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What impact the decisions of the National Bank of Ukraine have on the country’s defense.

While society was breaking down into quotes the famous article from The Washington Post and was rejoicing at another “bavovna” (explosions – transl.) in Crimea, there was an event in the financial sector that could significantly complicate the country’s defense in the near future.        

At another auction for the placement of military bonds taking place on August 16, the Ministry of Finance managed to attract a meager (relative to needs) UAH 71.5 million to the budget.    

The dynamics are impressive, because at the two previous auctions (on August 2 and 9), the volume of placement of hryvnia government bonds was although insufficient but more than UAH 3 billion.    

There must be a logical explanation for this. And it certainly is.  

The plunge in demand for military bonds is a consequence of the purposeful destructive actions of the National Bank of Ukraine.

Since the end of April the National Bank of Ukraine has begun to encourage the Ministry of Finance to place bonds on “market” terms. According to the NBU, this was supposed to be done due to Ministry of Finance’s raising the rates on government issued bonds “to more attractive levels for their buyers”.

In its recommendations, the NBU actually ignored the fact that the country is in a state of war, in which the concept of “market” is very limited.

The Ministry of Finance was in no hurry to follow such “advice”, since raising the rates on military bonds would lead to a significant increase in the cost of servicing the public debt, which is unacceptable during the war.

Therefore, the National Bank of Ukraine moved from calls to actions: on June 2, the key policyrate was raised from 10% to 25%.      

The purpose of this controversial decision was “protecting household income and savings in hryvnia, increasing the attractiveness of hryvnia assets, reducing pressure on the foreign exchange market and, as a result, strengthening the ability of the National Bank of Ukraine to ensure exchange rate stability and prevent inflationary processes during the war”.    

However, a month and a half later, we found out that big words about exchange rate stability are an empty sound: on July 21, the NBU announced a “change” of the official exchange rate by 25% to the level of UAH/USD 36.57.

The real purpose of raising the key policy rate to a sky-high level was to increase the interest rate on NBU certificates of deposit tied to it from 9% to 23% per annum.

Having received this fantastic alternative for investing free funds, the banks reacted quite logically – they significantly weakened interest in military bonds: the volume of placement of hryvnia government bonds fell to UAH 8.8 billion in June, and to UAH 6.5 billion in July, while as recently asMay it was UAH 27.2 billion.

An important point is that the annual inflation rate in April was 16.4%, and banks were perfectly aware of the prospect of its further acceleration to 20% and higher.

However, this did not stop them from buying military bonds in May at 9.5-11.5% per annum. That is, the determining factor was not the rate of inflation, but the level of interest on deposit certificates (9%) as an alternative for investing funds.

It should be emphasized once again that by raising the rate on deposit certificates to 23%, the National Bank of Ukraine took the unprecedented step that has no logical explanation.

Today, high inflation is a problem for almost the whole Western world. In the Eurozone, inflation reached a record 8.9% in July, but the ECB deposit rate is 0%.

This difference is even more pronounced on the example of Baltic countries (members of the Eurozone): in Latvia, the annual inflation rate in July was 21.5%, in Lithuania – 21.6%, in Estonia – 22.8%.

In Poland, which has its own currency, the central bank’s deposit rate is 6% with inflation at 15.6%. As they say, feel the difference!

But there is one but. No matter how absurd the National Bank’s decision to raise rates on deposit certificates significantly above the inflation rate (note that in May the inflation rate was 18%), it is surprisingly consistent with the law on the NBU.

The National Bank can set the rates it finds necessary. This is the price of central bank independence.

It is precisely because of discretionary powers (the right to act at one’s own discretion) thatpeople with an impeccable reputation and a deep understanding of the economy make the management of central banks in democratic countries. But, as we can see, this does not apply to Ukraine.

But what, after all, happened in mid-August? Why did the volume of placement of military bonds fall in 48 times to the level of statistical error in one week (from August 9 to 16)?

The factor of deposit certificate (the main one) has been in effect for the third month in a row, but the Ministry of Finance still managed to place government bonds worth several billion hryvnias in one auction. So, there were some other factors.

One of the likely reasons for the decrease in demand for military bonds in the primary market is the resumption of the stock market, which took place on August 8. Currently, government issuedbonds with a maturity of one year are offered with a yield of about 18%, which is certainly higher than the 14% at the auctions of the Ministry of Finance.   

Another reason is one more informational attack on the Ministry of Finance by the NBU causingpanic.

As part of this information campaign, the Governor of the NBU was not afraid to inform the public about the possible “catastrophic long-term effects” of emission financing of the budget, including the “collapse of financial stability and loss of control over economic processes”, despite the fact that this kind of rhetoric directly contradicts the main constitutional function of the NBU.

Therefore, Mr. Governor continued to impose his own vision of budget and debt policy priorities, which are the exclusive competence of the Ministry of Finance.

In addition, the head of the NBU took the liberty of suggesting a likely increase in the yield of government issued bond after the opening of the secondary market. There is no doubt that banks closely follow the statements of the National Bank of Ukraine management.    

On top of that, a “control shot” on the chances of the Ministry of Finance to place military bonds on acceptable terms is the rumors that certain employees of the National Bank of Ukraine call banks-primary dealers and “ask” them to set bids at auctions at rates of 20-23% per annum, forming the market conditions in this way.

Considering the persistence with which the NBU is “forcing” the Ministry of Finance to raise interest rates on government issued bonds, it is easy to believe that this information may be true.     

And if an excessive increase in the rate on deposit certificates can still somehow be “considered”within the limits of legality, then there will obviously be specific articles in the Criminal Code for such “requests” from the NBU.     

So, the situation looks like this: the state in a war suffers from a shortage of funds to finance military expenses, but about UAH 200 billion of free liquidity is blocked in the banking system (apart from the funds of banks in foreign currency), which increases by more than UAH 3 billion every month due to interest expenses of the NBU on deposit certificates.     

And our native National Bank of Ukraine is doing everything possible and even impossible so that this problem only deepens. Someone needs to change this asap…


advisor to the Minister of Finance, founder of the GROWFORD Institute