The US dollar exchange rate is on a downward curve in Ukraine. It has dropped by 10 kopiykas over the past several days, jeopardizing Ukrainians’ life savings, which means that those who had $1,000 stashed away for a rainy day have lost 100 hryvnias. Most experts believe that by dropping the dollar exchange rate, the authorities, in the person of the Ukrainian government and the National Bank of Ukraine, are trying to contain inflation whose high rate threatens to reach an unseemly two digits. We should remember that this inflation upsurge is the direct result of the Ukrainian cabinet’s populist social policy as well as of prospective investors’ fears that economic growth is slowing down and irresponsible polemics around reprivatization. Judging by the cabinet’s ratings, everything happening in this country impresses Ukraine’s most impoverished strata. The middle class (the principle holders of dollar savings) is financing the government’s growing ratings through revaluation. However, in addition to this political commotion, the situation on the foreign exchange market is shedding light on a number of long-standing problems, namely the National Bank’s independence and the absence of an economic political strategy.
Meanwhile, Prime Minister Yulia Tymoshenko states without any hesitation: “Today there is every reason to believe and predict that the exchange rate will remain stable.” She further claims that all decisions concerning the national currency have been made by the National Bank only: “Therefore, like all citizens of Ukraine, this government is a consumer with regard to the National Bank’s policies. As for the hryvnia exchange rate, it is largely formed by the market.” Yet we know that the press service of the Ministry of Economy issued a press release on Monday, August 29, quoting finance minister Serhiy Teriokhyn’s statement that “the NBU’s attempts to keep the hryvnia exchange rate impervious to revaluation may trigger off inflation.” The minister openly accused the National Bank of refusing to cooperate. Experts regard this as an obvious attempt to curb the central bank’s constitutionally established independence. “Regardless of repeated messages from the Ministry of Finance, the NBU persists in refusing substantial cooperation in the preparation of prognosticative and program documents, and it regards these documents as ones being executed exclusively by the government.”
Meanwhile, Valeriy Lytvytsky, head of a group of NBU consultants, believes that the current exchange rate strategy cannot be regarded as a panacea against inflation. When interviewed by The Day, he quoted figures confirming that the government is indeed pressuring for an inflation rate. He stated that, under the circumstances, the Ukrainian cabinet’s anti-inflation priorities boil down to increasing the economic growth rate and providing for an adequate commodity market demand. So far, statistics show that there is a sharp GDP decline (compared to last year’s indices), which may be regarded as a major result of the current government’s unbalanced performance. This could be why the Ministry of Economy hastened to publicize the minister’s statement. Indeed, in this situation they should have remained silent. The past six months show that the more information the ministry makes public, the worse the situation with the meat, oil, and sugar markets. Thus, it is difficult to dispute my claims that the NBU is practically being denied the right to wage its own independent policy in its own sphere of activities.
It is important to reassure public opinion in connection with current shifts in the foreign exchange policy. By this I mean liberalization and the changeover from the policy of a stable hryvnia exchange rate, its official (moderate) revaluation, to a floating exchange rate and its market regulation. Naturally, here the point is about principled innovation, which affects the interests not only of market operators but also practically every citizen of Ukraine — all of Ukrainian society. There are increased foreign exchange risks. This fact is apparent to everyone. Yet, there are also objective processes involved, which cannot be overlooked. All we can count on, under the circumstances, is the NBU people’s professionalism and their ability to make qualified decisions. Here it is especially important to uphold public confidence in the National Bank. Its functional independence must be secured in deeds, not in words. No one has the right to meddle in its functions, as set forth in the Constitution of Ukraine. There should be no exceptions to the law. I am also convinced that a number of problems that concern the current foreign exchange market situation and which are alarming our society are largely connected to precisely such meddling. This practice, which did not exist earlier, must end.
DEVALUATION
It is crucial to understand that the problem of overcoming the crisis that developed during the years of transformation, especially during the world financial crisis (1997-98), and the artificial devaluation of the national currency and its purchasing capacity, is not of recent vintage. It is a problem that has been repeatedly debated, not just by experts but also officially, during NBU board meetings. The year 2002 saw the launch of a balanced revaluation policy (1.5-2% per annum). However, this policy is now being called into question. Now they are looking for more effective mechanisms to solve their financial problems. This is only natural. Let me stress that we are faced with the pressing problem of strengthening the hryvnia exchange rate, and that this problem must be made public knowledge. What is this problem all about?
It is important to inform our public that there is an annual IMF index used to juxtapose the purchasing capacities of various currencies to establish purchasing power parity. These calculations are based on standard domestic and international standard goods and service costs, generally known as the consumer basket. According to the IMF’s World Economic Outlook Database of April 2005, Ukraine’s per capita GDP amounted to $1,366, and was worth $6,554 as per the purchasing power parity (PPP). The difference between the above sums — 4.8 times — is rather substantial. Thus, one can speak about the undervaluation of the hryvnia’s purchasing capacity at this exchange rate.
In 2004 Ireland was the only country whose exchange rate was on the parity level (1.0). The United States registered 0.86; Japan, 0.85, and so on. Naturally, this index was higher in less advanced countries.
The Czech Republic registers 1.75; 1.96 in Poland, 2.09 in Lithuania, 2.87 in Romania, 3.46 in Bulgaria, and 2.49 in Russia. By comparing these indices, one can very tentatively conclude that the hryvnia’s purchasing capacity in 2004 was 1.9 times lower than that of the Russian ruble, and 2.45 times that of the Polish zloty. Let me remind you that we are talking about calculations taken from official IMF data. The process of the hryvnia’s devaluation can be traced in a simpler way; through the dynamics of its official exchange rate: UAH/USD 1.89 in 1996; 3.42 in 1998; 5.44 in 2000; 5.31 in 2004, and 5.05 this year. Obviously, in 1996-2000 the hryvnia’s foreign exchange position weakened by 2.9 times, but then it stabilized and began to gain momentum. However, the difference between its current and 1996 rate remains significant.
What is the practical aspect of the problem and why does it require attention? There are several important aspects to consider. The devaluation of the hryvnia has an adverse effect primarily on Ukraine’s international image (add here the attendant political aspect). In 2004 Ukraine’s GDP, calculated according to the official exchange rate, amounted to $65 billion — and to $312 as per PPP. Adequate in this sense are the differences in the basic international per capita index, the GDP. One could also discuss the possibility of artificially understating the real per capita income. At present, the average monthly wage in Ukraine (as of 07.01.05) amounts to UAH 823.1, the equivalent of $163.00 according to the current exchange rate, compared to 1996’s $436.00. Another dangerous aspect here is the devaluation of this country’s financial and production assets, which provides artificial advantages for overseas capital. This is especially unwelcome at the stage of privatization of strategic entities, launched several years ago. Here is an example. Given the current hryvnia exchange rate, an enterprise offered for sale and worth UAH 10 billion will cost a foreign buyer $1,980,000,000 whereas at the 1996 exchange rate it would have been $5,291,000,000. There is much to ponder here.
Another aspect of the problem must be grasped. The hryvnia’s reduced hard currency value provides for inadequate cost preferences in export-oriented industries, and the bulk of net profit goes to pertinent enterprises. The steadily worsening structural deformity of Ukraine’s economy is due primarily to this circumstance. Whereas in 1993 the GDP export share stood at 26%, in 2004 it was over 60%. Accordingly, the domestic market potential dropped from 74 to 40% GDP. Russia, in contrast, registers 77% of the GDP and Poland, 74%. Here, we have long surpassed the admissible limit. At present, the Ukrainian economy largely depends on the world market situation and thus cannot be considered stable. In addition to everything stated above, strengthening the hryvnia’s foreign exchange position is important in the overall plan of reducing critical import, particularly energy supplies, machinery, and equipment used in domestic technological re-equipment projects. Efforts must also be made to reduce the public debt servicing costs and to use the exchange rate as a factor in lowering domestic inflation.
While deliberating the points at issue, I have tried to convince the reader about an extraordinarily significant point. I believe that the formulation of the question concerning the strengthening of the national currency’s foreign exchange stand is not an invention that sprang from the head of NBU chief Volodymyr Stelmakh or any other officials. What we are faced with is a strategic problem relating to the Ukrainian economy. What mechanism should be applied to solve it, and the timeframe for it, is another matter altogether. In my opinion, collisions within public opinion primarily concern this very aspect.
MECHANISMS
Suppose I start by stating the banal truth that any changes in foreign exchange policy should be considered in the context of an overall strategy of economic progress. We have two crucial options here: (a) a tangible increase in the competitiveness of the domestic economy (we placed 86th on a list of 104 countries), and (b) quick GDP growth (at 8-9%). Our current GDP rate amounts to $65 billion, compared to $107 billion in the small Czech Republic and $242 billion in Poland. Thus, under any conditions the NBU’s foreign exchange policy must be subordinated to implementing this two-pronged task. However, when it comes to the policy of revaluation, fundamental collisions emerge, which are difficult to resolve. The point is that global competition forces all countries, including the United States, to seek to protect their domestic markets and to support their export potential by means of mechanisms aimed at lowering, rather than raising, the national currency rate. This is exactly what is happening in Ukraine. We are faced with hardships, but so is the world money market; this is largely due to the purposeful policy of devaluating the US dollar. Its impact on the real economy can be understood proceeding from the following statistics. In 2004, Ukrainian commodity and services exports amounted to $38 billion. Given the annual hryvnia revaluation rate of 10%, as recommended by IMF experts, reducing Ukraine’s export position would amount to $3.8 billion. The GDP, exporters’ revenues, production output, and other rates would drop accordingly.
Another aspect of the issue is that Ukraine is planning to join the WTO this year. However, it is crucial to understand that any country joining this international body has to apply certain mechanisms for lowering the exchange value of its national currency as a protective measure to secure its economic competitiveness. Proof of this fact is the Chinese experience. The yuan’s low exchange rate had served as the basis of Chinese export expansion. Chinese-US economic disputes always focus on this problem. The yuan’s revolution in August, as reported by the press, was China’s concession to the US stand, in exchange for other preferences. Yet the yuan revaluation rate amounted to a mere 2% and did not eliminate the problem of the Chinese currency’s low exchange status (e.g., the PPP is 4.5) and active use of this factor in that country’s economic policy.
It is also important to be aware of another interesting aspect of the problem. In Ukraine, the USD exchange rate is still an inherent component of the national monetary system. Here we are faced with realities we cannot possibly overlook. According to NBU official statistics, the foreign exchange share in the national money supply was especially high as of January 1, 2005: 24.2%. Also, it is important to bear in mind the dollar savings of the population, ones kept off the bank accounts, which roughly amounts to another 25%. What we have here is an objective phenomenon of a transition economy, something that we cannot avoid reckoning with, all the more so as people who don’t bank their savings are not the wealthy stratum; for the most part, they are the middle and poor strata. Let me emphasize that, to them, this tangible revaluation represents considerable losses in terms of savings, money that was collected by literally saving every kopiyka over many years. This also means less popular confidence in the national currency, the NBU, and the government.
How can this situation be resolved? International business experience offers several effective monetary stabilization options, including perhaps the most practical one consisting of a monetary credit policy that relies on the inflation (monetary) targeting principle. Here the stability of the national currency is secured by the coordinated effort of the government and the central bank — precisely what we don’t have at the moment. This problem must be solved. An inflation targeting model, inherently combining monetary and nonmonetary instruments, may also prove sufficiently effective in Ukraine. It is sophisticated, judging by the mechanism involved, but we must work on mastering it.
At the same time, an official inflation targeting policy cannot be artificially counterposed to currency regulation mechanisms, as recommended by IMF experts. The recommendations set forth in the IMF memorandum of August 2, 2005, boil down to the following: a liberal currency (floating) exchange policy offered as a counterweight to the targeting policy, the latter aimed at sustaining a target-oriented inflation rate, using monetary instruments. Theoretically, this monetary policy model should not cause any doubts. It appears to be 100% valid. However, its principal shortcoming is that it does not allow for the specific realities of the Ukrainian economy, which cannot be possibly overlooked.
International business experience has shown that a theoretical model, one connected to foreign exchange policy, on the one hand, and to inflation targeting on the other, can be effective only in a sufficiently mature monetary system. We have not reached this stage; we have not accomplished the process of market transformations in the national monetary system; we have not secured its full adequacy to the principles of the market economy. Ukraine’s monetary system (even in the presence of certain institutional attributes) has not acquired the features of a stable market-type monetary and credit system. This is lowering the efficiency of purely monetary instruments of monetary and credit policy. I am well aware of this. However, IMF experts appear unable to comprehend this, and this is reflected in their contradictory recommendations. Meanwhile, it is clearly apparent that such purely monetary instruments of the monetary and credit policy cannot be effective in a situation where: (a) stock-market and mortgage-lending mechanisms remain practically inactive; (b) one-third of the money supply remains off bank accounts; (c) discount regulatory mechanisms are not functioning; (d) there is an excessive dollarization level, with the hryvnia only partially fulfilling the function of being a measure of value and accumulation; (e) when the level of the economy’s monetarization is optimal, and so on.
In this situation one must seek mechanisms aimed not at confrontation but the opposite, an optimal blend of inflation-targeting policy and foreign exchange regulation. We must not forget the lessons of the past years, with their numerous miscalculations in the monetary and credit policy, especially the economic crisis, which is explained, among other reasons, by the situation and our lack of critical perception in dealing with recommendations that often failed to reckon with our specific realities. We must move along the revaluation trajectory — I have often tried to prove that this is our objective reality — slowly but surely, taking one step at a time, stage by stage, by resolving accumulated problems.
As for the liberalization idea, which I personally advocate, here the correct approach would seem to consist of liberalizing the foreign exchange market in the first place (this is being done), capital flow, by gradually effecting a policy of a controllable floating exchange rate, while ensuring that the NBU is always actively involved in the money market and also upholding the policy of accumulating the NBU reserves, one of the major factors of ensuring Ukraine’s economic security. It is necessary to conduct a search for an optimal combination of these components. I am convinced that this truth is well known to the leadership of the National Bank. In general, I think that, given all the complexities of the current year (including the government’s present uncontrollable populism), we still have an opportunity (given an adequate central policy) of keeping the monetary situation under control. Nor should inflation expectations be overstated. This is dangerous. Considering this year’s favorable agricultural indices, customs import preferences in the consumer market, and specifically the rigid monetary policy — measures being taken in regard to the hryvnia’s revaluation and forecasts about the world’s peak oil prices (at long last) — it is possible to expect a relatively moderate upsurge of Ukraine’s inflation this fall and winter, and that its overall rate will not exceed 10-12%. This is a lot but not critical. It is important to prevent the inflation spiral from unwinding next year. We must seriously consider this threat. It is real. I proceed from the fact that what we need, a tangible decrease in the inflation rate, is the main prerequisite of not only stepping up the capital accumulation process, but also of an actual growth in per capita income. Under the circumstances, a stable hryvnia exchange rate spells 5- 6% annual inflation (compared to the 2% ceiling in the EU countries). This corresponds to the average annual statistics from 2001 to 2003. We must work hard on this now as well, but certainly keep in mind our current realities. Without a doubt, enhancing the hryvnia’s exchange rate is an important instrument of counterinflation policy, as discussed above. Yet its implementation must be thoroughly considered.
Finally, issues relating to a reliable constitutional support are gaining fundamental importance in the national monetary policy. As stated earlier, these are the NBU’s real independence and full guarantees against non-interference in its affairs on all levels. This includes renewing the work of the NBU Council, which under the Constitution of Ukraine is vested with exclusive rights to determine monetary policy and a number of other fundamental powers that are not being implemented. Finally, this includes making a number of legislative decisions in the monetary and credit domain, especially the draft Law of Ukraine “On Foreign Exchange Regulation.” It is shameful even to admit that no such law exists. These are hardly minor issues. They are interrelated, and together they serve to create tension, something we certainly do not need today.
