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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

National Bank as Psychotherapist

20 April, 1999 - 00:00

Last week, reports from Kazakhstan indicated that the republic's national
bank cannot maintain the tenge's exchange rate any longer. As a result,
the Kazakh national currency lost about half its value on the very first
day of its free flotation. The Russian ruble that broke free last year
is also having a hard time: in March alone, such freedom cost the Central
Bank 6% of its gold and hard currency reserves.

Against this backdrop, the news from the Ukrainian foreign exchange
market sounds wonderful. For the second week now, market participants have
been observing a continued decrease in devaluation expectations, and an
increase in foreign exchange supply to the market. On March 19, the National
Bank permitted free purchase of foreign exchange for commercial operations
on the over-the-counter interbank market, which had been prohibited since
last September. In the last ten days of March, the dollar hryvnia's exchange
rate fell by 10%, from 3.7620/3.9000 to 4.1508/4.2602. However, as early
as April, it began to stabilize, and over the last nine days hryvnia quotations
in legal kiosks have risen by 2%.

Now that the most difficult initial stage of market liberalization is
over, we can draw preliminary conclusions and clear up what we should expect
in the future. In the final analysis, the Ukrainian liberalization, unlike
in Russia or Kazakhstan, reveals two equally important components: one
is technological, the other psychological. The first component includes
a set of monetary measures, that is squeezing the hryvnia supply, supervising
banks' liquid assets, implementing administrative procedures for the distribution
of foreign exchange, etc. The means of psychological influence on market
participants have obviously included the large-scale public relations campaign
practiced by the National Bank.

In general, trying to differentiate the exclusively monetary measures
from psychological ones would probably be impossible. In fact, no step
taken by the National Bank concerning exchange controls would have made
any sense, had the subjects of the market not believed it. Remember the
Bolsheviks' motto? Ideas become a material force if they rule the masses.
Let us take the problem of establishing the procedure for setting the hryvnia's
exchange rate. Over several months, there was quite a few exchange rates
in Ukraine - black, gray, and white ones. Given all that, how was it possible
to convince traders, in only a few days, that the only precise rate is
determined on the interbank market? True, one has to physically eliminate
the very idea of multiple exchange rates, and, in addition, to create an
outward appearance of the freedom of the market and the National Bank's
surrender of exchange controls.

Was the closing of the Ukrainian Interbank Currency Exchange (UICE)
an ill-considered and hasty step? Not in the least. It was a very sophisticated
psychological trick. First, it eliminated the practice of setting the exchange
rate by fixing. Thus, the official exchange rate was no more geared to
the NBU's "views and possibilities with regard to currency

intervention." Second, the exchange quotation, which had become a sort
of a fetish for behavior, has as such sunk into oblivion. It should be
pointed out that the financiers have always associated the UICE as the
NBU's tool to control the exchange rate, so the UICE closure has accomplished
its mission and, as Viktor Yushchenko had wanted, became a signal to traders.

Interestingly, the National Bank's influence on the market's psychological
condition has increased manyfold due to the successful demonstration of
the bank's own (that is, different from the International Monetary Fund's)
position on foreign exchange controls. Since late 1997, NBU experts have
at least three times turned down IMF recommendations, and came out victors
in clashes with elements expecting devaluation. In fact, gripping the market
in the vice of administrative regulation, which was the case, violated
a number of Ukraine's international agreements. This concerns the four
foreign exchange controls disagreeing with Article 8 of the IMF's Articles
of Agreement, specifically: (1) controls on the possibility of foreign
currency debt servicing above a certain interest rate; (2) controls on
certain commercial credits denominated in hryvnias and foreign exchange;
(3) controls on repatriation of profits by certain nonresident investors;
and (4) controls on prepayment for imports. According to the draft prepared
for the first revision of the Ukraine-IMF cooperation program, the Ukrainian
officials insist that controls under (3) and (4) be preserved until the
end of next June. As to bureaucratic requirements for notarization of documents
by foreign exchange buyers, they are "applied exclusively for the purpose
of supervision" and thus are not subject to cancellation.

In conclusion, we should still say that no psychiatric treatment would
have been of help to the market unless the Ukrainian authorities had occasionally
been granted a breathing spell directly by the IMF. Obviously, when the
IMF and World Bank loans are exhausted, we will again be guessing at whether
this mass psychotherapy will encourage the recovery of the financial market
or not.

 

The liberalization of the foreign exchange market has been successful... So far...
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