Ukraine Rates No Relief for Worst Currency: East Europe Credit

Ukraine’s decision to increase interest rates is doing little to stave off concern that the currency will slide further even as the International Monetary Fund tries to keep the economy afloat.

The hryvnia fell 1.5 percent to 13.3 per dollar at 4:06 p.m. in Kiev, extending its August drop to 7.7 percent, the most among currencies tracked by Bloomberg. Forward contracts show it weakening to 13.6 per dollar in three months even after the central bank raised its overnight refinancing rate by 2.5 percentage points yesterday.

Ukraine, which agreed to a $17 billion IMF bailout in May, is grappling with foreign-currency reserves tumbling toward a nine-year low and an economy facing the worst contraction since 2009 amid a separatist uprising in the country’s east. Citizens have offloaded their hryvnia in “panic” due to concern that Russia, which the U.S. and its allies blame for destabilizing Ukraine, will invade the country, central bank Governor Valeriya Gontareva told lawmakers in Kiev on Aug. 12.

“The fate of the hryvnia depends on how the geopolitical situation evolves,” Thu Lan Nguyen, a strategist at Commerzbank AG, said yesterday. The IMF aid “is unlikely to be sufficient to reverse the trend of capital outflows, rather it will provide a bridge until the situation calms again,” she said.

Bonds Slide

Sovereign Eurobonds have lost 1.7 percent this month, the worst performance after Argentina, Pakistan and Venezuela among more than 50 countries in the Bloomberg Dollar Emerging Market Sovereign Bond Index. The yield on the government’s dollar debt maturing in April 2023 rose three basis points to 9.01 percent today after slumping 28 basis points yesterday.

Three-month historical volatility for the hryvnia has soared more than four percentage points this month to 14.6 percent yesterday, the highest globally. The lack of progress in bringing an end to months of fighting between government forces and insurgents has contributed to worsening the currency’s 38 percent retreat versus the dollar this year, the biggest in the world after Ghana’s cedi.

Ukrainian government forces have taken control of one of four districts in the pro-Russian separatist stronghold of Luhansk and are fighting in the city center, an army spokesman said yesterday.

Recession Worsens

While National Bank of Ukraine rate decisions may help temper hryvnia price swings, “there is not much more they can do,” Frankfurt-based Nguyen said by e-mail. Commerzbank is reviewing its year-end exchange-rate forecast of 11 per dollar due to growing “geopolitical uncertainty,” she said.

By contrast, Alexander Pecherytsyn, a Kiev-based analyst at Credit Agricole SA, is sticking to his projection for the currency to gain to 12.15 per dollar by Dec. 31. Yesterday’s policy move, which took the refinancing rate to 17.5 percent, “provides more arguments for hryvnia strengthening,” he said.

Economists scaled back their projections for Ukraine’s economy this year as Russian President Vladimir Putin’s annexation of the Crimea peninsula in March triggered the worst standoff between Russia and the U.S. since the Cold War.

The nation’s gross domestic product will shrink 5.2 percent in 2014, according to the median of 20 analyst estimates in a Bloomberg survey. That compares with forecasts for growth of 1.5 percent before Putin’s incursion into the Black Sea region.

Dwindling Reserves

Ukraine will run a budget deficit this year at 5 percent of GDP and the country will need more financial aid than planned under the IMF bailout, Finance Minister Oleksandr Shlapak told reporters in Kiev today. The government will organize a donor conference in September, he said.

“The original program assumptions were way too optimistic,” Timothy Ash, an economist at Standard Bank Group Ltd. in London, said by e-mail today. “Obviously the marked depreciation of the hryvnia also does not help.”

One of the conditions for the IMF aid package was for the country to reduce support for the currency, which depreciated to a record 13.715 per dollar on Aug. 12, according to data compiled by Bloomberg. The central bank, which didn’t reply to Bloomberg News e-mails seeking comment on its rate decision, also intervened in the foreign-exchange market yesterday, the Unian news agency reported, without giving details.

Foreign reserves fell by $1 billion in July to $16 billion, compared with a nine-year low of $14 billion in April. Inflation accelerated to a five-year high of 12.6 percent last month.

“This hike is a reaction to the weakening of the hryvnia in recent weeks,” Robert Simpson, a money manager at Insight Investment Management Ltd. in London, who helps oversee $3.5 billion in emerging-market debt, said by e-mail yesterday. “Ukraine needs to protect their reserves as they look to qualify for further IMF support and are also concerned about the impact of the hryvnia devaluation on inflation.”