UKRAINE: DOLLAR AUCTIONS TO OFFSET FALLING HRYVNIA

UNCLAS KYIV 002340 SENSITIVE SIPDIS DEPT FOR EUR/UMB, EEB/OMA TREASURY PASS TO TTORGERSON E.O. 12958: N/A TAGS: EFIN ECON ETRD PREL PGOV XH UP SUBJECT: UKRAINE: DOLLAR AUCTIONS TO OFFSET FALLING HRYVNIA REF: A) KYIV 2224; B) KYIV 2303 SENSITIVE BUT UNCLASSIFIED, NOT FOR INTERNET DISTRIBUTION ¶1. (SBU) The hryvnia traded around 6.7/$ on the interbank market on November 26, down roughly 3 percent from the previous day and falling from 6.0/$ a week ago. On Kyiv streets, dollar bids started around 6.65/$ with offers topping 7.0/$. Speculation about a developing black market filtered into the local press; these rumors were repeated anecdotally to Econoffs but have not yet been verified. At the retail level, many banks and kiosks have either refused to sell dollars or only with significant markups to advertised rates in the form of processing fees. ¶2. (SBU) Overall, the hryvnia lost 35 percent of its value over the last two months. After spiking around 7.0/$ on October 29, the currency stabilized near 5.8/$ during the first three weeks in November, when the National Bank announced it would sell unlimited dollars from its foreign exchange reserves (ref A). However, implementation of this policy has been piecemeal, and the NBU has repeatedly failed to fill all orders for dollars. As the NBU gradually backed away from this policy, it began implementing an auction system with the support of IMF advisors. Nonetheless, demand for dollars by both companies and the broader population has remained ferocious. Information last week about unfilled dollar requests prompted new fears of a dollar shortage, undermining recent stability and causing the hryvnia to fall again. The declines increased this week when the NBU reportedly did not sell any dollars for several days. The NBU last announced its reserves as of October 31, when they stood at roughly $31.9 billion. It is widely assumed, however, the reserves have dropped substantially in the weeks since the last announcement. ¶3. (SBU) Chairman Oleh Dubyna of Ukraine's national oil and gas company NaftoHaz underlined concerns about a jump in the exchange rate and a concomitant dollar shortage. Stating that NaftoHaz had placed 600 million hryvnia on the exchange without any buyers, Dubyna stressed the need to purchase foreign currency to pay for gas imports, especially at a time when the company was facing complications making payments. NaftoHaz needs dollars to settle a significant outstanding debt to Gazprom (ref B). ¶4. (SBU) In a November 25 press conference, NBU Governor Volodymyr Stelmakh called the latest developments on the foreign exchange market public panic and speculation. In order to slow demand for dollars, he announced the creation of a modified auction system for foreign currency, inviting bids from commercial banks for a minimum of $100,000. The auction system will take place overnight, with banks pre-paying hryvnia and then waiting until the following day without a guarantee that the NBU will actually sell them dollars. Speculation is that this new scheme will disrupt banking operations, heighten market uncertainty and, like previous NBU programs for intervening in the market, remain non-transparent. ¶5. (SBU) Comment. Moving towards a more flexible exchange rate regime is an important IMF conditionality. In practical terms, more flexibility means further devaluation, especially given Ukraine's current macroeconomic climate. A hryvnia devaluation is also necessary to improve the country's external competitiveness and help it tackle the burgeoning current account deficit. The NBU's management of the process has been suboptimal, however, marked by continuous changes in its intervention policy and growing concerns over favoritism when it sells dollars to banks. End comment. TAYLOR