Strengthening the hryvnia: risks and opportunities


Throughout 2019, the Ukrainian hryvnia has hit a record high. None of the experts, who gave forecasts of the hryvnia exchange rate for the last year, failed to anticipate in advance that the course will be strengthened so significantly. Neither business nor citizens were prepared for this situation and suffered losses. However, the state was also unable to predict the hryvnia exchange rate and adequately reflect this in key macroeconomic forecasts, which led to problems with the implementation of the state budget. It seems that in 2020 the situation is repeated.

The Ukrainian economy has experienced the hryvnia devaluation several times. Last year, everything was the opposite – the hryvnia strengthened. The official exchange rate of the dollar against the hryvnia , which is set daily by the National Bank of Ukraine, decreased by 14.5% in January-December 2019. According to the NBU, the rate decreased from UAH 27.69 / dollar as of December 29, 2018 to UAH 23.69 / dollar as of December 28, 2019. The annual average amounted to 25.85 UAH / USD,while rate of 29.4 UAH / USD was initially laid (later it became 28.2)

At the same time, most economic agents in the country were dissatisfied with the strengthening of the hryvnia. What is the reason for dissatisfaction? For business, stability and predictability are clearly better, as one must clearly understand what figures to put into the business plan.  Considering that there is a market exchange rate formation in Ukraine, currency fluctuations are natural phenomena. But it should be in the range of 5-10%, then it is a normal reflection of changes in the market. And when the course is strengthened by almost 15-20%, then something goes wrong.

Exporters, who had “costs of 27 and incomes of 23”, and importers who, on the contrary, “imported at 27 and were forced to sell at 23”, were affected because other importers were buying at a lower rate and the same goods should be cheaper.

The vast majority of the population also felt the strengthening of the hryvnia. This is especially  sensitive for those who have incomes linked to foreign currency. In addition, it is becoming less attractive for workers to transfer money to Ukraine. According to the NBU, in January-November 2019, these transfers reached $ 11.7 billion, which is 12.5% ​​more than in January-November 2018, in currency terms, but 4.4% less – in UAH. Under these conditions, a new trend is formed, when it becomes more profitable to transfer products rather than money. Moreover, in neighboring Poland many goods are already priced lower than in Ukraine.

Another downside of the revaluation is the increase in consumption of imported goods, leading to an increase in the negative balance of trade in 2019 above the planned volume – up to $ 13-14 billion.

The state budget for 2019 has not received 35 billion UAH of revenues. One of the key factors in this was the strengthening of the currency. In particular, according to the Ministry of Finance, the revaluation of the hryvnia brought down VAT revenues from imports to 87.6% of the plan.

In fact, the situation is repeated in 2020. According to calculations of the Accounting Chamber, due to the shortcomings of macroeconomic forecasting (hryvnia exchange rate), deficits to the state budget in January amounted to UAH 2.3 billion.

The strengthening of the hryvnia was not actually caused by positive systemic changes in the economy. It was caused by  the occasional favorable conditions – low prices for energy resources in the world market, a good grain harvest in Ukraine and an influx of  speculative capital.

More than four billion dollars were brought by T-bills (according to the NBU, T-bills in the hands of non-residents increased from UAH 6.35 billion (on 28.12.18) to 117.72 billion UAH (on 28.12.19). Ukraine is a very small country with a very narrow currency marke.  And against this background, direct investment to Ukraine was just over two billion dollars at the end of the year ($ 1.7 billion in the first three quarters of 2019.) Speculative capital went up twice as much than investments that add value.

If a country produces a product, then its exports will grow, and the currency will strengthen accordingly. In the case of Ukraine, a lot of speculative capital has emerged, believing that some day the direct investments will come to the country, which will be exported and will  support the hryvnia in 2020-21. Speculative capital has gone in and direct investments have not gone. The hryvnia strengthened, and the holders of T-bills earned on it. For example, if they purchased T-bills at 19% per annum in early 2019, their income for the year was 34% – 19% on T-bills and 15% on hryvnia appreciation.

The artificial monetary factors of strengthening the hryvnia should include the NBU policy – the policy of high interest rates, which was aimed at stabilizing the excess money supply. The NBU, in fact, did not issue liquidity from the banking system to the lending sector. NBU did this with the help of such a monetary instrument as a certificate of deposit – it sold it to banks and thus linked excess liquidity. An artificial shortage of hryvnia was created in the market. On the other hand, the Ministry  of Finance with the help of government bonds almost completely took all resources from the capital market. A currency surplus was created in the domestic market. On the one hand, there is a deficit of the hryvnia, on the other, a surplus of the currency. These two trends have created a trend towards hryvnia strengthening.

The hryvnia’s positions were also strengthened by the fact that in the last quarter of 2019, many private companies (ILTA, Nova Poshta, Ukreximbank, Metinvest, Kernel, DTEK) and the municipalities of Kharkiv and Lviv successfully restructured their debts or placed new ones, which helped to improve their financial condition .

However, the strengthening of the hryvnia had some positive aspects. The National Bank reported that due to the strengthening of the hryvnia, inflation slowed down by 2019 to 4.1%.

In addition, the positive features of the revaluation are that the wages of Ukrainians will become higher in dollars (the National Bank says that after the hryvnia has strengthened, it is interesting for workers to return, as the difference between wages has decreased).

The strengthening of the national currency leads to a decrease in the cost of servicing debt, part of which is denominated in US dollars and euros.

Exchange rate in 2020

The hryvnia exchange rate in 2020 will continue to depend on the policies of the NBU and the Ministry of Finance, investor activity, as well as the situation in global markets, where the risks of the economic crisis still persist.

External factors include the situation with the expected global financial crisis. It should be noted here that the likelihood of this crisis, compared with that predicted at the beginning of 2019, has significantly decreased. The second point is the Fed’s policy. If the policy of lowering interest rates continues, this will lead to an even greater outflow of capital to the market of states that are developing. Including – to Ukraine. This will strengthen the hryvnia rates – to decrease.

The main factors influencing the hryvnia exchange rate will be:

➡️ export volume and world prices for basic goods;

➡️ volume of imports, especially energy carriers (natural gas);

➡️ gas transit volume;

➡️ the amount of funds transferred by migrants  and foreign investment;

➡️ operations of the Ministry of Finance on bonds of internal and external state loans;

➡️ monetary policy of the NBU regarding the level of the discount rate during 2020.

After the earnings that portfolio investors received in 2019, they will continue to enter the government bonds market. The flow of foreign direct investment into production may also increase. Ukraine looks relatively good. There have been double elections, there should be no crises, so, probably, no revolution is planned, from time to time there are changes in the government and the National Bank. Politically and economically, the situation looks relatively stable. T he land law may be passed. The situation with the IMF is a bit more complicated, but there are no significant risks yet. Therefore, there is no landslide trend that after the hryvnia will strengthen tomorrow will turn around and the rate will be under 40-60.

But it is likely that the National Bank, after serving a negative on its policy, will not allow strong strengthening. However, if there is a flow of currency, the NBU will not buy currency from the market until the hryvnia weakens. In the future, there will be less aggressive strengthening of the currency. The fact is that no one could have predicted the arrival of portfolio investors in such volumes.