Russia’s Central Bank raising its refinancing rate from 50% to 150% took many by surprise. Of course, some Russian government response to the financial crisis was expected, but not such a radical one.
The results of a similar radical move in Ukraine are still unclear. How serious they will be depends on how much the National Bank of Ukraine is actually dependent on Russia’s Central Bank. Here the main question is, how will all this affect the NBU’s discount rate. So far, the RCB’s moves are portrayed by the media (and individual analysts) as “demonstrative.” The official version is that the Central Bank raised its rate so sharply to show all the stock market speculators that it will stop at nothing to support the ruble. The NBU has responded by raising its rate from 45% to 51%, a gesture its President Viktor Yushchenko attributed to “psychological reasons.” The general outcome will largely depend on how serious Russia’s crisis gets. For the time being, it is safe to assume that the government’s anti-inflation measures will keep the rate at 150% for quite some time.
Some experts believe the National Bank of Ukraine will adhere to a policy of gradually raising the discount rate, although most agree that there are no domestic reasons for increasing it further.
CAPITAL OUTFLOW
The NBU’s main formal reason for raising interest rates is preventing capital outflow to Russia (where prices are again soaring). Viktor Medvediev, deputy head of NBU’s Kyiv and Kyiv Regional Departments, feels certain such an outflow will occur. And the amount drained will depend on the relations between the Ukrainian and Russian economies. There are several opinions with regard to these relations. Nadra Bank dealer Pavlo Kozak thinks that the Russian and Ukrainian money markets “are not markedly interconnected because of the restrictions resulting, for example, from the exportation of capital or from Loro transactions” (this from Interfax-Ukraine).
True, what is meant in this case is “transparent” capital, something Ukraine still lacks. As for “shadow” capital, it has a sad regularity in Ukraine: the shadow category mostly implies not the kind of money originating from so many petty illicit operators, and not even from the rackets. Here the bulk comes from financial industrial groups working hand in glove with the powers that be. For them, Loro and other accounting problems are practically nonexistent. Such shadow money is mostly involved in trade, exporting cheap goods (metals and chemical products) and legalized-contraband imports (all of the importers are levied staggering government duties and excise taxes, but those with the right connections in the right places are spared the trouble). Comparing such revenues to those resulting from pumping money into Russia would be a very difficult task. In fact, the degree to which Ukraine’s refinancing rate will increase and the consequences would directly depend on the adequacy of NBU’s assessment of such domestic free assets and possible revenues from speculative operations in Russia.
Of course, any tangible increase in NBU’s discount rate will have most serious consequences for Ukraine in general. Let us consider what would happen if it were doubled as in Russia.
TRADE
In the commercial sphere, such an increased refinancing rate would basically result in boosting commercial bank loan interest. Trade is generally known to rely on credit transactions, so that higher bank credit interest indicates the need to get better returns. Contrary to what armchair analysts assume, Ukraine’s trade is in an even worse condition than production. Being used as a source of quick-bucks, Ukrainian trade attracts government-level and “independent” rackets. Graft, protection money, etc., serve to increase expenses and, of course, prices. Add here the populace’s low purchasing power, and the only possible inference becomes that Ukrainian commerce has no reserves for the growth of profits.
More expensive money would be ruinous for the middle link in the trade chain: medium size businesses trying to operate openly. Big-time trade would get their income at state expense, while small business will not use bank loans. We might possibly find ourselves confronted by yet another deficit, because medium-size commercial entities generally specialize in consumer goods.
PRODUCTION
Bank loans have long become too expensive for Ukrainian manufacturers, so any future refinancing rate rise is hardly likely to harm them. The production sphere will suffer indirect damage via the trade sector. Production-trade combination procedures will be noticeably simplified, reducing choice (there would be fewer dealers and traders), while increasing disbursements (one would have to adjust to the new conditions), and the quality and quantity of information would suffer, meaning that business entities could not adequately respond to changing conditions. This is especially important for domestic manufacturing which is habitually in the red, largely due to mismanagement and its stubborn reluctance to adjusting its methods to new market conditions.
GOVERNMENT EFFORTS
Let us start forth with one of the moment’s basic specificities. Russia’s discount rate rose from 30% to 50% previously — almost double. That of the NBU was 41% at the time, so the Russian Central Bank’s impact proved insignificant (up to 45%). Now both Russia and Ukraine are in about the same boat; to adequately respond to the NBU, we will have perhaps to raise the discount rate three times or thereabouts. Actually, here is the main problem: regardless of whether the Ukrainian economy is managed rightly or wrongly, it would be damaged fundamentally by radical changes in the rules of the game being played. Here serious consequences depend on how long NBU will be able to keep up its gradualism.
It should be noted here and now that the Cabinet’s measures to “soften” the blow of making money even more expensive could have results difficult to predict. Experience shows that one should predict the worst possible scenario which could be played out, but here, too, the problem is that no one knows which scenario is worst.
It seems safe to assume that the Cabinet and NBU will resort to monetary expansion. The refinancing rate hike we are in for is usually practiced when the monetary inflation ratio is high. The logical step to take under the circumstances would be to even out the money supply and refinancing rate. This implies the problem of assessing the response of Ukraine’s economy (which is no way near to being a market one, thus being unpredictable) and the high risk of inflation following its own unpredictable course. A graphic example of this contingency is that a normal economy must respond to money getting more expensive by lowering prices. Ukraine ought to have shown this response a long time ago. It has not. Worse, costs are on an upward curve, and real inflation is substantially higher than officially quoted.
To achieve a normal, predictable economy, it is necessary to liberalize economic relationships on the largest possible scale. Those in power will not do so because this would not serve their selfish interests. Under the existing regime any attempt to obtain maximum revenue (including state budget returns) is closely connected with the routine practice of squashing anything trying to move forward and getting out of the line. Here the deeper the economy’s regress, the greater is the pressure brought to bear from on high. Hence the government’s progressively lessening ability to cope with the situation, responding to such external factors as IMF requirements or Russia’s bank interest rate jumps.
Getting back to inflation, one must admit that the political barriers to be surmounted in trying to solve this particular problem mostly consist in the Cabinet’s attempts to cooperate with the IMF which does not approve of inflation in the first place. Devaluation seems a less likely contingency, but the risk is high anyway.
Photo by Valery Miloserdov, The Day:
No panic on the currency exchange market so far...







