This week, Ukraine's hryvnia market exchange rate fell from USD/UAH 4.75 on Monday up to 5.00 on Thursday. We see the exit of non-residents as the main reason for increased demand for foreign currency. Driven by the sharp worsening of the global financial crisis this week, foreign investors speeded up their selling of Ukrainian assets (equity, as well as domestic bonds). Another negative factor is the ongoing political crisis, which heightened the perceived country risk (see 5y sovereign CDS chart). The crisis intensified with the official dissolution of the ruling parliamentary coalition on Tuesday this week. Politicians have now 30 days to agree on a new parliamentary coalition. After that period the President Viktor Yushchenko has the right to dissolve the parliament and call for early elections.

So far, the National Bank of Ukraine has not intervened in support of the currency, but the deputy head of the national bank Anatoly Shapavalov expressed the willingness of the bank to step in, if the depreciation trend continues. Currently, the national bank’s monetary policy guidelines foresee a +/- 4% band around the official exchange rate of 4.8511 for the market rate, i.e. USD/UAH 4.66-5.05. However, the guidelines were not obeyed strictly in the past, as greater upward deviations were permitted in recent month. As of 31 August, the national bank was equipped with USD 37.2 bn of foreign currency reserves (IMF definition without monetary gold), USD 5.4 bn more than at the beginning of the year.

 

Money market rates measured by KIEVPRIME ON (8 major Kiev banks) and lowered since the beginning of the month from its last peak of 18% (20 Aug) to 3.47% on 18 Sep. This can be explained by sufficient free liquidity in the banking system – Ukraine banks balances in their correspondent accounts at the National Bank remained steadily above UAH 18 bn this month. In the short term usual factors like the tax payments period at the end of the month will drive up the rates again.

Another factor, which impairs liquidity since August, is the latest measure of the national bank to decrease the growth of foreign currency funding of local banks. According to central banker Shapavalov, the increase of mandatory reserve requirements on bank’s FX borrowing to 20% led to a drop of 50% of this type of FX inflow in August in comparison to July. This measure may show some impact on money market rates in coming months.

 

Despite its weakening since the end of August, the UAH is still marginally stronger than at the beginning of the year, when it traded at USD/UAH 5.048. From a fundamental perspective, we expect the hryvnia to depreciate moderately till the end of the year, based on (seasonal and structural) worsening of the trade and current account balance.