UKRAINIAN FOREX CRISIS PUTS BANKING REFORM AT RISK.

Although Ukraine has been widely criticized for its slow pace of bank and enterprise restructuring (compared to Russia and the Central European countries), a report recently issued by the Association of Ukrainian Banks (AUB) suggests that important progress with banking reform is being made. It also suggests, however, that this progress may be put at risk by Ukraine’s current foreign-exchange crisis. (See yesterday’s Monitor)

According to the AUB report (Nezavisimost, October 29), Ukraine’s commercial banks during the first three quarters of 1997 significantly increased the crediting of industrial enterprises, for both working and investment capital. While most (63 percent) of these credits took the form of short-term (three month) loans, the value of long-term loans increased by some 36 percent. Moreover, foreign-currency loans increased by a whopping 64 percent, largely because of rapid increases in the stock of the banking system’s foreign exchange. Commercial banks in the past generally stayed away from making longer-term or hard-currency loans, since these were less profitable and more risky than purchasing high yield-treasury bonds or selling dollars on the foreign-exchange market as an inflationary hedge.

In many respects, the growing willingness by Ukrainian banks to credit domestic firms stems from the success of macroeconomic stabilization. The authorities’ ability to maintain a fixed dollar-hryvnya exchange rate have ended the easy profits from foreign-exchange speculation, while the stable exchange rate and the virtual disappearance of inflation (prices are currently rising at eight to ten percent annually) have made Ukrainian treasury bonds more attractive to foreign investors. They, in turn, have bid up bond prices and pushed bond yields down. The disappearance of the high, risk-free yields on treasury bonds has therefore pushed the banks to increase their lending to enterprises. This trend, should it continue, could help launch Ukraine’s long-awaited economic recovery.

Unfortunately, the fourth quarter has seen a reversal of many of these favorable trends. The emerging-market instability that originated in East Asia in October spread to Ukraine this month, and many foreign investors are now demanding a higher risk premium on Ukrainian (and other emerging-market) debt. The higher bond yields, should they continue, can be expected to attract funds from the commercial banks that earlier this year were being lent to the enterprise sector. Indeed, should it last, the increase in treasury bond yields from 22 percent in September to 40 percent in mid-November (which, with 10 percent inflation, corresponds to a real return of 30 percent) could stop the new bank lending to enterprises dead in its tracks. (Russian agencies, November 26)

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