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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

Economy for the Week 

15 December, 1998 - 00:00

How Much is a Floating Rate?

 

About three months ago, when asked by journalists about the possibility
of devaluation, the President replied shortly and to the point: "I am not
a financier to make such forecasts." A lot must have changed since then,
because now hardly a week passes without Mr. Kuchma telling about what
should be done and how in the sphere of finance. It has got so that special
instructions are issued regarding separate fiscal aspects.

Thus, the President formally recommended the Cabinet and NBU (December
1) study the possibility of canceling the currency corridor and instituting
a free-floating exchange rate as of the beginning of next year. Last week
NBU Currency Regulation Department Director Serhiy Yaremenko said in an
interview with the Ukrainski Novyny Agency that the National Bank is indeed
studying the possible consequences of such a floating rate. "In accordance
with the President's directive, we must render recommendations before December
20," he added. Previously, in that same interview, Mr. Yaremenko suggested
that adopting a floating rate at the current stage would be premature,
and that the possibility should be regarded as practical at some later
date.

NBU Governor Viktor Yushchenko pointed out on November 25 that a floating
rate could be possible "in the event of a long-term improvement in the
currency market situation, by changing budget policy," along with changes
in the "trade and payment balance." Is one supposed to assume that the
problems mentioned by the chief Ukrainian banker are history?

The answer to this is yes and no. The thing is that the political decision-makers
have openly admitted (something NBU has long insisted upon) that in 1999
monetary policy will not determine economic policy but vice versa. Thus,
both the budget and production for exports will have to be adjusted to
a stable predictable exchange rate. The latter will service the absurd
budget policy and "planned" export losses. The National Bank will probably
have no alternative but comply with this "political" decision.

It is interesting to note that last week an influential Russian magazine
saw precisely a conflict of interests in the situation that has developed
in Ukraine's monetary market: "Ukrainian President Leonid Kuchma and the
National Bank's leadership are in an open confrontation now. President
Kuchma spoke for an emission and canceling the currency corridor. Addressing
the Verkhovna Rada, the Ukrainian President said that 'the economy should
be filled with money, because money has stopped discharging its function
there.' The President's demand contradicts the policy being pursued by
NBU and its head Viktor Yushchenko who is opposed to a large-scale emission."

However, judging by the NBU's decision to make corrections in financial
policy next year, the conflicting parties must have reached a temporary
compromise. In part, the updated "Basic Parameters of Fiscal Policy" for
the next year (prepared in early October) envisions monetary base growth
at 17.7% (Hr 9,846,000,000) and monetary growth at 18% (Hr 18,172,000,000).
The document further points out that NBU's 1999 fiscal policy has been
changed due to the expected inflation increment next year, from 7.8% to
19% (as requested by the President), GDP face value from Hr 117.5 million
to Hr 124.1 million, and that budget deficit will also rise. A week later
Premier Pustovoitenko stated that the government is working out new parameters:
24% inflation rate; 19.6% monetary growth; 1% GDP budget deficit, with
up to 1% GDP production decline. Mr. Pustovoitenko attributed this to the
Cabinet's determination to redeem all arrears on wages due budget-financed
employees and increase subsidies to the regions.

How will the National Bank react? But maybe its reaction will not be
all that important, because the "political decision" to finance government
spending using inflationary funds (something against which NBU has struggled
all the while) has been made. Note that the International Center for Policy
Research estimates that a 20% price increase will result in a 10% popular
income decline and the government's debts to the people will drop by precisely
that 20%. Such is the worth of the floating rate in an extended sense for
the year 1998. In 1999, this rate will cost more, of course.

In a qualified sense - i.e., in terms of the hryvnia's worth - there
are also quite a few interesting nuances. Suppose we try to figure out
the pros and cons of the fixed and floating rates. The pros of the NBU-backed
fixed rate are as follows: this makes it possible to plan the financing
of enterprises and hold back inflation; it enhances fiscal discipline,
"tying" the government to a prognosticated type of conduct; it is effective
on weak markets. But the cons are also tangible: (a) if a fixed rate is
not trusted it will be toppled by financial speculators sooner or later;
(b) the market is denied the opportunity to receive information about the
actual cost of the national currency, so its operators cannot get their
bearings in terms of production and trade strategies; (c) a fixed rate
demands from the National Bank sizable hard currency reserves.

A floating rate also has its pros and cons. Experts refer to the former
the possibility of effective rate-setting, denying speculators the opportunity
to stuff their pockets at the National Bank's expense, and preserving the
Bank's hard currency reserves. The cons include hardships in planning business
because of vague rate forecasts. Moreover, the government, no longer having
to combat devaluation, may well be tempted to conduct an inflationary budget
policy. Such is, in short, the theory of rate-setting alternatives that
helps a country select the most adequate option.

Unfortunately, those in power in Ukraine recall this theory at the last
possible moment. At present, they seem to be concerned about two things:
financing populist budget expenses and keeping afloat export "holding companies"
by devaluating the hryvnia (a kind of barter: I help you now, you will
back me during the elections). To both these a fixed rate is tantamount
to a death verdict.

 

By Iryna KLYMENKO, The Day

 

 

 

 

 

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