Ukraine to use mandatory currency sales to stave off devaluation

By bne IntelliNews November 7, 2012

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With the parliamentary elections over, attention in Ukraine has turned to the threat of currency devaluation. That has prompted the new parliament, in one of its first acts, to hand the National Bank of Ukraine (NBU) renewed power to force exporters to hand over hard currency earnings.

Economists estimate that the hryvna is overvalued by 10-20%, and it has been slipping over the last month or so as the economy slows on the back of falling steel prices - Ukraine's biggest hard currency earner. Heavy state spending has also contributed to the pressure.

The mandatory sale of hard currency earnings to the central bank was widely used in the 1990s across the former Soviet Union as a way of building up reserves while governments attempted to reboot their economies on a market basis. However, almost all have abandoned the rule. Ukraine was one of the last to abandon the rule in 2005.

It is a sign of increasing desperation that it has been revived. Ukraine's parliament voted on November 6 to empower the central bank to force exporters to convert at least part of their foreign currency earnings into the local currency. That suggests the government intends to hold the currency at its current level against the US dollar.

Allowing the currency to slip to its "natural" level would be potentially dangerous for the banking sector. There is anecdotal evidence that Ukrainians have already begun withdrawing savings from banks. In September 2011, speculation of a devaluation led to withdrawals of around $3bn in hard currency, almost sparking a crisis in the sector. A repeat does not look far over the horizon.

However, just because the NBU has the power to force sales doesn't mean it will use it. Indeed the mere existence of the law will serve to dampen attacks on the currency where traders attempt to force a devaluation a la George Soros and the Bank of England in 1992.

Looking longer term, Ukraine looks like it will have to finally resolve talks with the IMF over restarting its stalled $15bn Stand By Agreement, which would bring in billions of dollars and help stabilize the currency. With a huge volume of existing IMF loans due in 2013, the government has few alternatives but to seal some sort of deal. Even if the threat of mandatory currency sales shores up the hryvna in the short-term, the structural weakness of the currency have to be dealt with eventually.

The hryvna was trading at UAH5 to dollar for years, before it slid to around the UAH8 mark following the 2008 crisis. It dropped to a three-year low only this week to UAH8.19, according to Reuters. Non-deliverable forwards on November 6 put it at 9.27-9.57 in six months time and as high as 10.61 in a year.

However, in a move certain to boost government debt, as well as auguring ill for the IMF talks, the parliament also approved an increase in the 2012 budget deficit by UAH7.68bn ($960bn) to cover gas and heating price subsidies for households.

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