Down or up?

After the new government is formed, certain socioeconomic vectors are sure to change. This may also include Ukraine’s foreign exchange policy, especially since the Party of the Regions led in the parliamentary elections. This party is often referred to as the export lobby. By definition it favors devaluation.

But theories aside, will any changes to the exchange rate benefit them — or Ukraine? Valeriy Lytvytsky provides an answer to this question in the following article.

The current situation with the money market is the exact opposite of what was happening in March-April 2005. Now demand for the dollar is uppermost. At the same time, the economic growth rate is still low. The current account grew weaker again in February. Exports are taking their time going up. Consumer price inflation is gaining momentum.

Another negative factor is that the official exchange rate of the hryvnias is practically fixed for an unprecedented long period of almost one year. Perhaps it would be best to let this rate “breathe”? But when is it worth doing this so as not to damage the economy? I think it’s best to take stock of all possible gains and losses before making such a radical decision.

A positive aspect of this decision could be counteraction to inflation by removing excess liquidity and making interventions into foreign exchange sales at a lower exchange rate. Increased interest rates may result in larger deposits and ease the price increase burden. “Hot money” will be increasingly channeled into hard currency purchases. This will weaken the potential of their possible attack on problematic commodity markets.

The higher costs of imports will increase income to the budget and improve the fiscal balance. Hryvnia-supporting hard currency reserves will diminish. The exporter premium exchange rate will rise somewhat. Dollar savings nominally devaluated in 2005 will be renewed. Competitive import pressure on domestic producers will lessen, as will the demand for hard currency credits and attendant risks of their non-return. The population is gradually adapting to the exchange rate.

Among the negative aspects I would first point to increased inflation expectations. Because of the partial withdrawal of current and term deposits by people who have lost faith in the national currency, the cash flow outside banks may increase. Shunted into the legal sector, the hryvnia may exert a degree of liquidity pressure on consumer prices. Lowered export prices will reduce revenues to the budget unless the volume of exports goes up, owing to other reasons. This will worsen the budget balance. The easing of competitive pressure on imports may have an impact on the rise of wholesale and retail prices in certain sectors of the consumer maket.

The hryvnia’s weakened purchasing capacity will diminish the role of domestic consumer demand in terms of economic growth. The demand for investments will also be affected. Investment and modernization imports may be depressed, as well as imports for export (including gas). Citizens’ hryvnia savings will lose value. Servicing the external debt will become more expensive. The inflow of capital from non-residents and increases to the financial account will decrease.

Comparing these positive and negative aspects leads to more questions than answers. Therefore, the only conclusion may be advice not to force any radical changes, at least until the main trends of global demand, domestic price situation, and economic growth are understood.