National Bank as Psychotherapist

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.