Deciphering Ukraine's central bank move toward greater currency freedom

On December 1, the National Bank of Ukraine (NBU) allowed Ukrainian banks to sell dollars and euros in cash, without limiting the amount. 

Among other things, the regulator explained its decision by the need to bring cash and non-cash exchange rates closer together.

"All restrictions for banks and non-bank financial institutions on the amount of cash foreign currency they can sell to the public have been lifted," the central bank said in an explanation on its website. 

According to the NBU, this should help minimize differences between cash and non-cash exchange rates. As a result, this will lead to stabilization of exchange rate expectations and increase the stability of the foreign exchange market.

LIGA.net found out what market participants think about this and how this decision may affect the Ministry of Finance's plans for next year's budget.

Why did the National Bank lift currency restrictions for banks?

The differences between the national currency exchange rate on the interbank market and in exchange offices on the eve of the decision were indeed significant. Banks could buy dollars for their clients even cheaper than when the hryvnia was fixed at UAH 36.6/$. At the same time, the cash exchange rate in the exchangers and cash desks of the same banks was steadily holding high and refused to fall below UAH 37.2-37.4 per US dollar.

Banks routinely sold dollars to their customers' card accounts at more than UAH 37. The situation with the euro was similar.

The impression was that bankers stubbornly did not believe in the possibility of a long-term dollar exchange rate of around UAH 36 and believed that this was a one-time offer by the National Bank.

A month earlier, on October 3, the NBU announced the abolition of the fixed exchange rate and the transition to a "managed flexibility" regime.

This meant that prices could fluctuate within a certain corridor. At the same time, the NBU retained all the possibilities to control the exchange rate.

Against this backdrop, despite the general expectation that the value of currencies would rise, the opposite happened. In early November, the dollar was 40 kopeks cheaper at UAH 36.17/$. The decline caused outright surprise among experts.

"The exchange rate depends solely on the will or desire of the National Bank. Whatever it wants: it can be UAH 35 (per dollar) or even UAH 39. The regulator is playing a cunning game: there is demand for the dollar and it is not decreasing, but the exchange rate is going down. This is not a market," said Taras Kozak, a financier and investment banker, in a comment for LIGA.net.

His opinion was seconded by banker Vasyl Nevmerzhytskyi.

"The exchange rate can be UAH 35 (per dollar), or it can be, say, UAH 40 – it is manual control, not the market. The National Bank is selling a lot of dollars from its foreign exchange reserves," he told LIGA.net.

According to the NBU, in October, Ukraine's foreign exchange reserves decreased by 1.9% to $38.97 billion. The reduction continued in November.

At that time, the cash hryvnia exchange rate in systemically important banks weakened by about 0.3% to UAH 37.2-37.8/$. However, there were restrictions on sales volumes. Therefore, it was not always possible to buy currency at this rate as it could simply not be available.

There was more foreign cash in currency exchangers. However, the exchange rate was also higher at about UAH 38/$. This is despite the fact that in mid-November, the NBU's interbank exchange rate was UAH 36.26/$.

Oddly enough, the strengthening of the hryvnia coincided with the vicissitudes surrounding the return of exporters' foreign exchange earnings to the country and the seasonal trend of selling foreign currency to pay taxes in hryvnia.

Another possible reason is the need to purchase large amounts of foreign currency to import goods or equipment. In particular, for defense needs.

"The periodic large daily volumes of foreign currency purchases on the interbank market in November and early December are atypical and could have been transactions by state-owned enterprises or government agencies related to import contracts for the Defense Forces. However, this forced the NBU to keep its interventions in November quite large, reaching as much as almost $740 million per week," Taras Kotovych, Senior Financial Analyst at ICU Group, said in a comment to LIGA.net.

Among other possible reasons for strengthening the hryvnia was the regulator's desire to demonstrate that the national currency can not only depreciate but also appreciate, even in times of war. Thanks to the help of its partners, Ukraine now has perhaps the largest foreign exchange reserves in its history. Thus, the National Bank has significant opportunities to sell foreign currencies and support the exchange rate.

"The market felt that the exchange rate could move not only towards devaluation (depreciation of the hryvnia – ed.) but also revaluation (depreciation of foreign currencies – ed.), and we now have even a slight strengthening of the official exchange rate compared to the period of the fixed exchange rate. In the first 20 days of October, the cash exchange rate had little reaction to the movements of the non-cash exchange rate, which led to an increase in the exchange rate spread (the difference between the interbank and cash exchange rates – Ed.). However, since the end of October, the cash exchange rate has also started to move in the direction of strengthening, breaking through the level of UAH 38.00/$ in exchange offices," one of the NBU employees said in an interview with LIGA.net on condition of anonymity.

The central bank has no direct influence on the cash hryvnia market. It does not sell currency to the public. This is done by banks and financial companies in exchange offices.

Therefore, in order to influence banks, the regulator decided to lift the restrictions and introduced further easing in the market in early December.

"De facto, the existence of such restrictions is one of the reasons for the multiplicity of exchange rates. Therefore, by lifting them, we have reason to expect that this will allow us to keep the difference between cash and non-cash exchange rates at a minimum," NBU Governor Andriy Pyshnyy explained in his comment on the decision.

During the first ten days of December, the hryvnia was already sold to the public at UAH 37.4-37.6/$.

"Throughout November, fluctuations in the official interbank exchange rate had little impact on the retail market, both in terms of the exchange rate and the volume of foreign currency purchases and sales. However, the NBU's lifting of restrictions on the sale of foreign cash contributed to a noticeable strengthening of the cash exchange rate in early December and its maximum convergence with the rate for payment cards. At the same time, the weakening of the official exchange rate in December encouraged people to buy more cash and non-cash currency, but this may be a short-term phenomenon," says Taras Kotovych.

What hryvnia/dollar exchange rate can be expected in the future?

Anna Zolotko, director of treasury operations at Unex Bank, in a comment to the media, predicts that the general trend in the next few days and weeks will be a gradual convergence of cash and non-cash rates. This process will not be instantaneous. And it will be possible provided that the interbank market price remains stable without significant fluctuations. In her opinion, the value of dollars in the cash market may approach the psychological mark of UAH 37/$ by the end of the year.

Investment banker Tomáš Fiala said in mid-November that he believes the hryvnia's devaluation in 2024 will be much lower than the one envisaged in the 2024 budget and than some of his colleagues predict. According to his estimates, the dollar could reach UAH 37 at the end of 2023 and rise to UAH 39 by the end of 2024. Thus, in his opinion, the dollar will not rise to UAH 40/$, the rate that is set in the state budget for next year as a forecast.

On December 6, Olena Bilan, chief economist at Dragon Capital, noted that the dollar would not reach UAH 40 next year, as many analysts predict and as envisaged in the 2024 budget. Instead, it will remain at a level significantly below this bar. The average exchange rate for the year is expected to reach UAH 37.3/$, compared to UAH 36.5/$ this year.

How can the hryvnia exchange rate affect the 2024 state budget?

In September, Finance Minister Sergii Marchenko expressed concern about the strengthening of the hryvnia and said he expected the exchange rate to weaken to UAH 41.4/$. 

"We are concerned about the strengthening of the hryvnia. Next year we expect the exchange rate to be UAH 41.4/$," he said.

Commenting on the strengthening of the hryvnia, the minister stressed that "there are no fundamental factors for this". According to him, this is a disadvantage for export-oriented businesses and the country's economy in general. Marchenko added that "exports are not growing at all," while the situation with imports is the opposite.

At the same time, the official clarified that he does not advocate any sharp devaluation.

The National Bank has not publicly commented on the minister's words. However, NBU made it clear that such statements are not decisive for them in shaping their future vision of the situation with the national currency.

In the end, after all the discussions, the average exchange rate per US dollar for the year 2024 was planned at UAH 40.7/$.

The ministry's position is quite clear: the depreciation of the national currency has traditionally accelerated inflation in Ukraine. Thus, it increased the level of tax revenues to the budget. Because higher prices meant more taxes were paid, respectively. 

However, LIGA.net's sources in the central bank are convinced that the feasibility of such actions in the current environment is questionable. Because the losses for the economy and, as a result, the budget, due to the unwinding of inflation, can be even greater. Therefore, exchange rate stability, especially in times of war, is supposedly more appealing.

"Indeed, we are criticized for spending reserves to reduce exchange rate fluctuations. But in the event of a panic in the foreign exchange market and a sharp depreciation of the hryvnia, we would have spent much more reserves to stabilize the situation," the NBU said.

In addition, the hryvnia depreciation leads to an increase in the cost of servicing external borrowings, which are financed from the very same state budget.

"If the hryvnia is forcibly devalued, the budget will lose UAH 690 billion ($18.4 billion) a year due to an increase in external borrowings and the cost of servicing them. Therefore, it is actually beneficial for Ukraine to maintain this balanced exchange rate. It limits the state budget revenues from taxes to some extent, but at the same time, it allows us to save significantly on external borrowings and their servicing, and the share of these borrowings is growing. I think that the National Bank will maintain this balanced situation," stated Vitaliy Shakhtar, PhD in Economics, on the "Suspilne. Resistance" program.