Despite the fact that the National Bank says that the level of inflation should be the main benchmark for the Ukrainians for the third year in a row, the majority still considers the exchange rate as a measure of the stability of our economy. And the exchange rate of the national currency in recent years is just comforting – hryvnia has been stubbornly strengthening since the beginning of January. But does it speak about real economic victories and what will be the course after the presidential elections? Let’s try to predict.
The strength of the national currency is influenced by several external and internal factors. Political stability in the country and the course it will take is just one of many factors. But it is significant enough. Needing considerable Western investments and not finding the willing investors, the government began to raise funds actively by selling government bonds in recent years. Due to the high discount rate set by the NBU in an attempt to keep inflation within the target limits, the yield rates of government bonds are also high and sometimes more profitable than deposit rates. There are a lot of those who want to earn on government securities – now legal entities own UAH OVDP worth UAH 18.3 billion, and foreign currency OVDP – worth UAH 6.1 billion. Individuals hold hryvnia bonds worth almost UAH 2.4 billion, and foreign currency bonds – worth UAH 4.8 billion. In addition, foreigners also eagerly buy bonds, because nowadays non-residents hold bonds in hryvnia worth UAH 13.2 billion, and in foreign currency – UAH 807 million.
It is clear that a part of the owners bought OVDPs due to a patriotic desire to support the Ukrainian government, but their number is unfortunately small. Most owners, as experience shows, openly speculate on government securities, buying and selling them whenever it is profitable, avoiding risks and increasing their own income as much as possible. For this group of investors, the presidential election is one of the key indicators of whether it is time to sell government bonds. And it is not a matter of whether the winner’s of the election program will correlate with the views of bondholders, but rather of how predictable the newly elected president’s actions will be, whether the investors believe that he or she is able to maintain a constructive dialogue with the IMF and other international financial organizations that support Ukraine, whether the populist steps, which often harm sustainable economic development, are characteristic for the potential winner. If investors feel that an unpredictable candidate might win, whose policy might bring a lot of surprises to the state, they will get rid of the Ukrainian bonds in the time between the first and second rounds. And according to the laws of the market, the hryvnia will begin to weaken under the conditions of mass sale which obviously will be also with a discount. In addition, the uncertainty of the winner’s policy may affect further demand from investors. If at the beginning of January this year non-residents held foreign currency government bonds worth 210 million UAH, now they hold more than 800 million. So, while buying securities, the investors paid the state in foreign currency, preventing its deficit in the domestic market. If further cooperation with Ukraine becomes too risky or simply unpredictable in their opinion, they will begin to invest in other investment instruments, and we will feel the deficit in the foreign exchange market, which will instantly weaken the hryvnia.
Unfortunately, the list of factors that affect the stability of the national currency is not limited to political risks. First of all, it is worth remembering that the State budget of this year is adjusted to the rate of 29.4 UAH/USD, and the current rate deviates significantly from this figure. And, oddly enough, the strengthening of the hryvnia from this point of view is not positive, because if its rate is lower than expected, the budget revenues in foreign currency (in particular, import VAT and duty) are below the government benchmarks. Last year, the country experienced a similar situation. As a result, starting from mid-summer, the Ministry of Finance began to systematically buy up the currency in the domestic market, to reduce the price of the hryvnia at least a bit and “pull up” the revenue plans. It helped just partly. The budget was executed mainly due to the fact that the state stopped financing a part of the expenses by giving money only for social needs – for salaries of state employees, pensions, social payments.
According to the NBU, a fairly significant deficit of the consolidated budget was formed as a result in 2018 – 67.8 billion UAH or 1.9% of GDP. For the first time since 2010, the local budgets were executed with a deficit of 8.5 billion UAH (or 0.2% of GDP). Last year, we saw no increase in spending in the second half of the year for the first time. Also, it is quite atypical that the determining contribution to the growth of tax revenues was not taxed on imported goods, as usual, but the so-called internal taxes – on the income of individuals and profits of enterprises. So, domestic producers had to pay out of their own pockets for the mistakes of the NBU and the Ministry of Finance in their basic forecasts. This year the situation may repeat because the hryvnia is now much stronger than expected by the government.
Thus, this year the state budget is quite conservative compared to the previous one. It is based on a rather restrained growth of income and expenses compared to the actual figures of 2018 (10.6% and 12.8%, respectively). However, due to higher growth rates of expenses compared to revenues, the deficit will expand compared to 2018 – up to 2.3% of GDP, and the main risk is concentrated in the aspect of financing. Also, the budget traditionally includes the receipt of 17 billion UAH worth funds from privatization. Given the low income in previous years, the risk of shortfalls from this source remains high. Roughly speaking, if the elections will not devalue the hryvnia, then the government will do it because otherwise, it will simply not be able to execute the budget.
According to the regulator, the budget deficit and debt obligations in 2019 are planned to be financed mainly through internal and external borrowings, and internal borrowings are planned in the amount of UAH 202 billion, which is 15.9% more than the number of actual borrowings in 2018 and exceeds the volume of payments on internal obligations by 34%. Buying such volumes in the domestic market, the Ministry of Finance will be able to “swing” the hryvnia exchange rate in its favor, and it is profitable for them if it is cheaper.
The third factor that will affect the hryvnia exchange rate is the situation in foreign markets. Ukraine is an export-oriented economy, the well-being of the whole country without exaggeration depends on the success of our exporters. And the success of exporters often depends both on the situation on the world markets and on the economic situation of our main trading partners. It’s quite simple: the more actively the economies of our partners grow – the more goods we sell them, the higher prices on world markets – the more we earn, the more currency in the country – the less demand for it is, the stronger the hryvnia will become.
But the news here is not comforting. The external environment for our economy continues to deteriorate. The world is in the state of recession and the international trade slows down, as well as business activity in general. According to the NBU, the rapid increase in oil prices in previous periods and the depreciation of national currencies in relation to the US dollar led to the acceleration of inflation in the world and the tightening of monetary policy of the central banks of several countries. Investors’ interest in risky assets has significantly decreased, and global stock indices have decreased, most of all – in the US market. The growth of the world economy is slowing down under the influence of the gradual exhaustion of the positive momentum from the soft financial conditions and low-interest rates in previous periods. In addition, the development level in particular between the United States and the Eurozone, and the countries whose markets are developing (including Ukraine and most its partners) keeps growing uneven.
Also, the increased geopolitical tensions and protectionist measures have led to a further narrowing of demand and, consequently, a slowdown in world trade. In particular, the leading indicator of world trade (WTOI) fell to the lowest level in the last two years (98 p.) in the fourth quarter of last year. Moreover, all components of the index deteriorated. This indicates that there will be no growth in trade in the coming months. As a result, prices on most commodity markets fell, and the global price environment for Ukrainian exporters deteriorated significantly. Unfortunately, the growth rate of the global economy over the next three years will only slow down, as well as the growth rate of world trade, and the growth of prices on world markets will be very sluggish respectively. According to the NBU, prices on steel on world markets will remain close to current levels. Iron ore prices will decline mainly due to constant supply growth (especially from Australia and Brazil). World grain prices will be gradually rising due to the acceleration of global consumption growth. But this will be a restrained growth, as some countries plan to increase wheat production next year – by 8.3% in the US, by 5.1% in Canada, by 5.4% in Argentina. India, Iran, and Kazakhstan are also planning to increase yields. So, there will be no miracle and we do not expect a shaft of foreign currency from exporters this year. And it will also affect the stability of the hryvnia.
Given that Ukraine needs to pay off its foreign debts, which will require attracting not only new loans but also the foreign currency in the domestic market, the hryvnia will gradually weaken. And considering the above-mentioned factors, this trend will only increase. It is unlikely that we should expect a significant reduction in the cost of the national currency, but it will gradually approach the budgeted rate of 29 UAH/USD throughout the second half of the year. And the results of the elections, in this case, can only slightly speed up or slow down this process.
Text by Valentyna Yushchenko