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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

We have not had a devaluation like this

17 July, 1999 - 00:00

It is not our fault that a fall in the hryvnia's dollar equivalent is considered a national calamity in Ukraine. As a matter of fact, a «correct,» from the National Bank's viewpoint, regulation of the currency market was always impossible without «idolization» (from «idol») of the Bank's monetary policies. The hryvnia has long become an instrument used by the market's political subjects for domestic and foreign political purposes. This is why it is so difficult to grasp what really promotes and revives the economy and what suppresses it.

The way the hryvnia fell in July and August was in many respects similar to all previous cases: the hryvnia's stability, in the absence of economic grounds, was merely doomed to result in a new devaluation. Yet, today's devaluation is unique in a way. But before looking into its crucial peculiarities, we must recall what steps the National Bank (NBU) usually took to strengthen the local currency.

In general, manipulating the currency exchange rate (as a macroeconomic regulator) is difficult because, on the one hand, this rate affects the commercial links between Ukrainian and foreign enterprises, and, on the other hand, it determines the stability, first of all in terms of prices, of the domestic economy. When curbing inflation is a priority task for the state, with exports steadily surpassing imports, tight control over exchange rate dynamics is justifiable. In these periods, a stable currency rate is indeed the «anchor of prices.»

It is easy to notice that the horror of inflation is in fact forgotten in Ukraine, to a large extent, as the result of judicious use of the printing machine. This has brought to the foreground other «determinants» of the currency rate: export/import balance, domestic demand for the hryvnia and dollars, inadequate NBU hard-currency reserves, etc. However, market actors (the buyers and sellers of hard currency) were by inertia oriented toward old indicators. It is in fact for this reason that they could not believe, until the last minute, that the NBU would allow the hryvnia to «jump out» of its currency corridor bounds.

But the National Bank decided to act otherwise. They thought as follows: If prices in the oil sector have shot up by 200-300% over 2-3 weeks, keeping the rate stable at the expense of hard-currency reserves will automatically bring the importers of oil and gasoline a profit of at least 100- 150%. In this case, the profits of producers who consume fuel at God knows what prices, as well as the profits the state draws from foreign economic imbalances (exports would again become non-competitive), would look dubious. On the other hand, although the National Bank has not talked much about an emission policy lately, the mass of money in circulation clearly failed to encourage an increased demand for essential goods. Therefore, the NBU's worries about panic among the population (which can bring down not only the hryvnia but also the banking system) should not be overrated.

Some bankers think the National Bank could have offset such an abrupt and great leap in the hryvnia devaluation and effectively supported the market. But for what? The answers — in order to avoid a reduction in national incomes and increase in the government's foreign-debt payments, and not to mark up prices of imported goods — were in this case taken into account by the National Bank in a rather strange way. The latter must have had something else on its mind when it decided to encourage the «out- of-season» growth in the dollar price.

Firstly, the chief hard-currency regulator had no grounds (moral or material) to promote superprofits for oil exporters. Measures taken by the Cabinet of Ministers have increased the number of potential suppliers of fuel to the Ukrainian market from a few dozen to a few thousand. If all of them had a chance to earn at least a 100-% profit on one operation, no reserves would suffice to pay for this.

Secondly, given the NBU hard- currency reserve value which does not cover even 30% of the hryvnia mass, the hryvnia should fall by at least 200% (provided the reserves are convertible). So is it easy to choose how and at the expense of what to save the hryvnia?

Thirdly, the National Bank (and perhaps the whole economy?) must have matured enough to see not only the devil in devaluation. Devaluation makes the local currency cheaper, much to the chagrin of absolutely all importers and hard-currency borrowers. But devaluation is also able to stimulate the demand for local goods and increase output, and thus ward off growth in prices for Ukrainian products. It is also able to keep the until- recently free resources from being squandered and promote rational price-formation, which, in the long run, would push things in order: Ukraine's economy will at last look like that of any other normal country. By the way, the Cabinet is also doing something in this direction (not without IMF intervention). The launching of a money-based grain and gas trade system and the liberalization of oil supplies objectively enhance the value of, above all, the national currency. At the same time, foreign goods, purchased at an increased dollar price, will inevitably balance the profits of importers and exporters in the conditions of a viable hryvnia-based market.

And now let us try to answer the main question of today: how will the hryvnia fare tomorrow? Tomorrow, the hryvnia might as well be falling. To what extent abruptly, will depend on the NBU's psychological and material influence. But the day after tomorrow, when the National Bank finds the «export-import bottom» of the current corridor, the hryvnia will stop falling and even grow a little. What will it then cost? I do not think it will exceed greatly the currency corridor's upper limit. This is not as important from the viewpoint of economic and exchange-rate policy being pursued at the time.

The present-day devaluation is unique not because the hryvnia has never fallen for «such» reasons. It is unique because the hryvnia has never been «allowed to fall» for «such» reasons. If you want, the currency market, perhaps for the first time, has come face to face with the market whirlwind with the consent of the government and the National Bank. And the two latter must have done so contrary to their will because their resources had been exhausted. In other words, the absence of economic reforms will always end up in the future the way it did just now — with a new devaluation.

German consultants to the government, who traditionally argue with IMF advisors about the necessity of a strong hryvnia in a weak economy, suggest that the National Bank choose a crawling-peg rate for the hryvnia (when the NBU intervenes only to smooth over abrupt variations in the rate), with or without an indication of the corridor limits of fluctuation. What is more, under this strategy, the behavior of the market should conform to the central bank's forecasts, while the forecasting procedure is open to the public, for the formulas of calculations are periodically published in the press. What we have now is essentially «a fixed rate within the currency corridor.»

However, if the crawling peg finds a soft spot in the IMF and the National Bank, the hryvnia's crawling speed will depend not only on the inflation rate and the foreign trade balance. A new EFF credit installment is expected to be confirmed or rejected later in August. According to Vice-Premier Tyhypko, Ukraine should find, before August 15, a «theoretical» opportunity to plug a $2 billion gap in the budget. This will decide whether or not the loan will be issued. The latter will in turn only affect the medium-term reactions of the currency market to a chronically deficient balance of payments in this country (i.e., the import- export of money). Long-term reactions will depend on a different thing — on the behavior of market actors and their desire to produce at least something in Ukraine. As long as this desire does not exist, our unique devaluation will soon become a common trait of Ukrainian life.

It is not our fault that a fall in the hryvnia's dollar equivalent is considered a national calamity in Ukraine. As a matter of fact, a «correct,» from the National Bank's viewpoint, regulation of the currency market was always impossible without «idolization» (from «idol») of the Bank's monetary policies. The hryvnia has long become an instrument used by the market's political subjects for domestic and foreign political purposes. This is why it is so difficult to grasp what really promotes and revives the economy and what suppresses it.

The way the hryvnia fell in July and August was in many respects similar to all previous cases: the hryvnia's stability, in the absence of economic grounds, was merely doomed to result in a new devaluation. Yet, today's devaluation is unique in a way. But before looking into its crucial peculiarities, we must recall what steps the National Bank (NBU) usually took to strengthen the local currency.

In general, manipulating the currency exchange rate (as a macroeconomic regulator) is difficult because, on the one hand, this rate affects the commercial links between Ukrainian and foreign enterprises, and, on the other hand, it determines the stability, first of all in terms of prices, of the domestic economy. When curbing inflation is a priority task for the state, with exports steadily surpassing imports, tight control over exchange rate dynamics is justifiable. In these periods, a stable currency rate is indeed the «anchor of prices.»

It is easy to notice that the horror of inflation is in fact forgotten in Ukraine, to a large extent, as the result of judicious use of the printing machine. This has brought to the foreground other «determinants» of the currency rate: export/import balance, domestic demand for the hryvnia and dollars, inadequate NBU hard-currency reserves, etc. However, market actors (the buyers and sellers of hard currency) were by inertia oriented toward old indicators. It is in fact for this reason that they could not believe, until the last minute, that the NBU would allow the hryvnia to «jump out» of its currency corridor bounds.

But the National Bank decided to act otherwise. They thought as follows: If prices in the oil sector have shot up by 200-300% over 2-3 weeks, keeping the rate stable at the expense of hard-currency reserves will automatically bring the importers of oil and gasoline a profit of at least 100- 150%. In this case, the profits of producers who consume fuel at God knows what prices, as well as the profits the state draws from foreign economic imbalances (exports would again become non-competitive), would look dubious. On the other hand, although the National Bank has not talked much about an emission policy lately, the mass of money in circulation clearly failed to encourage an increased demand for essential goods. Therefore, the NBU's worries about panic among the population (which can bring down not only the hryvnia but also the banking system) should not be overrated.

Some bankers think the National Bank could have offset such an abrupt and great leap in the hryvnia devaluation and effectively supported the market. But for what? The answers — in order to avoid a reduction in national incomes and increase in the government's foreign-debt payments, and not to mark up prices of imported goods — were in this case taken into account by the National Bank in a rather strange way. The latter must have had something else on its mind when it decided to encourage the «out- of-season» growth in the dollar price.

Firstly, the chief hard-currency regulator had no grounds (moral or material) to promote superprofits for oil exporters. Measures taken by the Cabinet of Ministers have increased the number of potential suppliers of fuel to the Ukrainian market from a few dozen to a few thousand. If all of them had a chance to earn at least a 100-% profit on one operation, no reserves would suffice to pay for this.

Secondly, given the NBU hard- currency reserve value which does not cover even 30% of the hryvnia mass, the hryvnia should fall by at least 200% (provided the reserves are convertible). So is it easy to choose how and at the expense of what to save the hryvnia?

Thirdly, the National Bank (and perhaps the whole economy?) must have matured enough to see not only the devil in devaluation. Devaluation makes the local currency cheaper, much to the chagrin of absolutely all importers and hard-currency borrowers. But devaluation is also able to stimulate the demand for local goods and increase output, and thus ward off growth in prices for Ukrainian products. It is also able to keep the until- recently free resources from being squandered and promote rational price-formation, which, in the long run, would push things in order: Ukraine's economy will at last look like that of any other normal country. By the way, the Cabinet is also doing something in this direction (not without IMF intervention). The launching of a money-based grain and gas trade system and the liberalization of oil supplies objectively enhance the value of, above all, the national currency. At the same time, foreign goods, purchased at an increased dollar price, will inevitably balance the profits of importers and exporters in the conditions of a viable hryvnia-based market.

And now let us try to answer the main question of today: how will the hryvnia fare tomorrow? Tomorrow, the hryvnia might as well be falling. To what extent abruptly, will depend on the NBU's psychological and material influence. But the day after tomorrow, when the National Bank finds the «export-import bottom» of the current corridor, the hryvnia will stop falling and even grow a little. What will it then cost? I do not think it will exceed greatly the currency corridor's upper limit. This is not as important from the viewpoint of economic and exchange-rate policy being pursued at the time.

The present-day devaluation is unique not because the hryvnia has never fallen for «such» reasons. It is unique because the hryvnia has never been «allowed to fall» for «such» reasons. If you want, the currency market, perhaps for the first time, has come face to face with the market whirlwind with the consent of the government and the National Bank. And the two latter must have done so contrary to their will because their resources had been exhausted. In other words, the absence of economic reforms will always end up in the future the way it did just now — with a new devaluation.

German consultants to the government, who traditionally argue with IMF advisors about the necessity of a strong hryvnia in a weak economy, suggest that the National Bank choose a crawling-peg rate for the hryvnia (when the NBU intervenes only to smooth over abrupt variations in the rate), with or without an indication of the corridor limits of fluctuation. What is more, under this strategy, the behavior of the market should conform to the central bank's forecasts, while the forecasting procedure is open to the public, for the formulas of calculations are periodically published in the press. What we have now is essentially «a fixed rate within the currency corridor.»

However, if the crawling peg finds a soft spot in the IMF and the National Bank, the hryvnia's crawling speed will depend not only on the inflation rate and the foreign trade balance. A new EFF credit installment is expected to be confirmed or rejected later in August. According to Vice-Premier Tyhypko, Ukraine should find, before August 15, a «theoretical» opportunity to plug a $2 billion gap in the budget. This will decide whether or not the loan will be issued. The latter will in turn only affect the medium-term reactions of the currency market to a chronically deficient balance of payments in this country (i.e., the import- export of money). Long-term reactions will depend on a different thing — on the behavior of market actors and their desire to produce at least something in Ukraine. As long as this desire does not exist, our unique devaluation will soon become a common trait of Ukrainian life.

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