James Marson in Kyiv -

With Ukraine's central bank curtailing moves to support the free-falling hryvnia, the local currency has slid further from 5.79 to the dollar on November 18 to 7.24 on December 3, marking an almost 50% drop in value since the start of the year. The central bank now believes the market has almost found the "satisfactory" rate.

After massive currency interventions in October caused the country's foreign exchange reserves to drop by $6bn, the National Bank of Ukraine (NBU) has started to move towards a flexible exchange rate, a condition of the $16.4bn loan the country got from the International Monetary Fund. "Without a flexible exchange rate, we can't overcome the crisis. No amount of currency reserves would be sufficient," Oleksandr Savchenko, deputy chairman of the NBU, told a conference organized by Fitch Ratings on November 27.

Currency auctions have been introduced to smooth the hryvnia's slide to its equilibrium rate. "The market is looking for the satisfactory rate," Savchenko said. "We believe it has almost been found."

The hryvnia has come under pressure from all sides as the country's exports plummeted, demand for dollars shot up to repay dollar loans and people converted their savings out of the national currency. "People have been rapidly converting into dollars - there's low trust in the hryvnia," says Olena Bilan, an analyst at Dragon Capital. "When the hryvnia started to fall in October, people rushed to get rid of their hryvnia holdings." NBU figures show that Ukrainians bought $2bn more in foreign currency in November than they sold.

On the positive side, the hryvnia's fall is a boost to struggling exporters and should help Ukraine close its current account deficit, which reached 7% of GDP in the second quarter of 2008. "The implications of a weak hryvnia are huge," says Oleksandr Klymchuk, an analyst at Concorde Capital. "It raises the competitiveness of exporters and gives locally produced goods a price advantage over imports."

But it's also a threat to banks, as Ukrainians struggle to pay back their loans, 50% of which are denominated in dollars. Fitch on Friday downgraded the outlook for 11 of the country's banks, citing concerns about the deterioration in asset quality and the threat to confidence in the currency. "The devaluation pressure will persist into next year. It's difficult to predict where the exchange rate will move, as it's a question of confidence," Bilan said.

A recovery of the hryvnia next year is likely, analysts say, as people convert their money back into hryvnia to spend, and a tight monetary policy from the NBU restricts hryvnia supply. If currency inflows from foreign direct investment and privatization pick up, the hryvnia should stabilise around 7.5, Klymchuk believes. If not, he predicts the rate could slide as far down as 9 or 10 hryvnia against the dollar.

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