The Institute of Evolutionary Economics

Innovation is a historically irrevocable change in the way things are accomplished. J. Schumpeter УКР РУС

Attention: The Forecast!

Analysis of the current situation and the exchange rate forecast for 2009 from Oleg Ostrokomorts

We expect that the exchange rate in Ukraine should be established at a new balanced level in the range of UAH 8,7 – 9,0 in the end of 2009 – beginning of 2010. For its more accurate forecast some data on the balance of payments for the third quarter 2009 is required from Ukrainian National Bank. Assuming a steady-state value of the exchange rate of UAH 8,5 for $1 (not the official one of UAH 8,01) i.e. its current state in the cash market, we can expect its further decline to the level of UAH 9,0 for $1 in case of confirmation of a negative balance.

Considering the two factors we can expect that the national currency will strengthen to the level of UAH 7,7. First, Ukraine still has a shortfall of technological balance. Secondly, despite the fact there is a negative balance of payments, it continues to decline, and it's hard to say when the process will be stabilized. If to assume that by the end of 2009 or in the first half of 2010 it will be positive, then for sure we will speak about over devaluation.

The basis for this statement is the analysis of the current situation of Ukraine's balance of payments.

During the Q2’2009 we see a decline in current account balance to $54 million, which is due to increased amount of transfers of $1,054 million versus $629 million in Q1’2009 according to the Ukraine National Bank. Reduction of the current account deficit was also fuelled by reducing the negative value of the "goods" account due to a faster reduction of import Vs. export. The decline in domestic industrial production, the weakening of the exchange rate, reducing disposable income and consumer lending contributed mostly to this process.

According to official Q2 data the deficit of the account of capital and financial transactions was reduced from $4529 million to $2009 million due to the payments for the corporate sector obligations and a slight investment inflow. We can talk about some stabilization in the financial sector, as evidenced by the deficit decrease in the financial account versus the previous period. However, it is still far to go to complete stabilization, since it is not clear how this sector withstands the blow from the reduction of business activity caused by restriction digestion at the end of 2008 - beginning of 2009, when the monetary base and money supply were drastically reduced. Bankruptcies are not observed in this sector, but the number of administrations is growing.

The deficit of payments balance was financed in 2063 million dollars with an increase in reserves at 754 million dollars.

According to preliminary data for Q3, there is a decline of the negative current account balance up to $ 44 million, helped by growth in exports of goods by 6,5% compared to July. These data indicate the almost fully balanced current account in the prescribed by National Bank rate of UAH 8,0 for $1.

But perhaps to achieve the balanced value Ukrainian hryvna would fall below this value - to UAH 8,7 – 9,0. It could be forecasted more accurately when there is Q3 correct data available.

Forecast risks.

The processes that affect the dynamics of the rate may be varied in different directions based on different factors, not only on internal ones. Under certain circumstances, we can expect the strengthen increase of the external factors for hryvna. For example, a soft monetary policy of the Federal Reserve which holds the rate corridor and the federal funds rate of 0-0,25% is already causing concern among investors. This is the reason why a gold value as a hedge risk in case of dollar inflation is increasing. It is natural to expect that in the case of reducing the price of the dollar, hryvna will get an impulse for its strengthening.

If this factor works, the process of strengthening the hryvna can be sustained. In such a scenario the corporate sector and the population actively will bring dollar resources to the market. Ukrainian National Band is always ready to come back to the tight monetary policy, thus, there are the factors for a possible strengthening of the exchange rate in the medium term period.

In contrast to these factors we should consider the traditional way of organization of the Ukrainian economic system, namely a low level of economic development based on current situation.

The Forecast including the possible changes due to the risks of its implementation.

The domestic factors making the exchange rate low are still: an imbalance of the economic system which is expressed by the absence of capacity to produce the necessary quantity of goods and services; low level of economy. Eventually it causes the growing risks of the inflationary pressure and lowering the real level of living.

Taking into account the negative forecast of corporate management and worsening the financial conditions of commercial banks, we consider the rate of UAH 9,0 or even 10,0 or $1 for the calculation.

The dynamics of the account balance shows encouraging trends, so we can expect hryvna to be strengthen below UAH 8,0.

The finance situation in the corporate sector in general and in banking area in particular is a risk in the forecast.

In the past two years the economy has been supported by the harvest of agricultural crops. We will see whether it is the case this year.

Again, if the administrative intervention in the economy is too big, the economic recovery will take more time.

Conclusions.

Crisis tendencies in the economy of Ukraine in 2005-2008 are the result of breaking the fundamental macroeconomic proportions.

The imbalance of economic structure and the weakness of its industrial base are the significant part of crisis in the Ukrainian economy.

The adequate measures in this situation would be: in the short term it is an appropriate policy of Ukrainian National Bank, which would help to eliminate the negative current account balance of payments. In the medium and long term it is about to create and grow the innovative industries which could become the "locomotive" pulling the economy out of crisis, also develop the financial and currency market.