Ukraine devaluation fears on the rise

Speculation rises as central bank struggles to maintain dollar peg.

The threat of a devaluation of Ukraine’s currency hangs over the country after its central bank found itself temporarily unable earlier this month to defend the hryvnia’s peg to the U.S. dollar.

The threat comes despite the Ukraine government’s efforts to suppress devaluation risks posed by dwindling foreign direct investment and swelling foreign debt until after the parliamentary election scheduled for Oct. 28.

“The risk of a postelection devaluation remains high in our view, though a currency adjustment doesn’t seem inevitable as yet,” said Olena Bilan, chief economist at Dragon Capital, a leading investment bank in Ukraine.

100 Ukrainian hryvnia note. In early September, the National Bank of Ukraine, or NBU, allowed the hryvnia to slip about half a percentage point against U.S. dollar. The currency USDUAH +0.0117% is pegged at around 8 per dollar.

The two-day dip sounded alarm bells for the Ukrainian economy and lent credence to forecasts that the hryvnia could be devalued by as much as 20% by the end of the year. That is the rate hryvnia non-deliverable forwards are currently trading at, according to TRData.


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The Ukrainian hryvnia slid 0.6% on Sept. 4, trading near a three-year low of 8.19 per dollar after hovering in prior weeks in a stable range between 8.10 and 8.13. It has since rebounded to trade in the range seen before to the depreciation, but has shown volatility in recent days.

The hryvnia traded at a rate of 8.118 per dollar in recent action, little changed from Monday.

No 2008-09 rerun In a report, analysts at Dragon Capital examined risks tied to a 20% devaluation scenario.

“With hryvnia devaluation expectations for the second half of 2012 high and persisting,” the effect of a potential devaluation “will be less dramatic than in 2008-09, as Ukraine’s current macro backdrop is more supportive.”

In other words, don’t expect bank runs this year. Indeed, Ukraine’s economy has yet to fully recover from the 2008-09 global crisis, which sent the hryvnia plummeting 36 %.

The supportive factors cited by Dragon Capital include projections for gross domestic product to grow 1% in 2012 and 2.5% in 2013, compared with a 15% contraction in 2009.

Potential capital needs of $3.5 billion to $5.6 billion can be fulfilled by private banking groups and the government, compared with $18 billion injected into Ukrainian banks between fourth quarter 2008 and the first half of 2012.

At the same time, the economy has entered a cooling phase that began in the second half and will continue into next year, said Alexander Valchyshen, the head of research at Investment Capital Ukraine.

“Economic risks have grown, capital inflow from abroad has practically stopped and the interbank market finds itself in a state of distrust between participants, which is confirmed by the high rates for credit,” he said.

Foreign direct investment increased 1.8% to $1.6 billion in the second quarter of 2012 compared with the same period a year earlier, yet Valchyshen attributed much of that statistical result to money deposited abroad being transferred home by Ukrainians.

This lack of investment has exacerbated the trade deficit, which reached $8.7 billion year-to-date in July, or 29 % higher year-over-year.

The lack of revenue flowing into state coffers has led the government to borrow from foreign institutions, stretching the foreign debt to $62 billion, or 35 % of GDP. Bilan expects that to expand to $67 billion, or 37.8% of GDP, by year- end.

Meanwhile, fiscal policy questions remain as foreign businessmen continue to complain about hundreds of millions of dollars in unreturned value-added taxes.

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