit market. The larger budget deficit could put Kyiv at odds with the IMF, while the high real interest rates (25 – 30 percent) could further damage Ukraine’s prospects for economic recovery.

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