Cablegate: Nbu Stabilizes Hryvnia, but Further Weakening Necessary

DE RUEHKV #2224/01 3150956
P 100956Z NOV 08




E.O. 12958: N/A

B) KYIV 2207



1. (SBU) The hryvnia has stabilized in the past week as a result of
the National Bank of Ukraine's new policy to sell unlimited amounts
of dollars at an exchange rate that it resets daily. The strategy
is probably draining the NBU's reserves, which stood at $31.9
billion on October 31, but the NBU is not saying by how much. The
central bank has adopted additional harsh measures to stabilize the
hryvnia. It has ordered banks to buy and sell dollars in an
extremely tight range, drastically reduced the amount of money that
Ukrainians can transfer abroad, and ordered the closing of the
country's ubiquitous foreign exchange kiosks as of January 1, 2009.
The NBU faces strong political pressure to keep the hryvnia stable,
and to even allow it to appreciate, and the measures may well be
necessary in the short term to prevent further runs on banks.
Ukraine must allow the hryvnia to depreciate, however, if it is to
seriously tackle the ballooning current account deficit. The IMF is
aware of the policy trade-off that the NBU is facing, and believes
that the current policies can only be a short-term solution that
will ultimately need to give way to more exchange rate flexibility.
Looking forward, the NBU faces significant challenges if tries to
manage an orderly depreciation when politicians and popular
sentiment may be calling for just the opposite. End summary.

NBU Stabilizes Exchange Rate, For Now

2. (SBU) The National Bank of Ukraine's (NBU) heavy handed efforts
to stabilize the hryvnia are working, at least for the moment.
Since late October, the NBU has issued a daily statement announcing
its willingness to sell unlimited amounts of dollars at a
pre-determined rate. Each day, the NBU has reset the rate downwards
to allow the hryvnia to appreciate gradually. The strategy has
worked: before it implemented the policy, the hryvnia crossed the 7
UAH/$ mark briefly. It traded at about 6.20 UAH/$ on the fist day
of the NBU's new strategy, and at 5.81 UAH/$ on November 6. Rates
in the interbank market, and at the retail level in the many foreign
exchange kiosks on the streets of Ukraine's cities, have largely
mirrored the rate set by the NBU.

But At What Cost?

3. (SBU) The willingness to satisfy market demand has probably
drained the reserves of the NBU. It is unclear, however, how many
dollars the central bank has lost implementing the strategy. As of
Oct. 31, reserves were $31.9 billion (down 14.9 percent in October
and from a high of $38 billion earlier this year), but that was
before the NBU implemented the current policy in earnest. It has
not announced how many reserves it needed to sell to maintain the
policy since Oct. 31.

NBU Reduces Forex Market to That of An Agent

4. (SBU) Accompanying the strategy are new, harsh administrative
measures that, taken together, reduce the role of Ukraine's foreign
exchange market to an agent that executes transactions at prices
determined by the NBU. On November 5 the NBU issued a resolution
requiring banks to resell any dollars they buy at precisely the rate
set by the central bank. Banks may purchase dollars at a rate no
lower than three percent below the official NBU rate. In addition,
banks are not allowed to hold inventories of dollars for their
trading operations. All dollars purchased from the NBU must be
resold on the same day, or the next day at the latest. Taken
together, these measures mean that all dollar transactions in
Ukraine -- either between banks, between banks and clients, or on
the street -- are locked into a tight corridor dictated by the NBU.

5. (SBU) The NBU took this latest step after banks routinely resold
dollars purchased from the central banks with a markup, which ranged
anywhere from 5 to 30 percent in the last week, depending on demand.
Analysts have pointed out that such markups simply imply that the
correct dollar rate is somewhat higher than the rate set by the NBU,
but the central bank is determined to compel the market to trade at
rates that it, the NBU, believes are necessary to stabilize the

NBU Also Caps Transfers

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6. (SBU) The NBU announced other measures as well. Companies
wishing to purchase dollars had already been required to document a
need for the currency before buying. Now, companies must use the
purchased dollars within five days or resell the dollars on the
interbank market. In addition, Ukrainian residents are now limited
to transferring from 15,000 UAH to 75,000 UAH (about $2,500 to
$12,500) abroad each month. Before the change, residents could
transfer 15,000 UAH abroad daily.

NBU To Shut Down Kiosks

7. (SBU) To further control the market, the NBU also announced that
foreign exchange kiosks, ubiquitous throughout Ukraine and the place
where most ordinary citizens exchange money, must close on January 1
at the latest. Thereafter cash transactions will only be
permissible at bank counters. Kiosks not owned by banks are
regulated by another state agency. By all accounts, the kiosks are
currently well-regulated, and they are fully subject to the
country's anti-money laundering and terrorism finance regimes.
Hence the NBU action cannot be justified by the need to improve
supervision of the kiosks. Instead, they are a clear attempt to
broaden NBU control over the cash foreign exchange market, and will
certainly be unpopular among Ukrainians, who can now exchange money
seven days a week at kiosks co-located in grocery stores and other
retail outlets. It will also increase costs for banks, many of
which will have expand their opening hours to service clients who
now use kiosks.

An Estimated $50 Billion Cash Now In The Country
--------------------------------------------- ---

8. (SBU) Both the NBU and analysts have argued that the recent surge
in bank withdrawals and sharp devaluation of the hryvnia was driven
primarily by ordinary Ukrainians anxious to protect their savings
from inflation and further devaluation. On November 5, however, the
NBU reported that Ukrainian residents only purchased a net $938
million of the $4.1 billion sold by the NBU in October. Some
commentators are now claiming that subsidiaries of foreign banks
eager to repatriate dollars were among the biggest buyers. In any
case there is universal acknowledgement that ordinary residents
launched a run on banks after the Prominvestbank affair broke (ref
B). The NBU reported that residents withdrew $1.78 billion from
banks in October, or 11.3 percent of their total deposits. Nervous
residents withdrew hryvnia from their bank accounts and exchanged
them into dollars. (Note: The country director of a large foreign
company told us that his chief treasurer led the charge among his
employees; the nervous treasurer encouraged his colleagues to
withdraw their money from banks "before it was too late." The news,
coming from someone they naturally considered to be an expert on
money manners, prompted employees to desert their desks and dash to
their banks, we were told. Separately, a vice president of Nadra
Bank told us that his bank has no available safe deposit boxes after
a recent surge of interest from retail clients. End note). Most of
those dollars are still in Ukraine, in the form of cash kept in bank
safe deposit boxes or literally stuffed under mattresses. It is
estimated that up to $50 billion of dollar cash may now be in the
country, which would be nearly enough to cover Ukraine's expected
external financing need in 2009.

Political Pressure TO Stabilize Exchange Rate

9. (SBU) The NBU clearly expects that freezing the hryvnia into a
tight range is necessary to restore confidence in both the currency
and the banking system. A continued weakness could prompt further
runs on bank deposits, cause some banks to collapse, and quickly
undermine the confidence that the $16.5 billion IMF support plan
approved on November 5 is supposed to provide. The NBU's actions
also reflect the sensitivity that the exchange rate has in Ukraine,
and the political pressure that the central bank is facing. During
the hryvnia's recent slide, all political parties openly criticized
the NBU for not taking decisive actions to stabilize the currency.
Politicians of all colors, including President Yushchenko, continue
to call for a stable exchange rate. On November 6 Oleksandr
Shlapak, first deputy head of the Presidential Secretariat, even
assured Ukrainians that the hryvnia would remain at around 6 UAH/$
in 2009.

Comment: NBU Faces Policy Dilemma

10. (SBU) The NBU is not only stabilizing the currency, but even
pushing it to appreciate gradually in nominal terms. The NBU may be
thinking that nominal appreciation is necessary in the short run to

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reestablish trust in the currency. It may work, but if confidence
does not return quickly then the strategy could cause a severe drain
on the NBU's reserves. Dictating the exchange rate could also lead
to the rebirth of a black market for dollars, which has all but
disappeared in Ukraine in recent years. Most importantly, the NBU
actions could soon conflict with other monetary policy goals. The
hryvnia needs to depreciate, both in nominal and real terms, if
Ukraine is to seriously combat its swollen current account deficit.
Freezing the rate at current levels will actually cause the hryvnia
to appreciate in real terms because local inflation is far higher
than dollar inflation. The IMF is aware of this policy dilemma, and
believes that the NBU's current stabilization measures can only be a
short-term remedy to reestablish confidence and prepare the economy,
and society as a whole, for what needs to come next: namely more
exchange rate flexibility and managed further depreciation.
Allowing the hryvnia to depreciate may become very difficult, both
politically and psychologically, for Ukraine. End comment.


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