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On July 21, the National Bank of Ukraine literally became the main newsmaker in the country.

First, at 9:53 a.m., the National Bank of Ukraine announced a change of the official exchange rate of the hryvnia against U.S. dollar by 25%, to UAH/USD 36.57, which happened for the first time since the beginning of the full-scale war. Moreover, it was clearly mentioned that in the future the official UAH/USD exchange rate would remain fixed, as well as the rate of the cashless market (with a possible deviation of more than 1% from the official rate, i.e. up to UAH/USD 36.93). In addition, the National Bank of Ukraine introduced a number of additional restrictions, mainly on operations using hryvnia payment cards abroad.

However, already at 2:00 p.m. the Board of the National Bank of Ukraine announced another decision to keep its key policy rate at 25% per annum. Besides, for the first time during the full-scale war, the National Bank of Ukraine published its own macroeconomic forecast (in brief form).

Therefore, the traditionally high-profile event – the announcement of the decision on the key policy rate – was somewhat overshadowed by the morning decision on the exchange rate change. This is natural, because the exchange rate, unlike the key policy rate, really affects the level of consumer prices.

The decision to sharply change the official exchange rate was forced, as the situation with two exchange rates (officially cashless and quasi-market-cash) and the widening gap between them was becoming critical.

How optimal this change was is another matter.

In fact, the NBU “moved up” the official rate to the level of the cash market rate of the previous day. Despite the rather nervous reaction of the cash rate (a spike to UAH/USD 40), the gap between it and the official rate has narrowed.

Leaving aside the obvious impact of the sharp devaluation on the price level (inflation), the National Bank of Ukraine managed to mitigate the problem of multiple exchange rates for a while and thus to slow down the burning of international reserves.

Another “beneficiary” of the change of the official rate is currently the Ministry of Finance, as the devaluation raises the hryvnia equivalent of external revenues, which are the main source of financing the budget deficit, by 25%.

However, all these benefits are temporary. Combating symptoms usually does not guarantee recovery. The National Bank’s tactical decision by no means solves the problem, which is based on the attempt to combine administrative regulation with ‘market’ mechanisms.

For instance, the National Bank of Ukraine reduced the difference between the fixed and cash exchange rates, but the problem (the different logic of setting these rates) has not disappeared. The war is going on, the economy is in a deep recession, which together creates favorable conditions for panic moods… Meanwhile, the rate of the cash market is not controlled in any way. Logically, after some time the NBU may again be faced with the need to change the official exchange rate.

The problem obviously needs a comprehensive solution, but this is a topic for a separate conversation.

For now, let us return to the key policy rate.

I expressed my opinion about the increase in the key policy rate from 10% to 25% as early as June 2, immediately after the NBU announced this decision. Since then, my opinion has not changed, it is absurd.

Let me remind dear readers of the purpose of raising the key policy rate, vaguely formulated by the National Bank in the press release of June 2:

Along with other measures, this resolute step aims to protect households’ income and savings in the hryvnia, raise the attractiveness of hryvnia assets, reduce the pressure on the foreign exchange market, and thus enhance the NBU’s capability to maintain the stability of the exchange rate and restrain inflation processes during the war.” 

A logical question arises: how can the collapse of the official hryvnia exchange rate by 25% be reconciled with the concept of exchange rate stability?! And what about enhancing the capability of the National Bank of Ukraine?

The National Bank of Ukraine traditionally looks for the reasons for its failure in the actions of the Ministry of Finance, in particular, in the monetization of the budget deficit. They say, the “issued”hryvnia enters the foreign exchange market and puts pressure on the exchange rate.

However, this logic would work if the economy were limited only to the financial sector. Fortunately, this is not the case. And the budget money performs many socially useful functions and only later some part of it can enter the foreign exchange market.

Therefore, to directly compare the volume of the NBU currency interventions with the volume of monetization of military bonds (as the National Bank of Ukraine does it) is an open manipulation.

It should be noted that the Ministry of Finance, despite its obvious unwillingness, increased the yield of military bonds (which the National Bank of Ukraine has been seeking from it for almost three months). At the July 19 auction, one-year government issued bonds were placed at 14% per annum, compared to 11% a week earlier. Due to this, it was possible to attract UAH 1,780 million to the budget, against UAH 98 million attracted at the previous auction (for annual bonds).

It is easy to calculate that as a result of the increase in profitability by 3 р.p. additional budget costs for servicing annual government issued bonds placed on July 19 will amount to over UAH 50 million. And this is only one auction and a relatively small amount of placement. Such auctions are held every Tuesday.

But this increase in the yield of military bonds did not satisfy the management of the National Bank of Ukraine, which believes that ‘the Ministry of Finance is adapting to new conditions quite slowly’.

We expect that in the coming weeks the Ministry of Finance will more actively raise interest rates on its instruments, said NBU Deputy Chairman Serhii Nikolaichuk during the press briefing on July 21.

The press release of the NBU regarding the exchange rate change finishes with a “modest” wish:

Important measures to ensure exchange rate and macro-financial stability are the narrowing of the budget deficit, the replacement of monetary financing of the budget with market borrowing and the reduction of imports, in particular by imposing additional taxes on imports in order to increase the competitiveness of Ukrainian producers.

That’s right. Having showed great “success” in ensuring the hryvnia stability, the National Bankof Ukraine began to form budget, debt and tax policies. What would the NBU’s reaction be if the government allowed itself something similar regarding monetary policy?

Although in general the answer is clear. Volodymyr Lepushynskyi, Director of Monetary Policy and Economic Analysis Department of the NBU, actually responded to the quite diplomatic hints of the Ministry of Finance regarding the excessive attractiveness of NBU deposit  certificates that blocks liquidity in the banking system and makes it difficult to attract funds to the budget, as follows:

Determining the value of money in the economy, that is, conducting monetary policy, is the task of the NBU, not the Ministry of Finance. If the opposite happens, it will mean the loss of the independence of the National Bank of Ukraine, which will lead to deterioration of European integration prospects, have a negative impact on ensuring price and financial stability and on economic growth in general.

Briefly and clearly: “loss of independence of the National Bank of Ukraine”. The tone of such statements makes it clear that there is in fact no ‘active dialogue with the government’, as the NBU says. Even the war did not force the management of the National Bank of Ukraine to abandon their“corporate” logic.

The National Bank of Ukraine frightened everyone with the threat of fiscal dominance for so long and methodically that the society did not notice that it found itself in a situation of dominance… monetary. Is this normal? Obviously not. And in a state of the full-scale war, it is unacceptable.

In this regard, unfortunately, at the beginning of the full-scale war a wartime government was not created, which would coordinate the actions of various authorities (state administration), subordinating them to a single goal. However, it is not too late to address this shortcoming.

Mykhailo Dzhus, Head of Money Markets Department of the Growford Institute for LB