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Cablegate: Ukrainian Currency in Slide

VZCZCXRO0217
OO RUEHIK RUEHLN RUEHPOD RUEHVK RUEHYG
DE RUEHKV #1995/01 2811248
ZNR UUUUU ZZH
O 071248Z OCT 08
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC IMMEDIATE 6483
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUCNCIS/CIS COLLECTIVE
RUEHZG/NATO EU COLLECTIVE

UNCLAS SECTION 01 OF 02 KYIV 001995

SENSITIVE
SIPDIS

DEPT FOR EUR/UMB, EB/OMA
TREASURY PLEASE PASS TO TTORGERSON

E.O. 12958: N/A
TAGS: EFIN ECON XH UP
SUBJECT: UKRAINIAN CURRENCY IN SLIDE

REF: KYIV 1959

SENSITIVE BUT UNCLASSIFIED, NOT FOR INTERNET DISTRIBUTION

1. (SBU) Summary: Ukraine's external vulnerabilities - including a
substantial slowdown in capital flows, worsening terms of trade, and
a large current account deficit (reftel) - have caught up with the
economy, leading to a swift hryvnia (UAH) depreciation in recent
days. Although the National Bank of Ukraine (NBU) surprised
observers with a token effort to stabilize the situation, it appears
the government has not taken any coordinated steps to respond to the
broader economic causes of the currency slide. End Summary.

2. (SBU) Since June 2008, the NBU's official policy has been to
maintain a midpoint-based exchange rate. Set at 4.85 UAH per
dollar, with 4 percent flexibility in either direction (4.65-5.05),
the currency is, in theory, allowed to move within a fixed range.
In practice, however, market forces have pushed the currency's value
beyond the prescribed deviation. Last summer, for example, the UAH
appreciated below 4.65, and in recent weeks it has traded above 5.05
UAH at Kyiv exchange kiosks. (Note: On October 7, Kyiv vendors are
selling dollars for as much as 5.39 UAH. End Note.)

3. (SBU) As the currency has depreciated, embassy contacts and news
reports stated that the NBU would not intervene under any
circumstances. Then, on October 3, the National Bank announced it
had sold $342 million in reserves at the rate of 5.0 UAH to the
dollar, in order to stave off speculation and change the
"psychology" of the market. Bankers now say the intervention did
little to reverse the UAH slide and raised more questions about the
competence of NBU policymakers. In response to criticism, NBU
Council Chairman Petro Poroshenko stated unequivocally that the
National Bank would not engage in further currency intervention to
support the hryvnia. However, representatives from the arguably
more powerful NBU Board have been largely silent.

4. (SBU) Ukrainian consumers are subject to the risks of further
UAH depreciation, because many have taken on debt in UAH fixed to
the dollar exchange rate. This is also the case for corporate
borrowers whose loans in foreign currency (through syndicated loans,
Eurobonds, etc.) are repaid from UAH revenues. As the dollar
appreciates relative to the UAH, repayment schedules become more
expensive. These borrowers may soon face problems meeting loan
obligations, and banks that made loans for cars, vacations, and home
mortgages will also be in jeopardy, especially if defaults on
devalued assets occur in appreciating currencies. In addition,
Western banks (holding roughly 70% of the country's external banking
debt) remain focused on their home markets and liquidity of their
parent banks. One financier suggested that, other than funds to
roll over maturing foreign debt, little new capital is likely to
flow into Ukraine; rather, the trend could be in the opposite
direction.

5. (SBU) Ukrainian Finance Minister Viktor Pynzenyk recently
acknowledged concerns about the effects of financial volatility on
the Ukrainian economy. His was one of the first public statements
on the "crisis" uttered by a ranking government official. More
typically, however, bureaucrats, politicians, and the general public
exhibit a lack of interest or capacity to deal with the emerging
problems. One observer noted that the situation is worse than
"heads in the sand," since no one, perhaps outside of Pynzenyk, acts
as if there were an impending emergency. Another commented that
only three people - NBU Governor Volodymyr Stelmakh, Prime Minister
Yulia Timoshenko, and President Viktor Yushchenko - have the
wherewithal to pull needed economic levers, but a lack of
coordination among them has stalled any relief. In addition to not
addressing the broader causes of a currency slide, the NBU has been
silent on how to deal with bank solvency. Furthermore, the collapse
of the governing coalition in parliament (Verhovna Rada) has made
coordinating economic policy more difficult.

6. (SBU) Comment. A real devaluation of the hryvnia is needed.
Ukraine's real exchange rate may not have been overvalued before the
global economy fell apart, but mounting external vulnerabilities,
exacerbated by the worldwide financial crisis, are now forcing the
UAH downwards. It remains unclear whether the National Bank will
attempt to further defend the exchange rate corridor at its current
level, given the NBU's intervention of the past week. More prudent
policy might argue for saving the NBU's $37 billion in reserves for
bank bailouts or as a shock absorber for future economic needs.

7. (SBU) Should the NBU allow the UAH to stay outside its
established corridor, depreciation would have different affects on
various stakeholders in the economy. Exporters, like Ukrainian
steelmakers who complained recently about their lack of
competitiveness at current global commodity prices, should benefit
if inflation is controlled. Other Ukrainians, especially local

KYIV 00001995 002 OF 002


bankers, importers, and those holding highly exposed or hard
currency-linked loans, will likely not find UAH depreciation so
palatable. End Comment.

TAYLOR

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