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Where there is no law, but every man does what is right in his own eyes, there is the least of real liberty
Henry M. Robert

CURRENCY MARKET PREPARES FOR THE WORSE The symptoms of the oncoming crisis are becoming more obvious

13 November, 2012 - 00:00

I have had a feeling lately that the Ukrainian currency market is not a market anymore. The liberal hryvnia rate is nothing but tying the rate to the currency reserves of the National Bank.

The first symptoms of the oncoming crisis appeared two years ago. Market participants noticed that deals had an unpleasant tendency to decrease in volume. The Ukrainian Interbank Currency Exchange, followed by the interbank currency market was the first to slow down. It was only a currency exchange market, which displayed stable indices.

At the same time another participant in the currency market, the National Bank of Ukraine, had a slightly different position. Being aware that major problems of the currency market are connected with negative macroeconomic tendencies, the fiscal authorities preferred to use administrative measures. This was the beginning of a gradual ousting of the economic rate formation mechanism.

Experts say the currency crisis started worsening last autumn. A massive retreat of foreigners from the domestic debt market became one of the main reasons. Their share at the market used to reach from 50% to 80% according to different estimates. Now it does not exceed 20%. All of this hit the hryvnia hard. “The share of foreign investors at the domestic bonds market was cut more than in half since the beginning of the year,” Director of the NBU Emission and Loan Department of Natalka Hrebeniuk reported to Ukrainski Novyny (Ukrainian News). “Now non-residents account for approximately 20%, including hryvnia bonds placed with Merrill Lynch and ING Barings. In January 1998 it was still was over 60%.” Hrebeniuk did not make public the precise amount of the packages owned by foreign investors. According to Ukrainski Novyny, the sum total of domestic bonds belonging to foreign investors decreased from Hr 4.7 billion to Hr 2.1 billion, which means Hr 2 billion has left the market.

However, the NBU had a speedy reaction prohibiting speculative operations for both non-residents and local banks. As a result the hryvnia supply was cut because Ukrainian banks were the main suppliers. This way or another, non-residents lost an opportunity to conduct arbitration and speculation operations, and Ukrainian banks failed to get it. They were also hit with new reserve requirements, which considerably decreased their total liquidity. In addition, they had to meet new norms for international accounts. And the NBU changed the rules of rate formation, cutting its fluctuation to minimum.

Nevertheless, they failed to keep the hryvnia from falling. The currency corridor should have been canceled, because the hryvnia fell out of it on the Moscow market. The planned limits for 1998 have been also changed. At that time the futures market started to collapse. According to Expert magazine, it started actively developing last summer at the peak of non-residential investment in domestic bonds. Incidentally, according to official information there is no futures market in Ukraine, and all attempts of the Ukrainian Interbank Currency Exchange to launch a short term contract section have failed. Hence, small banks stopped paying at the end of last year. The big banks, mainly Russian, through which western investors were hedging rate hazards on the Ukrainian market, suffered the most. To keep their image, they had to execute unprofitable contracts. The futures market was totally ruined this March after hryvnia devaluation.

The infrastructure of the Ukrainian financial market does not meet civilized demands. A secondary domestic bonds market practically does not exist. The deals are being made only at the unorganized interbank market. Those who purchased domestic bonds with the purpose of speculation were forced to become investors. Now the devaluation threat is higher in Ukraine than in Russia. Russia shows a rather strict approach to financial and loan policy. Ukraine realizes its weakness and understands that it will attract less international aid than Russia.

The country has no sources to replenish its currency reserves. The trade balance is always negative and totaled $1.046 billion in the first six months of 1998. In 1997 50% of the negative balance ($2.9 billion) was compensated by western capital inflow. This year Ukraine is suffering from the double pressure of capital flight. Export perspectives for Ukraine are not at all optimistic: exports to Russia constitutes 44% and 30% to Asian countries, which suffer from their own crisis.

It is very hard for Ukraine to attract a market loan on the international market: contradictory information on the ING Barings loan (18% or 55% interest rate) is the best proof. This February when they needed to stop the hryvnia’s fall they attracted an exotic fiduciary loan totaling DM 750 million. Unlike ordinary Euroloans, the organizers — Merrill Lynch and Commerzbank — purchased all of it and placed it as they themselves wished. The price for the three-year loan totaled 16% a year including interest. This is insane profitability even considering the falling DM rate. If a bank asks for a dollar loan with 13% interest rate, it means that the bank is deep in trouble and is a potential debtor. Ukraine was broke, even Moscow was alarmed that it could serve as a precedent for other countries in the region. Another Euroloan totaling 500 million ECU was also considered rather unusual. It gave the impression that Western financiers are experimenting with Ukraine taking advantage of its funds shortage: at that time Ukraine was refused new installments of IMF and World Bank loans.

The IMF can potentially support the hryvnia by granting new loans. The hryvnia rate could even rise to Hr2.10 per dollar. But the interlude will definitely be a short one. It will last to the end of the year at most — investors do not want to take chances granting long term loans. There is also another limitation, the NBU currency reserves. They simply will not last long considering present demands of the state budget. Only structural reforms in the economy can cure the currency market, but there is no one to launch them.

 

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