Monetary running knot of Ukraine's National Bank

Author : Oleksiy Kushch

Source : 112 Ukraine

One of the secrets of opening the current crisis is the exchange rate and price stability of the hryvnia
14:30, 9 June 2020

Revenues of Ukraine's state budget

One of the secrets of opening the current crisis is the exchange rate and price stability of the hryvnia. Ukraine deals with a dual-currency economy, in which a significant part of the assets is “priced” in foreign currency, mainly in dollars. They also form shadow accumulations of the population and business ("under the pillows" and on offshore accounts). Currency speculator has already got a reflex if the crisis is near, devaluation is near. But for the second month now we have been closed for a lockdown, speculators have activated. After a short period of turbulence, the exchange rate stabilized again at an equilibrium market level with a minimum margin between the purchase/sale price. Of course, we can assume that we are not in a crisis, but in an “ocean of tornado,” when everything around is raging, and we have “quiet and smooth” and still ahead. After all, along with the economy, imports also stopped. In addition, the decrease in fuel prices on the world markets had a significant impact. That is, everything can change when business activity resumes at the end of quarantine. But for now, the fact remains: the rate is stable, and the price dynamics are at all at historical lows, showing annual inflation in the range of 2-3%.

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Take exchange rate extremes or the point-to-point ratio: 2019 began with the official exchange rate of 27.68 UAH per USD, then as a result of untwisting the speculative model of government bonds and the influx of "hot" money from non-residents, the rate was atypically strengthened and the apogee of an anomaly occurred in December last year: 23, 25 and December consumer price deflation at the level of 0.5%, which has not happened since 1991 and which became a kind of red line that the government drew under the year of de-industrialization, industrial recession and partial deconstruction of the export potential of the economy.

In 2020, the exchange rate devaluation extremum stopped at around 28.13 at the end of March with a correction to the level of 26.97 in the last days of April.

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In fact, only March was relatively disastrous, when the volume of operations on the interbank market (excluding the National Bank) grew from the usual 7.3-7.6 billion USD to 9.3 billion USD, and the National Bank’s intervention in the sale of foreign currency amounted to 2.45 billion USD. In April, the regulator already bought out 723 million USD in the market, and the total balance of foreign exchange interventions for the first four months of the year was only 0.7 billion

To understand this phenomenon, we will be transported for a moment to the middle of the last century. In 1957, Jacques Jacobus Polack, who since 1947, that is, since the IMF was founded in 1944 at the Bretton Woods Conference, worked as one of the foundation’s key analysts, published its mathematical model, which was called the Polack model.

In fact, this is a mathematical matrix that the fund imposes on each country, which needs its resources to patch up the balance of payments holes.

This model excludes the possibility of a crisis country to improve its balance of payments through an independent industrial policy. Export is an independent (exogenous) factor. It does not depend on the actions of the "problem" country but is a derivative of the dynamics of the GDP of countries - trading partners. In other words, if global sales markets grow, then exports will grow, and if they fall, no incentives and industrial policy will save. The same works with import: the country has an indicator “marginal propensity to import” from 0 to 1. The higher this propensity, the more people and businesses convert their incomes into the purchase of imported goods. Import substitution does not work here either.

The Polak Model is essentially a straitjacket that the IMF puts on small, open, commodity economies that are used to growing along with foreign markets and falling just as fast.

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And for this, the growth dynamics of the monetary base must be tightly tied to the growth indicators of the central bank's net foreign exchange reserves and the size of the domestic loan.

There is a very simple formula: monetary base (MB) = net domestic assets (NDA) + net international reserves (NIR).

The IMF requires satellite countries to set a maximum bar (limit) for net domestic assets and a minimum value of foreign exchange reserves.

In 2020, the National Bank, in fact, threw a whole series of monetary constraints on the economy: if in 2019 the indicator of net external assets fluctuated around UAH 280 billion (10 billion USD) in equivalent, then by March 2020 this indicator had risen sharply to 434 billion (16 billion USD). And now we recall the formula mentioned above: to maintain equality, it was necessary to reduce the indicator of net domestic assets, and it decreased from 150-170 billion UAH (5,6-6,4 billion USD) in 2019 to 47 billion in March 2020. And if in March last year, foreign assets accounted for 65% in the structure of the monetary base (which is also too much), then in March 2020 - 90%!

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The National Bank simply strangled the financial basis of economic development through the use of structural "muzzles" worn on a monetary base. As a result, there is no money not only for currency speculation but also for the further development of the economy: net domestic credit decreased from 322 billion UAH (12 billion USD) in February 2019 to 155 billion UAH (5,8 billion USD) in February this year, that is, more than doubled.

In this paradigm, the National Bank is turning into a kind of "escort service" for lenders and oligarchs. Both the first and second want to withdraw their capital from the country: lenders - speculative investments in government bonds, oligarchs - received economic rents. To do this, we need an acceptable exchange rate, even if at the cost of the final de-industrialization of the economy and the loss of another million jobs, because the industrial lobby is no longer in the corridors of the current government, its place has been filled by agrarian raw materials and credit.

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The usual division into developed countries and developing ones would not exist anymore. The watershed will pass along a new axis: countries capable of independent monetary policy without external restrictions, and countries that impose “voluntary” emission restrictions on themselves.

In order to save the economy, it is necessary to radically restructure the existing monetary regime, aiming at achieving employment goals and GDP dynamics, and for this it is necessary not only to lower the National Bank discount rate but also completely change the emphasis of monetary policy when moderate inflation and devaluation partially compensate for the post-crisis economic shock.


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