UKRAINE: HRYVNIA CONTINUES ITS SLIDE AS

UNCLAS SECTION 01 OF 02 KYIV 002141 SENSITIVE SIPDIS DEPT FOR EUR, EUR/UMB, EEB/OMA TREASURY FOR TTORGERSON E.O. 12958: N/A TAGS: EFIN PGOV PREL ECON ETRD XH UP SUBJECT: UKRAINE: HRYVNIA CONTINUES ITS SLIDE AS EXPECTATIONS OF FURTHER DEVALUATION GROW REF: A. KYIV 2039 AND PREVIOUS ¶B. KYIV 2030 Sensitive But Unclassified. Not For Internet Distribution. Summary -------------- ¶1. (SBU) The hryvnia continues its slide against the dollar, having crossed the psychologically important barrier of 6 UAH/$ on October 24-25. It appears that demand for dollars by ordinary Ukrainians, fearful of further devaluation and inflation, is beginning to drive movements in the market, a trend acknowledged by the National Bank of Ukraine (NBU). Companies are also adapting their behavior in anticipation of further drops in the currency: some retailers are reviving the practice of indexing their prices to the dollar, and exporters are reportedly becoming increasingly reluctant to cash in dollar revenues for hryvnia. The NBU has openly threatened to force exporters to turn over dollar receipts, but otherwise is standing on the sidelines as the currency slides. The hryvnia's sudden and sharp turn of fortune is bound to damage the Ukrainians' fledging and fragile trust in their currency. Whether the damage can be contained will depend on how swiftly, and effectively, the NBU and GOU implement an expected IMF support package. End comment. Hryvnia Crosses Psychologically Important Barrier -------------- -------------- ¶2. (SBU) The hryvnia continued its slide against the dollar on October 24 and 25. Retail kiosks around central Kyiv were buying dollars at the rate of roughly 6.1 UAH/$, and selling at about 6.3 UAH/$. Late on October 24 banks were also seeking to buy dollars above 6 UAH/$ on the interbank market, marking the first time in the current crisis that the exchange rate closed above this important psychological barrier. The hryvnia had reached its peak at 4.63 UAH/$ in late June, and only a week ago was trading at 5.34 UAH/$. "Tail Wags the Dog" -------------- ¶3. (SBU) Various sources are telling us that demand for cash dollars by ordinary Ukrainian citizens is beginning to drive the market. In normal times, the well-regulated street kiosks, most of which are operated by banks, set their rates in accordance with developments on the interbank market. It now appears that "the tail is beginning to wag the dog," as one commentator put it, with Ukrainians increasingly seeking to move into dollar cash as fear of further devaluation, possible bank failures, and a renewed surge in inflation mounts. Anatoliy Shapovalov, deputy governor of the NBU, admitted as much in an October 24 statement to the media, claiming that the market was now being driven by panic within the population. Consumers and Companies Position For Further Devaluation -------------- -------------- ¶4. (SBU) Anecdotal evidence suggests that growing numbers of Ukrainian businesses and households are expecting further devaluation and adapting their behavior accordingly. We have heard that some retailers are indexing prices for higher-end consumer goods to the dollar, with the customer paying in hryvnia at whatever exchange rate is in the market at the time of the purchase. This practice, widespread in the 1990s and still common for real estate and automobile transactions, had virtually disappeared in other retail sectors in recent years as the exchange rate remained stable and confidence in the hryvnia grew. We have also heard numerous reports that exporters are increasingly keeping dollar receipts rather than converting them to hryvnia. One commentator told the media that the practice has increased dramatically since October 13, when the NBU adopted its Resolution 319 limiting the ability of companies to transfer foreign currency abroad (ref B). The NBU's Shapovalov openly threatened to re-introduce regulations forcing exporters to turn over foreign currency receipts if the practice continues. Such NBU action would be "an extreme measure," Shapovalov acknowledged, but added that it might become necessary if the situation on the foreign exchange market worsened. NBU Stands Aside and Hopes for Swift IMF Action KYIV 00002141 002 OF 002 -------------- -- ¶5. (SBU) The NBU is looking increasingly reticent to step in and influence the foreign exchange markets. It continues to intervene, but only in a negligible manner, selling small amounts of dollars at exchange rates far below where the markets are trading. Many commentators are questioning why the NBU is essentially giving away dollars to a lucky few buyers who ostensibly plan to use them to purchase imports, but who could just as easily resell them on the interbank market for an instant and riskless profit. Most believe the NBU is trying, increasingly without success, to portray some semblance of being an active player in the markets. Changing its policy and selling at current market rates could even put further pressure on the hryvnia, some speculate, as the market might interpret such NBU behavior as a sign that the central bank expects the hryvnia to drop even further. Shapovalov told the media that the NBU had sold $2.777 billion since the beginning of October to prop up the hryvnia. Comment -------------- ¶6. (SBU) The NBU's actions continue to lag behind the market, and commentators are increasingly questioning whether the central bank even has a strategy to deal with the currency's slide. Many think it does not, but the local IMF rep told us on October 25 (septel) that the NBU is the only actor in the Ukrainian public sphere actually doing anything at the moment. Most likely, the NBU is buying time and hoping that an IMF deal will be struck soon and reestablish confidence in the hryvnia before more severe controls on currency movements and bank deposits become necessary. ¶7. (SBU) In any case the sharp turn of fortune of the hryvnia will have a longer term impact on how Ukrainians view their currency. In recent years trust in the currency had grown slowly yet consistently on the back of a stable exchange rate and growing nominal hryvnia-based incomes. Ukrainian citizens and companies were growing increasingly comfortable using the hryvnia as a store of value, as evidenced by the rapid growth in bank deposits from very low levels in recent years, and by the fact that indexing prices had become less common. The current sudden shifts in behavior suggest that such fledging trust has already been damaged, and that it will take time for faith in the currency to return. Just how long, will depend on how quickly and effectively the NBU and government use an IMF package to reestablish stability in the economy. End comment. TAYLOR