Ukraine’s currency, the hryvnia, has lost more than 20% of its value against the U.S. dollar since the start of the week, trading at 9.45 hryvnia per U.S. dollar yesterday on the inter-banking market, according to ukrdealing.com. At the same time, the central bank maintained the official rate of 7.8788 hryvnia per U.S. dollar, while doing hardly anything to cushion the fall or close the gap with the market rate. Indeed, the central bank has devised no clear strategy to deal with the crisis so far, half-heartedly following the International Monetary Fund’s (IMF) advice on one hand and remaining inexplicably inert on the other, even after having pledged to get onto the foreign exchange market and halt the fall of the hryvnia by selling hard currency. However, market interventions are constrained by an agreement signed with the IMF declaring that official foreign exchange reserves, which currently stand at around US$32 billion, must not fall below US$31.4 billion until the end of the year.

Meanwhile, mutual accusations are flying between the government and the central bank. Prime Minister Yulia Tymoshenko said yesterday that the hryvnia’s fall was a "planned operation" by the central bank, which from her point of view had engaged in unwise currency speculation. The governor of the central bank, Volodymyr Stelmakh, immediately rejected her remarks blaming the government instead for the collapse of Ukraine’s entire financial system. The central bank is currently trying to scale back the number of hryvnia circulating in the financial system. Indeed, the central bank believes that excess hryvnia funds have been used to purchase U.S. dollars, thus putting pressure on the exchange rate. As a reaction, the central bank has raised the cost of refinancing for banks further from 18%-20% to 22%. The average rate could see a further rapid rise in the short term.

All this suggests that there will hardly be anything to soften the hryvnia’s downside during the next few weeks unless markets allow a rebound soon. Indeed, dollar rates of 12 or even 14 hryvnia per dollar are already being discussed. There is surely a significant speculative momentum behind the current trend, yet it is nonetheless a fact that Ukrainian companies, banks, and households have to live with for the moment. External debt, which has risen rapidly during the third quarter , is weighing much heavier on Ukrainians’ solvency, virtually doubling between six months ago and now in local-currency terms.

According to our latest sovereign risk forecast from November, Ukraine’s total external debt obligations due in 2009 amount to US$57 billion, with debt amortisation including short term debt equalling US$51 billion. In light of latest trends, however, this forecast is certainly too high, since Ukraine’s external borrowing will be much lower now as the current-account deficit shrinks. Encouragingly, the bulk share of these debt obligations will be rolled-over since most of the debt is related to lending between foreign parent banks and local subsidiaries. Ukraine’s government and the IMF assume a roll-over rate of 83%, while anticipating total debt amortisation to amount to US$40 billion.

Outlook and Implications

At the current hryvnia/dollar-rate, mass default of corporate sector and banking foreign currency loans looms for 2009, which will severely aggravate Ukraine’s already distressed situation. Households which have borrowed heavily in hard currency will be hard hit as well. Public-sector finances are heavily constrained by mounting external public debt, which has of course doubled in local-currency terms as well. As a result, the government’s financial resources to support and recapitalize the economy are melting away. Moreover, there is also a growing discrepancy between gas utility Naftogaz’s local-currency revenues and foreign-currency denominated debt obligations. There are some reasons, however, to assume that the hryvnia’s most recent decline went much too far and might be revised during January, with the hryvnia climbing back to around 7 hryvnia per U.S. dollar. Rumours about speculative moves by some well-connected Ukrainian banks may not be unfounded. If the hryvnia bounces back soon, the worst outcome could possibly be averted, yet we will continue to observe the situation very closely, especially with respect to Ukraine’s sovereign risk rating (‘55’ or B+, with a negative outlook). If the hryvnia does not rebound, a second IMF package or an upgrade of the current program might be necessary. However, we think that there is some risk that the Fund might refuse to grant a follow-up program under current circumstances, bearing in mind the political situation.