4 Second part of the strategy: prevention of a sudden devaluation
4.1 Evaluation of the NBU instruments for prevention of
Box 4.1
Three concepts of international reserves
A central bank’s international reserves are conventionally classified as gross, liquid, and net reserves.
Gross international reserves are the amount of “external assets that are available to and controlled by monetary authorities” (Balance of payments Manual, 5th edition; IMF).
Liquid international reserves are the part of gross international reserves that is readily available for the financing of external payment imbalances or for interventions in foreign exchange markets.
Net international reserves are the difference between the monetary authority’s external assets and its external liabilities.
In Ukraine, in line with the International Financial Statistics (IFS) methodology, gross international reserves are composed of:
1. Monetary gold;
2. Reverse position of Ukraine in the IMF;
3. Special drawing rights (SDRs) belonging to Ukraine, and 4. Foreign currency, including:
4.1. Cash money in freely-convertible currencies, and
4.2. The NBU’s claims on non-residents in form of bank deposits, treasury bills, short-term government securities, and other claims usable in the event of balance of payments need.
5. Other foreign assets like claims on non-residents that are of limited usability in the event of balance of payment need.
Ukraine’s liquid international reserves do not include the latter (No. 5) component of gross international reserves, as listed above.
Source: IMF
Gross international reserves measured in months of import coverage confirm that Ukraine’s reserves are insufficient. They cover only 1.78 months of imports in the third quarter of 2001 (Graph 4.2) compared to the conventional benchmark of three months of imports.46 This ratio is the lowest among the countries of Central and Eastern Europe, excluding Belarus (Table 4.1).
46 IMF (2001): Ukraine: Fifth and Sixth Reviews Under the Extended Arrangement – Staff Report; Staff supplements and News Brief on the Executive Board Discussion. Country Report No. 01/216, November.
Table 4.1
Gross international reserves in months of imports of goods and services among selected countries of Central and Eastern Europe
1996 1997 1998 1999 2000*
Belarus 0.6 0.5 0.5 0.6 0.5
Bulgaria 1.0 4.4 5.4 5.3 5.4
Croatia 2.8 2.7 3.2 3.7 4.4
Czech Republic 4.4 3.6 4.4 4.6 4.5
Estonia 2.5 2.4 2.2 2.7 2.4
Hungary 5.7 4.0 4.1 4.6 4.2
Latvia 2.5 2.5 2.2 2.8 2.6
Lithuania 1.9 1.9 2.7 2.7 2.7
Moldova 3.0 3.1 1.4 2.9 2.6
Poland 6.0 5.8 6.6 6.4 6.5
Romania 0.5 2.0 1.3 1.6 2.1
Russia 1.6 1.7 1.3 1.9 4.7
Slovak Republic 3.1 2.8 2.3 3.1 3.4
Ukraine 1.1 1.3 0.5 0.9 1.0
* Estimation
Source: EBRD (2001): Transition Report
The level of Ukraine’s gross reserve in months of imports was lower than the respective ratio of other countries in the region both before and after the crisis of 1998, and has never exceeded a two month import coverage, indicating constantly lower provision of reserves in Ukraine.
Graph 4.2
Gross international reserves in months of imports
Source: NBU; UEPLAC
0.00 0.20 0.40 0.60 0.80 1.00 1.20 1.40 1.60 1.80 2.00
Q1 95 Q2 95 Q3 95 Q4 95 Q1 96 Q2 96 Q3 96 Q4 96 Q1 97 Q2 97 Q3 97 Q4 97 Q1 98 Q2 98 Q3 98 Q4 98 Q1 99 Q2 99 Q3 99 Q4 99 Q1 00 Q2 00 Q3 00 Q4 00 Q1 01 Q2 01 Q3 01
months of imports
4.1.2 Non-feasibility of interest rate policy as an NBU instrument against a sudden devaluation
Currently the interest rate policy cannot be used as an instrument against a sudden devaluation in Ukraine. That is in the first place determined by absence of the NBU market leadership in establishment of short-term interest rates. Changes in discount rate do not significantly influence volumes of commercial banks’ refinancing, as well as their interest rates.
Other factors including generally low efficiency of the Ukrainian financial system and riskiness of business environment seem to determine interest rate policy of commercial banks, countervailing the NBU discount rate policy.
Graph 4.3
Discount rate of the NBU and lending rate of commercial banks for credits in national currency
Source: NBU
At the time of the 1998 crisis, the increase in the NBU discount rate did not cause an equivalent jump in the lending rates for credit in the national currency by commercial banks (Graph 4.3), and the spread between these rates became negative.
An additional precondition for a workable interest rate policy is a country’s ability to attract cross border flows of capital in response of changes in interest rates. However, in Ukraine the balance of short-term capital47 and portfolio investments (Graph 4.4) is currently quite low. In 2001 the balance of short-term capital reaches 26% of the current account balance.
The amount of portfolio investments outflow increased in 2001 to 62% of the current account balance, compared with 17% in 2000. The insignificant balance of short-term capital and portfolio investments’ outflow (Graph
47 Balance of short-term capital is presented in "other investments" position in capital and financial account of the balance of payments. It equals to difference between assets and liabilities excluding mid-term and long-term loans.
y
-40 -20 0 20 40 60 80 100
Jan-98 Mar-98 May-98 Jul-98 Sep-98 Nov-98 Jan-99 Mar-99 May-99 Jul-99 Sep-99 Nov-99 Jan-00 Mar-00 May-00 Jul-00 Sep-00 Nov-00 Jan-01 Mar-01 May-01 Jul-01 Sep-01 Nov-01
Spread between lending rate and discounts rate
Lending rate, credits in national currency
Discount rate
% per annum, average over period
4.4) give no reason to expect a boom in short-term capital inflow, if a balance of payments need occurs in the mid-time horizon.
Graph 4.4
Balance of portfolio investments and short-term capital
Source: NBU
4.1.3 Foreign exchange restrictions already very strong
Existing foreign exchange market restrictions form a mutually supporting cycle of transactions, and actually guarantee current market stability. On the one hand, supply of foreign currency is regulated by the mandatory return and sale of foreign currency receipts. On the other hand, demand for foreign currency is tightly bound to the import needs of the economy.
Among the list of foreign exchange restrictions, the following are the most important:
1. Restrictions on transactions with foreign currency.48 The national currency is the sole legal tender in Ukraine. Payments between residents and non-residents in foreign currency, which are conducted as a part of trade turnover, are administered only through the Ukrainian authorised banks.
2. Licensing of transactions with foreign currency. The NBU issues two types of licences.49 General licenses are designed for commercial banks and other financial institutions, while individual licenses are provided to residents and non-residents permitting a one-off currency transaction. Among the major exemptions from licensing are import payments, the return of interest or income on credit and investments as well as return of the principal amount of investment if it was discontinued.
48 Decree of the Cabinet of Ministers “On System of Currency Regulation and Currency Control”, No. 15-93, 19.02.1993 (as amended of 04.10.2000).
47 Ibid.
-3000 -2500 -2000 -1500 -1000 -500 0 500 1000 1500 2000
1995 1996 1997 1998 1999 2000 2001
USD m
Portfolio Investments
Short-Term Capital
inflowoutflow
3. Return of export receipts in Ukraine. Residents’ receipts of foreign currency must be deposited in a resident’s foreign currency account in an authorised bank within 90 days following the registration of export custom declaration.50 The only exemptions are the pharmaceutical industry (180 days for return of export receipts) and the space industry (500 days). In other words, the Ukrainian exporters are obliged to deposit the foreign currency they earn in the Ukrainian banking system, thus, increasing the supply of foreign currency.
4. Mandatory sale of 50% foreign currency receipts. Judicial persons resident in Ukraine must sell 50% of the foreign currency receipts arriving in their authorised bank account.51 There are several categories of receipts that are not subject to mandatory sales, including credit in a foreign currency, foreign investments, and deposits in a foreign currency in Ukrainian banks. This restriction constitutes the second level of regulation system ensuring foreign exchange supply at the market.
5. Limited period for import contracts pre-payment. Import transactions that require more than 90-days for postponed supply of goods or services require a licence from the NBU. This measure allows keeping foreign currency in the country as long as possible.
6. Anti-speculation regulations include:
• Ban on forward contracts and financial derivatives. All transactions with fully convertible currencies52 and all cashless purchases of foreign currency with hryvnia are conducted only as today, tomorrow, or spot (delivery in two days) transactions. All forward contracts as well as the use of financial derivatives are prohibited.
• Control of motives behind currency purchases. All applications to make purchases of foreign currency should be accompanied by the relevant documents that prove the non-speculative character of the purchase. All purchased currency must be used in line with claimed objective within five working days of the currency’s receipt. If residents violate the five-day limit, the currency is re-sold on the inter-bank market, and any positive difference due to foreign exchange rate changes is transferred to the state budget, while any negative difference is accounted as a loss for the purchaser.
• Ban on bank foreign currency speculation. Authorised banks are required to submit exactly specified claims for purchases or sales of foreign currencies on the market before the trading session
50 Law of Ukraine “On Order of Payments in Foreign Currency”, No. 185/94-BP, 23.09.1994 (as amended of 16.03.2000).
51 Decree of the NBU Council “On Introduction of the Mandatory Sale of Receipts in Foreign Currency Received by Residents – juridical persons”, No. 349, 04.09.1998.
52 Decree of the NBU “On Ratification of Classifier of Foreign Currencies”, No. 34, 04.02.1998 (as amended of 07.02.2000).
begins. It is forbidden for the banks to buy and sell the same currency during an individual session, as well as to exceed the claimed amounts.
This situation provides little room for manoeuvre for the NBU should pressure for a sudden devaluation occur. A further tightening of the regulations like the introduction of 100% sale of export receipts or a shortening of the period for import contract prepayment will negatively affect the balance of payments and economic development as a whole. If market restrictions become stronger, there is a high risk of export receipts not being returned to Ukraine and of a blossoming of spurious accounting in international contacts.