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08KYIV2464, UKRAINIAN HRYVNIA IN FREEFALL AS NBU BOTCHES POLICY

December 18, 2008

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Reference ID Created Released Classification Origin
08KYIV2464 2008-12-18 13:57 2011-08-30 01:44 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Kyiv

VZCZCXRO9681
PP RUEHIK RUEHLN RUEHPOD RUEHSK RUEHVK RUEHYG
DE RUEHKV #2464/01 3531357
ZNR UUUUU ZZH
P 181357Z DEC 08
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 6939
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUCNCIS/CIS COLLECTIVE
RUEHZG/NATO EU COLLECTIVE

UNCLAS SECTION 01 OF 02 KYIV 002464 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR EUR/UMB, EEB/OMA 
TREASURY PASS TO TTORGERSON 
 
E.O. 12958: N/A 
TAGS: EFIN ECON ETRD PREL PGOV XH UP
 
SUBJECT: UKRAINIAN HRYVNIA IN FREEFALL AS NBU BOTCHES POLICY 
RESPONSE 
 
Sensitive but Unclassified.  Not for Internet or Distribution 
Outside the USG. 
 
1.  (SBU) Summary.  A casualty of the worsening financial crisis, 
Ukraine's currency has lost another 12 percent of its value in 
recent days.  Following an interim visit by the IMF to monitor GOU 
progress in implementing the $16.4 billion Stand-By Arrangement 
(SBA), the National Bank of Ukraine (NBU) has again boosted bank 
liquidity contrary to common economic principles and reverted to 
non-transparent foreign exchange interventions below market rates. 
Its reputation as a policy arbiter has been severely damaged, while 
Ukraine's national economic outlook looks gloomier by the day.  End 
summary. 
 
2.  (U) The UAH plummet has accelerated in mid-December, with 
depreciation against the dollar drawing the interbank rate down to 
9.90 UAH/$1 on December 19.  The precipitous decline is leading to 
more one-way bets against the hryvnia at both the retail level and 
on the interbank market.   Since late September, when Ukraine's 
economic crisis was first broadly diagnosed, the hryvnia has lost 
over half its value. 
 
3.  (SBU) The most recent slide took place despite low trading 
volumes on the inter-bank currency market.  In the face of growing 
payment arrears and mounting debts, exporters still holding foreign 
exchange appear to be trying to hold off selling dollars as long as 
possible.   Most are betting that volatile prices and limited dollar 
availability will continue to push the hryvnia downward.  At the 
same time, the shrunken dollar supply has collided with sharply 
increased dollar demand.  Reportedly, energy monopoly Naftohaz has 
been purchasing dollars as well, possibly in an attempt to settle at 
least part of its outstanding gas debt to Gazprom. 
 
4.  (SBU) Deeper reasons for the UAH slide reflect the manifold 
challenges that must still be overcome before Ukraine's currency 
stabilizes.  Most glaringly, the National Bank of Ukraine continues 
to lose confidence as a result of its non-transparent and 
inconsistent attempts to intervene in the foreign exchange market. 
This week's currency slide began after the NBU pumped more liquidity 
into the money market.  A similar slide in the hryvnia occurred in 
November after the NBU increased bank liquidity.  In both cases, the 
liquidity, far in excess of what the banking system needed, flowed 
straight into dollars, further depressing the hryvnia rate.  The 
IMF, in its latest visit to Ukraine last week, criticized the NBU 
actions in November, arguing that the NBU needed to tighten 
liquidity in order to support the hryvnia, and it left the country 
thinking that it had NBU assurances for the same.  However, the NBU 
reverted to its former practices after the IMF departed, providing 
significant longer-term liquidity to selected banks according to 
criteria that were not publicly disclosed and not readily understood 
by the market.  This week, the NBU again sold dollars to selected 
buyers at far below market rates, and it conducted another currency 
auction on December 17 that, according to market participants, was 
not fully transparent, as several banks reportedly claimed that 
their bids had been excluded for reasons that the NBU would not 
specify.  At a recent press conference, NBU Governor Volodymyr 
Stelmakh and Finance Minister Viktor Pynzenyk said interest rates 
would rise and liquidity would be curtailed, yet they gave 
conflicting statements on the nature and extent of planned rate 
hikes.  We understand that the IMF is intending to write to the NBU 
and MOF to drive home the message that liquidity needs to be 
tightened, that interventions must be made more transparent and 
consistent, and that progress needs to be made on bank 
reconstruction. 
 
5. (SBU) The NBU's actions raise more questions about governance, 
corruption, and behind-the-scenes deal-making.  Major television 
programs are addressing the NBU's lack of capacity to handle the 
crisis as their number one news item.  Business daily Profile has 
advertised its current edition on billboards across Kyiv by 
brandishing a picture of NBU Governor Volodymyr Stelmakh in a pose 
of dramatic shame.  There is also a pervasive lack of trust in the 
banking sector.  Raiffaisen Bank Aval, the country's second largest 
bank with an Austrian bank as its majority shareholder, has resorted 
to building-sized advertisements in central Kyiv, marketing high 
interest rates to bolster deposits and reign in withdrawals. 
Businesses and workers report to us, however, that Raiffaisen has 
held wage and other corporate payments for two or more weeks before 
transferring money to accounts.  ING Bank has pressed orange clad 
teens into service, canvassing passers-by with offers of special 
deals for term accounts.  We hear anecdotally that ordinary 
Ukrainians are withdrawing hryvni
a deposits from subsidiaries of 
foreign banks, such as ING, in order to convert savings into 
dollars.  The lack of available safe deposit boxes does not deter 
 
KYIV 00002464  002 OF 002 
 
 
most Ukrainians, who have a tradition of storing wealth under 
mattresses or beneath loose floor boards. 
 
6.  (U) Ukraine's economic crisis is getting very bad very quickly. 
The government reported a 14.4 percent month-on-month drop in GDP 
(from October to November), and a cumulative 2008 GDP decline from 
5.8 percent (in January-October) to 3.6 percent (in 
January-November), reducing the overall GDP forecast for the year. 
The largest sector-based declines were registered in construction 
and energy (falling 16.1 percent and 3.6 percent, respectively, in 
January-November).  Industrial production contracted 28.6 percent 
year-on-year in November (in October the decline constituted 20 
percent).  The steep fall in domestic and external demand, due to 
the plunging global commodity prices, sharp economic slowdown in 
major trading partners and frozen credit activity, has caused a 
severe contraction in all industries.  The largest output fall in 
November was registered in export-oriented sectors, such as 
metallurgy, machine building and chemicals (declining 48.8 percent, 
38.8 percent, and 35.2 percent year-on-year respectively). 
 
7.  (SBU) There are growing concerns about the sufficiency of the 
IMF program to plug Ukraine's 2009 financing gap.  The Ukrainian 
government announced that external debt grew to $107 billion at the 
end of the third quarter of 2008.  This figure could increase, if 
rating declines trigger technical defaults or loan calls with 
sovereign guarantees.  In a December 16 discussion with us, the 
EBRD's Piroska Nagy said many foreign parent banks would fail to 
roll over debts owed by subsidiaries, contrary to a key IMF 
supposition in its SBA, and questioned whether the IMF's projected 
financing gap for 2009 of somewhat more than $10 billion is still 
accurate.  According to Deputy Prime Minister Grigoriy Nemyria, who 
spoke with the Ambassador on December 17, Prime Minister Yulia 
Tymoshenko reportedly reached out to IMF Managing Director Dominique 
Strauss-Kahn on December 17 to discuss the IMF program in light of 
the worsening economic situation. 
 
8.  (SBU) Comment.  Tied up in knots over policies that have all 
gone wrong, the NBU is failing to take the most rudimentary steps to 
reestablish trust in the hryvnia.  The IMF is likewise stuck with 
more than its reputation on the line.  The first $4.5 billion 
tranche has already been disbursed and roughly $12 billion awaits 
GOU action on key fiscal policy and banking sector reforms.  IMF 
officials recognize they tread a thin line.  After speaking softly 
to journalists about the GOU's unsteady implementation of 
conditionalities last week, the IMF's Ceyla Pazarbasioglu privately 
expressed deep concerns about the deteriorating economic situation 
and poor policy making at the National Bank and the Ministry of 
Finance.  Yet the IMF's overall criticism of the NBU policy response 
has remained mild.  Despite perceived risks to market confidence, 
the IMF will likely need to come down harder on Ukraine to maintain 
credibility and increase the chance that its conditionalities will 
be fulfilled.  Otherwise, were the next IMF tranche not disbursed, 
Ukraine will undoubtedly fail to meet external commitments, greatly 
increasing the odds of a true country-wide meltdown.  End comment. 
 
TAYLOR

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