Cablegate: Ukrainian Hryvnia in Freefall As Nbu Botches Policy

DE RUEHKV #2464/01 3531357
P 181357Z DEC 08




E.O. 12958: N/A


Sensitive but Unclassified. Not for Internet or Distribution
Outside the USG.

1. (SBU) Summary. A casualty of the worsening financial crisis,
Ukraine's currency has lost another 12 percent of its value in
recent days. Following an interim visit by the IMF to monitor GOU
progress in implementing the $16.4 billion Stand-By Arrangement
(SBA), the National Bank of Ukraine (NBU) has again boosted bank
liquidity contrary to common economic principles and reverted to
non-transparent foreign exchange interventions below market rates.
Its reputation as a policy arbiter has been severely damaged, while
Ukraine's national economic outlook looks gloomier by the day. End

2. (U) The UAH plummet has accelerated in mid-December, with
depreciation against the dollar drawing the interbank rate down to
9.90 UAH/$1 on December 19. The precipitous decline is leading to
more one-way bets against the hryvnia at both the retail level and
on the interbank market. Since late September, when Ukraine's
economic crisis was first broadly diagnosed, the hryvnia has lost
over half its value.

3. (SBU) The most recent slide took place despite low trading
volumes on the inter-bank currency market. In the face of growing
payment arrears and mounting debts, exporters still holding foreign
exchange appear to be trying to hold off selling dollars as long as
possible. Most are betting that volatile prices and limited dollar
availability will continue to push the hryvnia downward. At the
same time, the shrunken dollar supply has collided with sharply
increased dollar demand. Reportedly, energy monopoly Naftohaz has
been purchasing dollars as well, possibly in an attempt to settle at
least part of its outstanding gas debt to Gazprom.

4. (SBU) Deeper reasons for the UAH slide reflect the manifold
challenges that must still be overcome before Ukraine's currency
stabilizes. Most glaringly, the National Bank of Ukraine continues
to lose confidence as a result of its non-transparent and
inconsistent attempts to intervene in the foreign exchange market.
This week's currency slide began after the NBU pumped more liquidity
into the money market. A similar slide in the hryvnia occurred in
November after the NBU increased bank liquidity. In both cases, the
liquidity, far in excess of what the banking system needed, flowed
straight into dollars, further depressing the hryvnia rate. The
IMF, in its latest visit to Ukraine last week, criticized the NBU
actions in November, arguing that the NBU needed to tighten
liquidity in order to support the hryvnia, and it left the country
thinking that it had NBU assurances for the same. However, the NBU
reverted to its former practices after the IMF departed, providing
significant longer-term liquidity to selected banks according to
criteria that were not publicly disclosed and not readily understood
by the market. This week, the NBU again sold dollars to selected
buyers at far below market rates, and it conducted another currency
auction on December 17 that, according to market participants, was
not fully transparent, as several banks reportedly claimed that
their bids had been excluded for reasons that the NBU would not
specify. At a recent press conference, NBU Governor Volodymyr
Stelmakh and Finance Minister Viktor Pynzenyk said interest rates
would rise and liquidity would be curtailed, yet they gave
conflicting statements on the nature and extent of planned rate
hikes. We understand that the IMF is intending to write to the NBU
and MOF to drive home the message that liquidity needs to be
tightened, that interventions must be made more transparent and
consistent, and that progress needs to be made on bank

5. (SBU) The NBU's actions raise more questions about governance,
corruption, and behind-the-scenes deal-making. Major television
programs are addressing the NBU's lack of capacity to handle the
crisis as their number one news item. Business daily Profile has
advertised its current edition on billboards across Kyiv by
brandishing a picture of NBU Governor Volodymyr Stelmakh in a pose
of dramatic shame. There is also a pervasive lack of trust in the
banking sector. Raiffaisen Bank Aval, the country's second largest
bank with an Austrian bank as its majority shareholder, has resorted
to building-sized advertisements in central Kyiv, marketing high
interest rates to bolster deposits and reign in withdrawals.
Businesses and workers report to us, however, that Raiffaisen has
held wage and other corporate payments for two or more weeks before
transferring money to accounts. ING Bank has pressed orange clad
teens into service, canvassing passers-by with offers of special
deals for term accounts. We hear anecdotally that ordinary
Ukrainians are withdrawing hryvnia deposits from subsidiaries of
foreign banks, such as ING, in order to convert savings into
dollars. The lack of available safe deposit boxes does not deter

KYIV 00002464 002 OF 002

most Ukrainians, who have a tradition of storing wealth under
mattresses or beneath loose floor boards.

6. (U) Ukraine's economic crisis is getting very bad very quickly.
The government reported a 14.4 percent month-on-month drop in GDP
(from October to November), and a cumulative 2008 GDP decline from
5.8 percent (in January-October) to 3.6 percent (in
January-November), reducing the overall GDP forecast for the year.
The largest sector-based declines were registered in construction
and energy (falling 16.1 percent and 3.6 percent, respectively, in
January-November). Industrial production contracted 28.6 percent
year-on-year in November (in October the decline constituted 20
percent). The steep fall in domestic and external demand, due to
the plunging global commodity prices, sharp economic slowdown in
major trading partners and frozen credit activity, has caused a
severe contraction in all industries. The largest output fall in
November was registered in export-oriented sectors, such as
metallurgy, machine building and chemicals (declining 48.8 percent,
38.8 percent, and 35.2 percent year-on-year respectively).

7. (SBU) There are growing concerns about the sufficiency of the
IMF program to plug Ukraine's 2009 financing gap. The Ukrainian
government announced that external debt grew to $107 billion at the
end of the third quarter of 2008. This figure could increase, if
rating declines trigger technical defaults or loan calls with
sovereign guarantees. In a December 16 discussion with us, the
EBRD's Piroska Nagy said many foreign parent banks would fail to
roll over debts owed by subsidiaries, contrary to a key IMF
supposition in its SBA, and questioned whether the IMF's projected
financing gap for 2009 of somewhat more than $10 billion is still
accurate. According to Deputy Prime Minister Grigoriy Nemyria, who
spoke with the Ambassador on December 17, Prime Minister Yulia
Tymoshenko reportedly reached out to IMF Managing Director Dominique
Strauss-Kahn on December 17 to discuss the IMF program in light of
the worsening economic situation.

8. (SBU) Comment. Tied up in knots over policies that have all
gone wrong, the NBU is failing to take the most rudimentary steps to
reestablish trust in the hryvnia. The IMF is likewise stuck with
more than its reputation on the line. The first $4.5 billion
tranche has already been disbursed and roughly $12 billion awaits
GOU action on key fiscal policy and banking sector reforms. IMF
officials recognize they tread a thin line. After speaking softly
to journalists about the GOU's unsteady implementation of
conditionalities last week, the IMF's Ceyla Pazarbasioglu privately
expressed deep concerns about the deteriorating economic situation
and poor policy making at the National Bank and the Ministry of
Finance. Yet the IMF's overall criticism of the NBU policy response
has remained mild. Despite perceived risks to market confidence,
the IMF will likely need to come down harder on Ukraine to maintain
credibility and increase the chance that its conditionalities will
be fulfilled. Otherwise, were the next IMF tranche not disbursed,
Ukraine will undoubtedly fail to meet external commitments, greatly
increasing the odds of a true country-wide meltdown. End comment.


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