Last week, against the backdrop of a record hryvnia rate increase in the last three years, the Minister of Finance criticized the National Bank's policy. In her opinion, the National Bank (NBU) did not make enough efforts to contain the strengthening of the national currency.
The head of the Ministry of Finance also called on the National Bank to increase the volume of currency purchases on the interbank market in order to restrain the appreciation of the hryvnia. Is the criticism of the Ministry of Finance justified, or is the National Bank doing everything right? Let's try to figure it out.
Since the beginning of the year, the hryvnia has strengthened against the dollar by 9.1%, and this is the best result among all the national currencies of the world. On August 1, the official dollar exchange rate reached a record low for three years - 25.02 UAH. A significant strengthening of the hryvnia is associated with a number of reasons; one of the most important is a sharp increase in the volume of government bonds purchased by the non-residents.
Indeed, since the beginning of the year, the government bonds portfolio has grown 13 times, and the total volume of investments by non-residents in government bonds as of the end of July reached $ 3.6 billion. Moreover, at a particularly high pace, non-residents began to buy government bonds in the summer.
How to evaluate such an appreciation of the national currency, is the strengthening of the hryvnia a serious cause for concern, or vice versa - a positive signal for the economy?
There is no definite answer. The depreciation of the dollar leads to a reduction in the cost of imported goods. Accordingly, we have a positive factor for reducing inflation, which has already manifested itself in June deflation. Given that reducing inflation is a priority goal of the National Bank, it can be argued: strengthening of the hryvnia is a positive signal for the economy.
Considering that a significant part of technological equipment and raw materials is imported into Ukraine, the strengthening of the hryvnia has a positive effect on industrial inflation, which, with a certain time lag, will additionally positively affect consumer inflation.
In addition, in June-July, Naftogaz pumped large volumes of gas into underground storage facilities and with a stronger hryvnia, the cost of buying gas was less.
Repayment and servicing of foreign debt denominated in foreign currencies, while strengthening the hryvnia, is cheaper. For example, it helped to save quite a lot in May, when the volume of payments on external public debt amounted to about 1.7 billion dollars.
But there is a flip side to the coin. Cheaper in hryvnia equivalent imported goods mean a reduction in tax revenues (import VAT, excise tax, duty). In addition, the depreciation of the dollar is deterioration in the position of exporters, because their income, expressed in national currency, has declined.
And this, in turn, leads to a decrease in tax revenues from the activities of exporters.
It turns out that strengthening the hryvnia is both a positive and at the same time a negative phenomenon for the economy. The National Bank is not worried about this, in its coordinate system the strengthening of the national currency is movement in the right direction. But what about the Ministry of Finance, for which this means difficulties in the implementation of the revenue side of the state budget?
The fact is that in the budget for the current year, calculations are made based on the rate of 29.4 hryvnias per dollar. Serious strengthening of the hryvnia significantly complicates the implementation of the revenue side of the budget. For example, in June, the state budget missed 17.8% of planned revenues. And in total for January-July, the revenue plan was completed by only 96.4%.
Now more about what caused this strengthening of the national currency. This is largely due to increased demand for government bonds, including from non-residents. The reason for the great demand is both the stabilization of the Ukrainian economy and the receipt of political certainty, as well as the high attractiveness of government bonds for investors.
Indeed, 15.5-16% on long-term government bonds is a good return for the investor (it’s another thing what it will cost the state). And if investors sold the currency to buy government bonds at a higher rate than they expect to buy, then they can also count on income from exchange rate differences.
An important question: why does the Ministry of Finance place in large volumes precisely long-term government bonds, while reducing the supply of short-term ones? Indeed, if it is necessary to eliminate cash gaps in the budget of 2019 or to be safe at the beginning of next year, it would be more logical to focus on securities with a circulation period of six months.
It is advisable to shift the focus on the issue of short-term government bonds - this way you can reduce the cost of servicing debt on bonds.
I find this explanation - apparently, the Ministry of Finance suggests that the ultra-high demand for Ukrainian government bonds will not last long. Apparently, the Finance Ministry believes that now is an exceptionally convenient moment - there has been no such demand for Ukrainian debt securities since 2005-2006. And it enjoys the opportunity.
Probably, the National Bank also suggests that the situation may change, but in a different direction. There is an empirical relationship between government bond rates and the NBU discount rate.
And since the National Bank predicts a reduction in the discount rate from the current 17% to 8% by 2021, this further encourages investing in government bonds right now, when the yield is at the level of 15-16% for the longest securities.
Of course, 8% is a forecast that may or may not come true, but there is a risk of a decrease in bond yields, and investors are well aware of this. And are taking advantage of the moment, increasing investments in government bonds.
It turns out that not only the goals of the NBU and the Ministry of Finance are not completely coordinated with each other, but also the forecast for the development of the situation varies considerably. We can’t see the future. Only later will we be able to judge whether the National Bank was overly optimistic in its forecasts, or in an attempt to be safe the Ministry of Finance placed long-term government bonds at too high rates.
The Ministry of Finance and the NBU in their activities objectively do not always have the same goals. The actions of one can affect the state of another or a set of tools that it can use. And most importantly, they can influence the ability to achieve each other's goals. Things are not going well with the coordination of fiscal and monetary policies.
As we saw in the example, a large influx of non-residents' funds in government bonds led to a sharp increase in the hryvnia exchange rate. Perhaps the NBU could respond more quickly.
But, on the other hand, it pursues a flexible exchange rate policy, adheres to publicly announced policies and procedures on foreign exchange interventions, and, most importantly, has the right to take advantage of the hryvnia's appreciation, which helps to achieve the inflation target.
So whether the National Bank really bought out insufficient volumes of currency, whether it really acted late? In total, from January 1 to August 2, the NBU bought 2.91 billion dollars. Here are the monthly volumes of the purchase of foreign currency by the National Bank in 2019:
January - $ 208 million
February - 327 million
March - $ 257 million
April - 321.5 million
May - $ 203.5 million
June - 322 million dollars
July and the first two working days of August - $ 1,271 million.
July 22 - August 2, namely during this period, the hryvnia exchange rate was at the highest levels against the dollar, and the National Bank bought $ 771.4 million.
And if the NBU bought 26.5% of the total amount of currency purchased in 7 months of the year at the most favorable rate, then it certainly did not deserve accusations on this issue.
Moreover, in July, the National Bank increased international reserves by almost 6% ($ 1.27 billion), bringing them to $ 21.8 billion.