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As pressure on hryvnya mounts, the IMF on November 13 called on the Ukrainian government to switch to a flexible exchange rate mechanism to cushion the blow of external shocks.

Ukraine is slipping towards crisis on the back of government efforts to artificially prop up the currency, which economists believe is at least 10% over valued. The IMF's representative in Ukraine Max Alier told a conference that a flexible exchange rate is essential if Ukraine's economy is to stand up to potential external shocks.

"Since 2006-2007, we have been putting these recommendations into our reports. We believe that the Ukrainian economy, which is deeply integrated into the global economy and dependent on exports of exchange commodities, is exposed to volatility in the market," Alier sid, according to Interfax. "We believe that for an economy like this it would be much better to have a floating exchange rate."

However, rather than let the market decide the value of the currency, the government has given itself powers to maintain the exchange rate by administrative means. The Rada voted through laws last week that will allow the National Bank of Ukraine (NBU) to force exporters to sell some hard currency earnings to the central bank, a rule Ukraine, and most of the former Soviet Union states, abandoned in the last decade after transitioning to a market economy.

Data for October released last week confirmed that pressure on the hryvnya exchange rate is rising. Net foreign exchange purchases in the cash market totalled $2.2bn - the highest since 2008 - while retail hryvnya deposits saw an outflow of 1.8%. NBU reserves suffered an 8.4% decline in October, to $26.8m the lowest since mid-2010, while a $1bn debt repayment to the IMF in November is set to further exhaust reserves, VTB Capital said in a note.

"Over the last several days $/UAH in local interbank forex breached 8.24 amid persistent downward pressure on UAH and the absence of direct NBU interventions," the analysts added, predicting the mounting pressure will see the central bank put its new powers into action soon.

"However," they warn, "in the medium term, the effectiveness of the NBUs possible moves depends, in our view, on complementary measures to ensure higher volumes of forex repatriation through dealing with transfer pricing schemes and other legislative loopholes."

Meanwhile, Ukrainians continue to lose confidence in the banking sector, which is already seeing deposit rates fall. "A trend towards a decline in interest rates on bank deposits is already being seen," the NBU said this week.

Rates were hiked ahead of the October 28 general elections, and tough completion for deposits has held them high. However, the NBU is worried that these high rates are forcing banks to take unnecessary risks. The NBU also said it was thinking of adjusting the size of payments into the deposit insurance scheme.

"The National Bank cannot set any threshold levels on interest rates on deposits, but the [Individuals' Deposit] Guarantee Fund is considering the issue of taking interest rates on deposits into account during the calculation of the sum to be paid by a bank to the fund," the NBU said.

The IMF's demand holds no little weight given its central role in events. The government is hoping to restart a $15bn stand by agreement that would release billions of dollars that would stabilize the currency. Moreover several billion dollars of IMF debt comes due next year that the government currently has no way of financing.

The Director of Emerging Markets Economics Research at Credit Suisse Sergei Voloboev predicted at the same conference that the hryvnia exchange rate would not fall by more than 10% from the current level, provided that the cooperation with the IMF resumed.