Two Scenarios for Ukraine after the Resignation of the NBU Governor

Launching “the money-printing press” or maintaining the independence of the bank?

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In our latest “What about the economy?” podcast on Hromadske Radio we spoke to Olena Bilan, Chief Economist of Dragon Capital, board member of VoxUkraine Editorial and Supervisory Boards, about the two potential scenarios for Ukraine after the resignation of the NBU Governor, about the importance (and complexity) of the notion of NBU independence and about ways for the economy to recover after the quarantine. 

To listen to the full conversation click here.

On the resignation of the NBU Governor Yakiv Smoliy

These events were shocking to many. Nobody expected the resignation of Mr. Smoliy. In mid-May, he said that he was planning to work until 2025 and that he did not feel any critical pressure imposed on the National Bank. 

What is important here is not his desire to leave but that he had to resign because of systemic political pressure. It is a much more alarming fact, that the resignation itself. People may quit for various reasons but here the primary reason is pressure on the National Bank – an institution that has a fine reputation in international circles, an institution that is professional, and that, in my opinion, was pursuing the right policy in the past years. This is what caused the negative reaction of the international community, foreign investors, businesses, and opinion-makers inside the country.

What will happen next? We all understand that Mr. Smoliy would have hardly handed in his resignation without knowing that it would be granted. I mean, of course, he will be dismissed, but going forward I see two scenarios – and here the ball is in Mr. President’s court as it is he who is to submit the new candidature for the approval of the Verkhovna Rada. Both scenarios depend on who the potential new NBU Governor is.

On the two possible scenarios for the NBU

Under the negative scenario, the new NBU Governor will be a politically dependent person, who will cater to the desires of politicians – the Office of the President, the government, the parliament. 

Politicians always look at very short periods as they are interested in making their constituency happy right then and there. However, the methods they use to maintain this level of welfare, as a rule, create economic problems and lead to a crisis. 

It is also possible that the National Bank, which has been independent since 2015, will become subordinate to the whims of politicians and will start mass printing of money to finance the significant budget deficit.

In this scenario, the economy will suffer negative consequences like increased growth of prices, inflation, fiscal market issues, weakening of currency rates, banking system problems. I believe this type of policy will quickly result in a financial crisis. Consequently, we will have a fiscal crisis in addition to a crisis in the economy.

In a more positive development, the President will appoint someone more prone to stimulating policy and decrease of interest rate instead of mass emission. And, most importantly, the person will be willing to stay in the IMF program. 

This scenario appears quite plausible, which we can observe in the reaction of financial markets – the initial response was very negative, dollar demand increased, yet everything died down quickly. We hope that the markets are right, and the President will suggest a candidate who will pursue a more or less reasonable policy and will continue cooperation with the IMF. 

On the NBU independence

The independence of the central bank is an essential condition of the IMF program. However, this independence has no quantitative measurement. Do we have 100% or 90% independence? Independence is a more qualitative index, which is hard to assess. 

The national bank must make collegiate decisions, i.e. involving all members of its Board. The switch to such a decision-making mechanism was an important part of the National Bank reform. There were cases when the National Bank Governor had a different opinion than the rest of the Board. And the Board decided against the opinion of the Governor. This is also a part of political independence as it is easier to convince and influence one person than a group of people. Among the most pressing questions, as for me, is whether the new Governor keeps this decision-making mechanism.

On loans and budget deficit

What is happening to the budget this year? The budget deficit is very high. It approaches the equivalent of 10 billion USD. Apart from funding this sum until the end of the year, we will also need to attract funds to cover the debt. We should pay the holders of Eurobonds and international partners. Besides, we need to pay off domestic debt under UAH and foreign currency bonds that are currently held primarily by banks, but also by foreign investors. The budget requires total funding of around 17 billion USD until the end of the year. 

To finance these needs, we will have to attract funds – primarily from our international partners like the IMF, the World Bank, the EU. Why? Because they offer cheap resources. Cheap and for quite an extended period. For instance, the World Bank has recently approved a loan for 30 years. It is impossible to attract funds from other creditors for such a long period.

Concerning the canceled sale of Eurobonds for 1 billion USD – we need these funds, but they are not critical at the moment – we can attract them later. 

There is no emergency about resources as in June Ukraine got the tranche of 2.1 billion USD from the IMF. The USA and the US extended another 500 million euros. What is more, the budget is replenished by two state-owned companies – Naftogaz and PryvatBank. They transferred a large sum in dividends – approximately 25 million UAH from PryvatBank and even more from Naftogaz – up till 40 billion UAH. All this resulted in an adequate level of liquidity for the government – more than 5 billion USD on the accounts in UAH and foreign currency. The Eurobond sale can be revisited later – on condition that Ukraine continues cooperation with the IMF.

On economic recovery after the pandemic

I have seen different forecasts of economic recession this year – varying between 1% and 10%. The same goes for positive forecasts for the next year – some predict an increase of 1%, others expect 6% or 7%. We expect a decrease of 7.2% this year and an increase of 4.3% next year. 

The results differ so much because they are based on different scenarios of coronavirus spread. It remains a major factor that we cannot foresee, and which will determine whether the national quarantine is prolonged. What is positive is that the government switched to adaptive quarantine – it was recommended by analytical centers, Centre for Economic Strategy, Kyiv School of Economics and the government took the recommendations into account. Nevertheless, the requirements of social distancing remain and will serve as a limiting factor for the economy. 

It means that passenger travel will not bounce back to the pre-crisis level for a very long time – both air travel and municipal and inter-regional travel. The same goes for restaurants and travel companies – they are among those that have suffered the most and will take a long time to recover and go back to the pre-crisis levels.

Yet, there are sectors of the economy that almost did not feel the hit – industry, for instance. We did not shut down large plants. Some export-oriented industries like the iron and steel industry, for example, are strengthening their positions day by day as the demand is increasing across the globe, especially in China. For the first time in many years, our steelworkers were able to increase the number of products they export to China, the same is true for ore producers. 

I sincerely hope that the situation in the financial market will become more stable so that we can speak of continued economic recovery, even though a gradual one. 

On support to business during the pandemic

The introduction of the so-called fiscal stimulus was a positive step. That is why the budget deficit was increased from 2% of GDP to 7.5% of GDP. According to my estimates, 3.5% of the sum was allocated for fiscal stimulus. It includes an increase in pensions which is maybe not the best, but still a smart move. Pensioners will spend this money on essentials and in such a way will support production. They will not buy dollars with this money. 

Another step in the right direction is an increase in unemployment benefits and the introduction of the so-called partial unemployment when the government helps businesses keep the jobs. Due to partial unemployment, the companies can receive reimbursement of salary for their employees if they do not let them go.

The idea with “great construction” does not seem very efficient to me. Construction is the industry where it is so easy to steal and the involvement of people in low-qualified jobs does not compensate for the expenses in other industries. For instance, the government was thinking that our labor migrants would stay in Ukraine to do construction and would not go to Poland instead, but that is not going to happen. These are very different situations – the people who were picking up strawberries cannot start working in construction. Overall, the idea sounds appealing but is hard to implement. 

Also, I do not really like the urges for protectionism, for the support of domestic producers. It is the kind of policy that usually results in a dead-end. Such trends exist in the world, but we need to be smart about the way we apply them.

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