NATIONAL BANK CRITICISED AS INFLATION FEARS WORSEN
By Jim Davis, Business Ukraine magazine
Kyiv, Ukraine, Monday, November 12, 2007

In Ukraine's political vocabulary, stability and the free market are basic parts of the mantra. Yet, in practice the two may be antithetical, a point that may soon be proven in the market place, in spite of the National Bank of Ukraine's efforts to the contrary

A growing number of economists and others believe that the hryvnia stability drive which has been the centre of NBU policy in recent years is under threat and a major adjustment is no more than a year away. There are also indications that the legislative straightjacket within which the NBU works requires urgent rethinking by a parliament that does not exist today and one which according to accepted wisdom will hardly be prepared for serious legislative reform when it finally does.

Dangerous balancing act

A major part of the problem is the NBU balancing act in which it tries to exercise its legal responsibility for maintaining stability of the national currency, while it also for other reasons tries to keep good political relations with whoever might be in power. These two often competing elements of the same equation now seem set on a collision course that may already be beyond correction.

The roots of the looming crisis to some extent lie in Ukraine's persistent habit of forcing what should be measured long-term economic decisions into some sort of rhythm with Ukraine's cycle of elections. Thus, when Ukraine has two major elections in a relatively short time, the contrasting tides tend to make for whirlpools of economic danger.

The NBU loosened the money supply by a huge amount as the recent parliamentary elections neared. In spite of this money influx, the nation's inflation rate was officially registered as a remarkable 0.6% in August.
However, almost all economists contacted by Business Ukraine believe the August inflation number as officially reported was questionable at best.

They point to the far higher post-election inflation numbers cited in a number of influential international reports as evidence that the August number was deflated in the extreme. Inflation rates were stated at 2.2% in September and jumped again to 2.9% in October, leading to a belief that the August number was seriously understated.

Even more revealing is a year-to-year comparison, which shows that October
2007 inflation was 14.8% over the rate in October 2006.

Valentin Zelenyuk, an economist who recently left academia for financial services provider Millennium Capital commented that the NBU showed its concern for the situation with its huge jump on November 8 in the refinance rate from 9% to 12%, with the rate actually climbing to 12.5% for all those funds not underwritten by government bonds.

"No one expected such a large increase. I think it was too much; it would have been better to do slowly, perhaps with an initial 1.5% jump with a further 1% later, if necessary. This move would have helped suppress inflation, but it will also slow down growth. However, if this doesn't work, then the NBU has no other tool. Another 1% jump would not work and another 3% jump would be crazy," he argues.

Zelenyuk remains confident that economic growth will continue even in the face of inflationary fears, but counsels caution. "For now, we are sticking with our figure of a 6.9% increase in gross domestic product (GDP) but we think those in government who are projecting an even higher increase are off the mark."

He reflects that the key to economic stability is a continued inflow of foreign direct investment, something that at this point appears to be on track, which should be sufficient to counter other, negative factors.

Perilous printing practices

Oleksandr Zholud, an economist with the International Centre for Policy Studies, sees an inflationary role being played by the rising tide of international capital being attracted to Ukraine. "The NBU is faced with a rising supply of foreign capital. They bought the equivalent of USD 7 billion during the first 10 months of 2007, which all went towards increasing Ukraine's foreign currency reserves.

However, these purchases were financed simply by printing hryvnias, not by the issuance of domestic bonds, which would have been a less inflationary way to accomplish the same thing," Zholud opines.

"The problem is that the domestic bond market is small and huge government bond sales would have a very negative impact on the ability of private companies to raise money through the same mechanism. The domestic bond market is too small and not as liquid as it should be," he adds.

Unsound economic structures

Another noted economist, Pavlo Prokopovych of the Kyiv School of Economics, believes that impending hryvnia instability with its associated problems is to some extent the result of structural problems in the government.

"The NBU says its responsibility is to keep the exchange rate stable. The Ministry of Economy says that its mandate is to keep the economy growing.
Neither one assumes responsibility for keeping inflation under control, which means the job is not getting done," Prokopovych says.

This has led to a lack of accountability at a high policy level of government and allowed top officials to skate round the serious issue of rising inflation. It has also allowed government bodies to pursue short term solutions that might well have unfortunate repercussions if the global economic slowdown kicks in, as many expert are predicting.

Prokopovych argues that the recent money-printing escapades of the NBU have positioned the Ukrainian economy in line for a fall. "Huge economic problems are approaching. With the money printing that the NBU did during the summer and the world problems such as the subprime credit crunch, which has had an effect on all major world markets, I see a major economic readjustment coming in Ukraine, probably no later than the end of 2008. The situation is deteriorating pretty fast," he offers.

Accusations of meddling

The predicted devaluation of the hryvnia is not the only NBU-related problem that concerns some in the business community. A well-known lawyer, speaking on the condition of anonymity, said, "The NBU does not listen. They had a tendency to meddle in matters outside their banking domain under previous bank governors and that remains the case with the current leadership. They simply have no idea about the world market.

"If one of my foreign clients wants to make an intercompany loan to its wholly-owned subsidiary in Ukraine, a license from the NBU is required. It appears they deliberately slow down the process and make it more difficult.
What they are doing is called a license, but actually it is required prior to approval by the NBU of an intercompany loan that should be none of their business."

The source also pointed to a lack of logic in the NBU's relations with the State Tax Administration (STA). "There are times when the NBU requires a certificate from the STA for the repatriation of certain assets of international companies. We go to the STA, where we are told that such a certificate is not needed and furthermore that they will not issue one. One government agency says we must have the certificate, another says it's not needed and our client is left in a muddle - in the middle," the source adds.

Unnecessary red tape

"They [NBU] create redtape for no reason and they are a deterrent to foreign investors here with their overregulation. There is a need for a new generation of managers to bring the NBU into the 21st century," the source concluded.

Margarita Karpenko, managing partner of DLA Piper Ukraine LLC, said, "We tend to cooperate with other law firms when we get into the international area. However, several years ago, we were doing more business that required direct NBU contact. We found it difficult to deal with them then and we think that the situation remains unchanged. Ukraine's banking laws are just not adjusted to the business climate."

LINK: http://www.businessukraine.com.ua/national-bank-criticised-as