Ukraine, economics: exchange rates, Feb 2022

Reserves fall, amid strong downward pressure on the hryvnya

(for the EIU)

Ukraine’s international reserves came to US$29.29bn at the end of January, down by US$1.65bn on a month earlier, according to the National Bank of Ukraine (NBU, the central bank). Correspondingly, reserve coverage of imports fell to 3.6 months, from 4.1 months at the end of 2021.

The level of reserves held by the NBU is an indicator of the authorities’ capacity to meet their debt commitments and to protect the financial system from destabilisation—in particular, to smooth out sharp movements of the hyrvnya exchange rate to the US dollar.

In 2021, Ukraine’s international reserves rose by US$1.8bn, or 5%, to US$30.94bn. The NBU was able to achieve this owing to a mix of favourable price and demand trends for key Ukrainian exports, alongside continuation of loan inflows, including from the IMF and the European Commission (EC).

Since December, however, the NBU’s net currency purchases have turned negative, quite sharply in January—first, as a Russian troop build-up along the Ukrainian border, and then Western warnings of an imminent invasion, unsettled investors, so putting strong downward pressure on the hyrvnya. After appreciating for much of last year, the hryvnya fell from about HRN26:US$1 in early November 2021 to a low of almost HRN29:US$1 towards the end of January this year, a nominal depreciation of more than 9%.

Last year, the Ukrainian government raised US$11.2bn on domestic and foreign capital markets and spent a total of US$11.5bn on servicing and paying down its debts, according to the NBU. In January, however, the funds raised by the government were both smaller in scale and solely from domestic sources, as the cost of borrowing from abroad rose prohibitively.

The recent falls in the currency and reserves illustrate a point made by the Ukrainian president, Volodymyr Zelenskyi, when he expressed concern that, by overstressing the change in the level of threat from Russia, Western leader’s warnings of an imminent military attack was destabilising the Ukrainian economy.

A phase of currency weakening would add to the array factors keeping domestic inflation high, undermining growth by eroding the real wage, and perhaps by keeping domestic interest rates high for longer. Although reserves are nowhere near as low as during the crisis of 2013/14, the sharp fall in January this year, alongside an effective closure of international capital markets to Ukraine, will begin raise concerns about the government’s ability to meet its upcoming debt commitments.

Key issues to watch out for include whether ongoing international diplomacy has any success in assuaging the security concerns of the Russian leadership; and whether, and how quickly, the emergency financial aid promised to Ukraine by the EU arrives.

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