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Cablegate: Ukrainian National Bank Imposes Capital Controls

VZCZCXRO5356
OO RUEHIK RUEHLN RUEHPOD RUEHVK RUEHYG
DE RUEHKV #2030/01 2881439
ZNR UUUUU ZZH
O 141439Z OCT 08
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC IMMEDIATE 6530
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 002030

SENSITIVE
SIPDIS

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

E.O. 12958: N/A
TAGS: EFIN ECON PGOV XH UP
SUBJECT: UKRAINIAN NATIONAL BANK IMPOSES CAPITAL CONTROLS

REF: A) KYIV 2028, B) KYIV 1995, C) KYIV 1959

SENSITIVE BUT UNCLASSIFIED, NOT FOR INTERNET DISTRIBUTION


1. (U) Summary. The National Bank of Ukraine (NBU), pressed to
stop a run on deposits in commercial banks, sharply tightened
capital controls on October 13. The measures effectively prevent
Ukraine's banking system, which has relied heavily on foreign
borrowing to fuel its breakneck growth in recent years, from
expanding any further in the short term. The action comes after an
estimated $3 billion, or 4% of total deposits, were withdrawn from
the banking system over the past two weeks. The October 13 measures
are the first taken by the NBU to preempt capital flight and
stabilize the country's teetering financial system. Coming just
prior to an International Monetary Fund (IMF) delegation to Ukraine,
the NBU's heavy-handed measures may prevent a meltdown in the very
short run, but they could have a severe impact on economic growth in
the medium term if not modified or replaced by more flexible
measures. End Summary.

2. (U) The NBU's Resolution 319 introduces a wide range of
restrictions on the financial system that will effectively prevent
banks from expanding in the short run. Banks may only extend a new
loan when an existing loan is paid back, and they cannot expand
their loan portfolios beyond their October 13 positions. Banks are
also forbidden from releasing deposits earlier than the maturity
agreed upon when the deposit was received. In addition, banks may
not sell foreign currency to purchase imports without proof that the
imported goods or services have been delivered in Ukraine, with few
exceptions. In order to reduce the recent wild swings in the UAH
exchange rate, the NBU introduced measures aimed at limiting the
spreads between the buy and sell exchange rates quoted by banks to
five percent. Such "bid-ask spreads" had recently widened
dramatically in tandem with the mounting insecurity over the hryvnia
(Ref A and B).

3. (SBU) The harsh NBU measures, according to national bankers and
politicians, were designed to boost confidence in Ukraine's overall
financial system. First Deputy NBU Governor Anatoliy Shapovalov
pointed to the need to calm fears, since "panics are 90 percent the
result of psychological triggers." NBU Governor Volodymyr Stelmakh
and Finance Minister Viktor Pynzenyk had conducted an emergency
meeting with Ukrainian President Viktor Yushchenko to discuss
possible steps and receive blessing for NBU actions. After the
meeting, Yushchenko, himself a former bank governor, shied away from
talk of a financial crisis. Instead, he placed blame on the "weak"
budget policy of Prime Minister Timoshenko that has led to the
"challenges that have emerged."

4. (SBU) Prices on Ukraine's small and illiquid stock market fell
after the NBU's stabilization program was announced. Analysts
suggested this was primarily due to the NBU's unusual limitation on
early withdrawal of deposits. Mindful of the need to prevent a run
on banks, parliamentarians proposed their own alternative plan to
increase deposit guarantees up to $40,000. The Rada measure has
stalled, however, due to Ukraine's concurrent political crisis. The
effect of Resolution 319 on banks and the equity market was
immediate, with the PFTS stock index losing 5.5 percent over the
course of the day. In addition, S&P lowered its ratings for three
Ukrainian banks - Hadra, Alfa-Bank, and Kredobank - from "stable" to
"negative," reflecting the rise of systemic risks in the financial
sector.

5. (SBU) The International Monetary Fund has confirmed to us that
a delegation will arrive in Kyiv on October 15. IMF sources say
that a request was made in recent days by the GOU, but no official
announcement has been released. It remains unclear whether the
Ukrainians have requested a financial assistance package or
so-called "exceptional access."

6. (SBU) Comment: The NBU's resolution, coupled with major
downward pressure on the hryvnia (Ref B), are strong evidence that
the spreading global financial crisis may cause a meltdown in
Ukraine's financial sector, which had grown rapidly in recent years
on the back of foreign borrowing. Although it has targeted the
capital market to prevent further panic, Resolution 319 may also
stifle economic activity by restricting credit for investment and
debt repayment. The undifferentiated, across the board cap on
credit growth may prevent banks from financing even the most worthy
of investment projects. Import markets -- even for investment goods
needed to expand the economy -- are reportedly coming to a
standstill, because banks cannot extend hard currency for payment
until goods are imported. The NBU gave no indication how long the
new regulations will remain in force, but the rules will no doubt
need to be modified or relaxed once confidence in the financial

KYIV 00002030 002 OF 002


system is restored, so as not to put a further break on Ukraine's
economic growth. End Comment.

TAYLOR

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