Ukraine's Keystone Central Bankers.

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Ukraine Floats Currency. It Sinks.

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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Only yesterday, the Belarusian ruble was the year's worst-performing currency in the world. Today, after Ukraine's National Bank effectively floated the hryvnia, it overtook the neighboring country's currency in a race to the bottom. In the weeks ahead, despite expected financial aid from the International Monetary Fund, the hryvnia's fall will be hard to top.

In recent months, Ukraine was probably pursuing the most clueless exchange rate policy in Europe. In the run-up to the October parliamentary election, President Petro Poroshenko used his good relationship with National Bank governor Valeria Gontareva to persuade her to keep the exchange rate below 13 hryvnias to the U.S. dollar. In late September, banks were ordered not to sell more than 3,000 hryvnias' worth of foreign currency per day to their customers. At the same time, the National Bank started holding special auctions in which it sold $3 million per day to banks to set a so-called "indicative rate" that they were supposed to follow in transactions with clients.

After the election, even that artificial rate dropped quickly, moving to 16 hryvnias per dollar in a matter of days. The banks, however, only displayed that rate at exchange offices, where citizens could barely buy any foreign currency anyway. Among themselves, they traded at rates that were about 20 percent higher than the official one. For ordinary Ukrainians, there was also a lively black market, where rates were closer to the interbank ones than to the official benchmark.

Today, Gontareva announced the end of indicative auctions, allowing the banks to move to a single, market-determined rate. The result was a collapse of the hryvnia's value:

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The Ukrainian currency is now down 35 percent for the year, joining the Belarusian ruble and the Russian one (with drops of 29 percent and 15 percent, respectively) as the three worst-performing currencies in the world.

Gontareva's turnabout was likely prompted by the International Monetary Fund mission in Kiev, which has been busy drawing up plans for a new lending program for the country. It would be hard for Ukraine to claim it was treading the path of reform as long as it had a currency black market. Besides, uncertainty over the actual rate was distorting Ukraine's financial projections for the year. At a press conference today, Gontareva vehemently denied that she had agreed to an exchange rate of 25 hryvnias to the dollar with the IMF. "It's not even being considered," she said. But at the time of this writing the hryvnia was trading at 24.85 to the dollar.

The National Bank has imposed a 5.5 percentage point refinancing rate hike to 19.5 percent. It has also kept certain restrictions in place, including the 3,000-hryvnia restriction for private individuals and a requirement for exporters to sell 75 percent of foreign currency revenues for hryvnias. The first one means the black market will not go away: Ukrainians do still take foreign trips, and they need more foreign currency than they are officially allowed to buy. The second one is being willfully ignored as exporters choose not to repatriate their revenues. According to the National Bank, exports dropped 14.4 percent to $55.6 billion last year, partly because of the fighting in Ukraine's biggest industrial regions, but partly because official statistics don't record all the country's transactions.

Because of this, the National Bank's decision to float the hryvnia will hardly change anything for citizens or businesses -- they just won't have a useless official exchange rate to laugh at. Ukraine saw 25 percent inflation last year; this year, prices will keep rising at a fast clip.

At the same time, the high interest rate will severely limit lending to businesses. Russia tried a similar rate hike in December, but it had little effect on the ruble's value and the country's central bank is now rolling it back to make it easier for businesses to borrow and invest. Ukraine will probably do the same as soon as IMF aid arrives. For now, however, it can't afford to defend the hryvnia against banks and businesses hoarding foreign currency: today, the National Bank said its international reserves had shrunk to $6.4 billion at end of January, after the government paid $624 million in foreign debt servicing, sold $464 million to Naftogaz, which imports natural gas from Russia, and sold the rest at indicative rate auctions to banks.

The Ukrainian financial authorities' blundering has worsened the country's already desperate economic situation. The IMF is effectively setting Ukraine's policy now, because it is the country's only reliable source of foreign currency. It needs to focus on preventing Ukrainian politicians from making stupid self-serving decisions like the ones that caused the hryvnia debacle and spawned the black market. The Russian-instigated war in the east is not Ukraine's only problem: When it inevitably ends, bureaucratic incompetence, plaguing the country's transition to a modern economy, will remain behind.

To contact the author on this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor on this story:
Cameron Abadi at cabadi2@bloomberg.net