UAH: Reviving after the Storm (November 24, 2014)

The UAH currency has declined by 45% YTD vs. USD due to political instability, imbalanced external sector, conflict in Eastern Ukraine and lack of certainty. While we think it is highly unlikely that hryvnia will recoup all its losses, we also believe that the USD/UAH exchange rate has “overshot” a balanced level and should return to a range of 14.5-15 along with new tranches of international aid and stabilization of conditions in the East of Ukraine.

 

Ukraine’s balance of payments improved to a moderate deficit of USD -663 mn in 3Q2014 from a more significant level of USD -4.2 bn in 1Q2014 (equivalent to 12% of GDP), after the UAH devalued to USD:UAH 12 from USD:UAH 8.24 in 2Q14. We believe the recent wave of devaluation, to USD:UAH 15 from USD:UAH 12, was mostly due to the panic associated with military actions in Eastern Ukraine and political instability. We believe the UAH should strengthen when panic subsides.

Financial support from the IMF and other international financial institutions (IFIs) should stabilize international reserves, the banking system and public finances, thus instilling confidence in the UAH to companies and the population. IFIs will further urge the government and parliament to pursue necessary reforms. At the beginning of 2015 Ukraine should receive funds from the IMF in the amount of USD 4 bn and another USD 8 bn through the end of the year. Moreover, the World Bank should disburse USD 1 bn in the first quarter of 2015. Next year the European Commission is expected to deliver EUR 1 bn to Ukraine. In total, Ukraine is expected to receive around USD 14.25 bn of international support in 2015.

The NBU’s international reserves stayed at the low levels of 78-88 days of imports in July-September 2014, limiting the ability of Ukraine’s Central bank to support the UAH. From April 1, 2014, international reserves decreased by USD 2.5 bn, or 16.6%, to USD 12.6 bn. We note this is still higher that the USD 11.3 bn floor required by the IMF. Nevertheless, the NBU committed to support the UAH in case of necessity, and the IMF during the upcoming review mission will discuss lowering the reserve floor.

Since summer 2014 the NBU has employed a number of administrative measures to tighten interbank and cash markets of USD. In the short-term, we expect increase of administrative regulation of banking system, including prohibiting pre-mature withdrawal of all deposits and increasing the banks’ capital requirements. In the intermediate term, the interbank and cash market should be liberalized. Moreover, we expect the parliament and the NBU to implement reforms in the banking sector. The banking reform and subsequent consolidation of the sector are expected to restore at least partially the USD 11.3 bn that individuals have withdrown from deposits since the beginning of the year.

The strengthening of the US dollar to key currencies put additional pressure on the UAH exchange rate. The USD rose 8.2% YTD vs. EUR, 16.5% vs. JPY, and 0.6% vs. CNY.

USD:UAH exchange rate volatility should decrease as the military conflict and political instability in Eastern Ukraine subsides. These are the main factors which negatively impact investors’ expectations for the Ukrainian economy. In 9M2014, Ukrainian GDP contracted 3.5% y/y. In 10M2014, industrial production declined by 9.4%, with most of the contraction in the Eastern regions of Donetsk and Luhansk (-27.6% y/y and -34% y/y respectively).

 

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