Ukraine Euro Move Is A Sign, Not Policy Shift

MOSCOW, Russia -- Unprecedented moves by Ukraine's central bank to bid for euros this week should signal that the dollar's importance for the country is waning and that a multi-currency basket could be on the horizon.

But analysts said any decision to change the bank's policy of pegging the hryvnia to the dollar will not come swiftly -- fraught as it will be with political wrangling, instability and a changing economic landscape.

The bank on Tuesday for the first time bid openly for the euro at 7.3739 hryvnias and on Thursday bid again at 7.3195.

The bank's transactions are normally private, between individual banks.

"I see in this a step towards a more complex formula for establishing the exchange rate. This is a movement towards a basket," the central bank's top adviser Valery Lytvytsky told Reuters in an interview on Thursday.

Lytvytsky did not specify which currencies could be in a basket, but said there could be more than two and that a change could come about as early as this year. Russia already has a basket of 0.55 dollars and 0.45 euros for its rouble.

"The basket need not necessarily be made up of just two currencies," Lytvytsky said. "In my opinion, this can and should be done at some point this year, although we would have to see what the situation looks like in autumn."

Ukraine's central bank has already shifted away from a strict three-year policy of pegging the hryvnia to the dollar at 5.00-5.06 and intervening on the market appropriately.

It was absent from the market around February-March when the hryvnia crept up against the dollar, fuelling speculation that it could revalue its official rate. It did just that in May.

But the revaluation to 4.85 hryvnias to the dollar from 5.05 did not go smoothly -- the bank's council vetoed it only to have that decision overturned by the executive board, headed by veteran Chairman Volodymyr Stelmakh.

Many believe the differences within the central bank reflect the tug-of-war between President Viktor Yushchenko and Prime Minister Yulia Tymoshenko, allies during the 2004 Western-orientated "Orange Revolution".

While the two battled over privatisation, energy policy and benefits, inflation soared and has stayed around 30 percent annually, forcing the bank to loosen its rigid policy.


Yet even then Yushchenko appeared to back the bank's council by saying that revaluation would hurt exporters, while Tymoshenko left the topic alone, citing the bank's independence.

Such wrangling prompts little hope for a decisive move soon: the bank's adviser speaks of no formal links to the dollar, while the council has just set an official rate of 4.85 hryvnias to the dollar, plus or minus four percent.

"The situation in Ukraine is quite dangerous ... Authorities should take inflation seriously. It's very hard to call whether this will be done or not, given the track record of successful talks," said Katya Malofeeva, analyst at Renaissance Capital.

"The sooner the central bank very clearly states what its policy targets are and what instruments it will use and the government supports that, the better."

Analysts say there are strong reasons to give more weight to the hryvnia's value against the euro.

"When it comes to the Ukrainian trade basket, the euro is quite important ... If Ukraine moves toward a euro-dollar basket that would quite accurately reflect a trade basket," said Martin Blum, head of emerging markets macro and strategy at Unicredit.

But other factors may weigh against such a move.

"A lot of the key commodities are still transacted in dollars -- oil, gas, metals," said Ivailo Vesselinov, analyst at Dresdner Kleinwort. "That is still an important anchor and something the authorities recognise."

Ukraine's economy is driven by exports, in particular steel -- a commodity that has enjoyed soaring prices in the past year.

The hryvnia is also expected to weaken towards the end of the year due to a wider balance of payments as prices for gas imports have risen steeply since 2005 and may double next year.

"In addition, if you believe that the euro/dollar (exchange rate) is about to turn around, then pegging to a potentially depreciating currency will also have its implications," Vesselinov said.

"(A move is) much more a factor for 2009 and beyond. Of course, the increase in the focus on the euro is an ongoing trend that has already begun. You'll see more of this in coming months, such as the bank regularly quoting euro rates."

Malofeeva was also pessimistic.

"Ukraine's own situation with a widening current account deficit and at least some portion of debt traded by speculators, definitely does not bode well for a stable or an appreciation of the currency vis a vis the dollar or anything really," she said.

Source: Guardian UK