The currency market is showing signs of a strengthening hryvnia. Judging from the latest data, is this a steady trend or mere fluctuation of the hryvnia exchange rate? There is no simple answer. In any case, an analysis of the foreign trade activity of Ukrainian business can provide the benchmark data for the right conclusion.
According to preliminary estimates, last year Ukraine’s current balance-of-payments surplus (and above all the difference between exports and imports of goods and services) almost reached the record high of 2002, and in the eleven months of 2003 it even exceed by $25 million the balance-of-payments surplus for the same period of 2002. Last year, imports increased by 28.3%, which was largely due to investment imports, and exports by 24%. An additional impulse came from a sharp increase in the import of foodstuffs resulting from the low crop of 2003. Yet every cloud has a silver lining. Analysis suggests that had the growth ratio of exports and imports remained at the 2002 level, with exports up by 10.7% and imports by 5%, the hryvnia would have appreciated against the dollar by 2-2.5% and not by the current 0.2%. Last year’s foreign trade situation also enhanced the role of domestic demand and adjusted the balance of domestic and external factors determining economic growth.
Simultaneously, the dynamics of changes in current accounts was one of the macroeconomic determinants influencing the internal value (prices) and external value (exchange rate) of the nation’s currency. A combination of a major trade surplus and a minor budget deficit (0.5% GDP) along with significantly improved macroeconomic indices (GDP, output, labor productivity, and employment gains) are behind the moderate nominal 0.017% appreciation of the hryvnia against the dollar. And this is at a time when the real appreciation was nearly 8%. The hryvnia strengthening at such a rate has not dampened exports, because the NBU prevented excessive appreciation of the hryvnia relative to the dollar and its devaluation against the euro and ruble so as not to depress food and investment imports from Europe and Russia. Nominal devaluation against the euro was 20.4% in 2003 against 18.5% in 2002. Despite stagnating economies in most European countries, Ukraine’s exports to the EU increased by 52.6%. The share of exports to the EU has risen from 32.1% to 38.6% of total Ukrainian exports. This has been largely due to the growing external demand in the ten prospective EU member states and the depreciating hryvnia. Other factors were at work in the Russian segment of Ukraine’s foreign trade. The hryvnia’s nominal devaluation against the ruble was almost 7.9%, the first during the years of economic growth in Ukraine. And although it was not significant, with Ukraine’s inflation lower than that of Russia (8.2% against 12%) the hryvnia’s real devaluation against the ruble has increased to some extent the share of Ukraine’s exports to Russia (from 17.1% in 2002 to 18.2% in 2003).
Last year’s higher import growth was due in particular to the higher price of imports resulting from the strengthening euro relative to the hryvnia and a fivefold increase from 2001 in the volume of euro purchases for NBU reserves. This can be viewed as an alarming factor. However, one should take into account the fact that if Ukraine’s economy continues to expand at the same rate, import dynamics will eventually improve. Aside from being an adequate price for economic growth, more expensive imports are also one of the preconditions for continued modernization of the economy and reduction of the inflationary threat. If it were not for growing food imports, whose share in the structure of all imports in 2003 increased by 2.9%, inflation in Ukraine would have been even higher. Meanwhile, without the 2.7% increase in the import of machinery and equipment last year, Ukraine would have received much less investment in fixed assets, which is at its highest level since independence.
Yet, the adequate changes in the NBU’s currency and exchange rate policy that reflected the fluctuations in the current balance of payments and demand for money were poorly received by the players on the foreign trade market. We were urged to depreciate the hryvnia relative to the inflation rate. But there were no macroeconomic reasons for depreciating the hryvnia and, as we can see, it has stood fast.
Now that January is over, similar proposals are being made. Fortunately, thus far they are unfounded. Just as in 2003, a balance-of-payments surplus is forecast for this year, for which reason additionally stimulating it by means of devaluation would not encourage exports, but only increase the risks of inflation and recession. After all, the hryvnia’s stable exchange rate itself led to a 2.4 times increase in export dynamics last year. Moreover, there are no reasons to believe that we have exhausted the devaluation reserve of 1998-1999, which continues to stimulate import replacement. Moreover, last year it was complemented by devaluation, both nominal and real, against the euro and ruble. The hryvnia also continued to decline against a number of currencies of the countries that receive the lion’s share of Ukrainian exports.
In the situation we faced in January, the measures taken by the NBU to strengthen the hryvnia exchange rate reduced the risk of excessive borrowing for the purchase of foreign currencies, a practice the NBU cannot discard for legal and economic reasons, the latter being that a threat of excessive strengthening of the hryvnia exists alongside the threat of inflationary factors issuing from last year’s monetary policy results summed up last December. Currency purchases significantly influenced the increase in money supply. There is no denying that last year’s inflation of 8.2% was caused in part by the excessive growth in the monetary supply. However, according to my estimates, currency purchases did not account for more than 0.5% of the 8.2% inflation rate, although this problem in general merits special note. Combined with other inflationary factors this might affect the results of the country’s anti- inflation policy this year. In January alone, currency purchases ($214 million) almost doubled last year’s January figures ($116 million). Should this continue, the NBU will have no choice but to reduce somewhat the refinancing of banks, a step that could adversely affect the economy. An alternative measure could be the use of budget funds for domestic debt service. Simultaneously, the government could refrain from abruptly withdrawing its deposits from the NBU in the first quarter, and in case of an unplanned budget surplus, some of it could be used for the early repayment of the government debt to the NBU.
In any case, should the January volume and growth rate of currency purchases continue, the NBU might be forced to additionally strengthen the hryvnia exchange rate in order to counter inflation and prevent excessive emission. However, this can be done only if the positive trends in the dynamics of the balance of payments continue. If the requirements for mandatory sale of a part of foreign currency receipts remain unchanged, a greater appreciation of the hryvnia will seem a quite justified policy. The January dynamics of exports could provide reasons for the continuation or adjustment of such a policy.