Economic Pessimism - on the National Bank of Ukraine's Decision to Raise the Interest Rate to 25%
Translation of a facebook post by the Ukrainian economic expert Aleksey Kusch. The NBU announced this decision on the 2nd of June - it will be the highest interest rate since 2015, when the IMF-curated ‘independent national bank’ set an interest rate of 30%.
One note to this article - Kusch notes that the fixed exchange rate will make it difficult to tame inflation. Today, news emerged that the NBU is planning to return the hryvnia to a floating exchange rate.
This is when the decisions of the government or the National Bank in the rear destroy the remaining pockets of the country's economic potential.
It is very difficult to write this post.
It is necessary to restrain oneself and not to voice many things in public - the war dictates its own rules. One mustn’t multiply unbelief and despair.
The decision of the NBU to raise the rate of interest from 10% to 25% seems to many to be purely technical, not affecting their daily lives. For me, it's a marker.
Yesterday I had doubts for the first time in 100 days. No, not in victory. But about the fact that after it the development of our country will begin differently: not in favor of the "superstructure", but in the interests of the "basis".
For three months, I observed a paradigm shift in the main approaches: a fixed exchange rate, blocking the channels of capital outflow from the country, and the purchase of defense bonds from the Ministry of Finance directly by the National Bank.
It even seemed to me that what I have been writing about since 2016 in my numerous articles (their number exceeded 500 in ‘Delovaya Capital’ alone, and there were also some in ‘Focus’ and others) began to be put into practice.
As it turned out, it only seemed to be the case.
The National Bank again imagined itself to be the regulator of some small, cozy European country, such as the Czech Republic.
Where there is no war, but there is a NATO security umbrella and a financial channel for EU assistance.
Where all structural problems in the economy have been resolved and the only pain is inflation, which needs to be targeted at a low level.
The actions of the NBU can be compared with the work of a doctor:
he looks at the patient and understands that actions "according to the protocol" will kill the patient with a probability of 100%, but no one will blame him for the death of the patient;
but you can go against the protocol and the patient will survive, but there is a 10% chance of death from complications and then you will have to "go down to the doghouse".
And the doctor treats according to the protocol, and the NBU raises the rate to 25%. Allegedly to combat inflation and the devaluation of the hryvnia.
As a result, this autumn, the NBU will be met with both inflation and devaluation, and, in addition, a cardiac arrest in the economy.
Yes, according to the protocol, everything is correct: there is a risk of inflation and depreciation of the hryvnia - raise the rate.
This, in theory, will strengthen the exchange rate of the national currency and reduce prices.
Again, in theory, the Ministry of Finance will be able to raise government bonds to 28% and attract hryvnias from the market.
And the NBU will attract money from commercial banks with its deposit certificates at 22%.
But why will all of the above in a war not work?
The pain threshold for private capital in relation to Ukraine is now extremely high, it cannot be broken by a rate of 30%.
Suffice it to say that our dollar Eurobonds with a maturity date in September of this year were quoted on the secondary market with a yield of 250%!
So, will we drive the interest rate up to 250%? Risks are now making ANY increase in rates pointless.
Inflation in Ukraine is not in the nature of demand inflation (when there is a lot of money), but cost inflation: gasoline is rising in price not due to increased consumption, just as food is rising in price.
And in general, how can we expect the hryvnia exchange rate (one of the tools used to reduce inflation in 2019) to strengthen if we have a fixed exchange rate of 29.25!? Where will it settle down? To 29.25?
Yes, it can be assumed that the increase in the interest rate is a prologue to the opening of the interbank market and the removal of foreign exchange restrictions.
Well then it's really bad.
In 2014-2015, they already played around with the market, floating the rate to withdraw the capital of political elites. We remember well how it all ended then.
But then we had exports, albeit reduced by the crisis, but we had them. And they went through working ports.
Now we have, at best, 40% of exports from 2021 level. You can imagine what the exchange rate will be like when importers buy foreign currency on an active interbank market.
It seems that the main beneficiaries of such a scheme are structures that want to withdraw their capital from the country (the 100-day pause put them under a lot of pressure).
As for attracting money "from the market" for government bonds.
The limit of participation of the population and business in defense bonds has already been reached. There is no more money.
Only short government bonds (3, 6, 9 months) will be bought. With a yield of 30%.
And these super-yields (without taxation, by the way) will have to be paid back this autumn at the expense of the state, expanding the already endless hole in the budget (Note from eventsinukraine - According to the Ministry of Finance, in May 250 billion hryvnia were spent (for military purposes - 118.4 billion, for social protection - 29.4 billion, for medicine and education - 28 billion), while budget revenues from the tax service and customs was only 83 billion, or less than 30% of what was needed.).
On the other hand, some banks (mostly foreign) will win, since they will be able to drain their liquidity of UAH 250 billion (a general indicator of the system) into NBU certificates of deposit at 22%.
Financial speculators on government bonds at 30% will win (which will know about the risks of restructuring in advance).
But not all banks will be kings.
Some of them will face a lack of resources (few people will pull through refinancing the NBU at 27%).
We will have to build up reserves, increase credit interest to 45-50%.
And the growth of interest rates on deposits will not lead to a significant inflow of money from the population.
Borrowers will stop lending, and those who took a loan at a floating rate will go bankrupt.
The growth of problem loans and the risk of bankruptcy. Again a remake of 2014-2015.
So wave the pen with state interest rate compensation programs: no one will compensate the interest rate on loans from 50% to 0%, no budget money will be available.
We are now waiting for the collapse of business lending.
And do not believe the theses that now no one wants to take loans.
There is a demand for loans and it is large: for relocation, for energy saving and energy efficiency programs (against the background of shortages and the high cost of energy resources), for import substitution of those goods that have become unavailable, for structural restructuring of the economy under martial law, for defense orders, for the partial restoration of business processes.
But even a first-class borrower with a good rating, a positive credit history and liquid collateral, will only be able to take out a loan at a minimum of 35%. And for most - at 40-50%. Nobody needs these loans now.
In other words, we have before us a "mundane murder of the economy" under the pretext of fighting inflation, carried out in the interests of several banks and structures preparing to withdraw capital from the country at an acceptable rate.
As a result, we will get inflation, and devaluation, and an increase in the rate of economic decline, and an aggravation of the budget crisis.
Surprisingly, even within the framework of the outdated, retrograde monetary strategy of the last century, which the NBU imitates, it could not be consistent.
There is such a thing as an "impossible trinity" or a monetary trilemma: you cannot simultaneously play at monetary sovereignty (move the rate), fix the rate and block the outflow of capital.
You can only perform two actions at the same time.
In February of this year, the NBU chose to block capital outflows and fix the exchange rate. And it was the right decision.
The interest rate remained on pause at 10%.
Now the NBU has decided to “do the impossible": a fixed exchange rate, currency restrictions and the interest rate - up.
It's like taking a laxative and a sleeping pill at the same time and hoping for a comfortable morning. The morning will not be comfortable.
The course has nowhere to strengthen, it is anchored.
True, voices are already being heard that the NBU thereby influences the rate for exchangers on the gray market.
Well, building your monetary strategy based on the rate at the exchange office of the Darnytsia market (a big outdoor market far from the centre of Kiev with many interesting characters) - this is the road towards becoming mice (a hard-to-explain Russian idiom about degradation).
What should have been done?
It is necessary to freeze the discount rate at a minimum level. And come to terms with the fact that no increase in the rate now will bring financing for the Ministry of Finance "from the market."
We need to issue targeted military bonds from the Ministry of Finance at a zero rate of return, which will be bought directly by the NBU to finance the budget deficit.
Targeted, well-aimed emission through clearly defined channels.
Many developing countries did this during the pandemic, I studied the experience of Indonesia and described it in my articles.
As a result, these states received a powerful growth impetus on the way out of the crisis, but we did not (Ukraine's GDP growth in 2021 was only 3.6%).
Yes, their recovery growth was accompanied by inflation.
But after all, we got inflation too. We just lost our recovery growth.
For an ordinary person, inflation is not so terrible as a complete lack of money.
If one’s solvency has decreased by 25% as a result of rising prices, this is bad.
But if inflation turned out to be slightly lower (20%), but there is no money in your pocket at all, this is a disaster. The NBU followed the second scenario.
Yes, the decision was unexpected, and many see this as a plus. There is such a theory - "the Lucas critique".
If economic agents expect an increase in the rate, they include it in their prices, and the anti-inflationary impact of the increase in the interest rate decreases.
But each theory has natural limits, determined by the idiocy in its implementation: the rate of interest could have been increased up to 100%, it would have been even "unexpected".
Why did I give the fact of raising the discount rate such a metaphysical depth.
The fact is that I see ongoing economic processes quite deeply.
And many knowledges multiply great sorrows.
I am well aware that only a miracle can save us economically. An economic miracle.
After all, war is a confrontation between economic potentials.
In terms of potential, we are inferior to the Russian Federation.
That is, we can win through the efficiency with which we use this potential.
Understand a simple thing: we will be saved by the time of the Titans, who are not afraid to jump over the flags of retrograde and outdated theories.
We need the surgeon who is ready to take responsibility for the patient's life.
Instead, the NBU is likened to a tailor who says, looking at an ugly suit: I personally sewed on the buttons... any questions? No, they are sewn on quite tightly.
The time of the Titans should pull us out of the abyss of the crisis, even if those around us laugh and say that we are pulling our hair like Munchausen.
We need bold and unprecedented solutions, as once happened in Korea in the form of Park Chung Hee's reforms: a breakthrough from post-war poverty to prosperity.
And for this, it is necessary to purge the Ministry of Finance, the government, the National Bank of people who are not capable of understanding the tasks facing them.
But for now, the Titans are at our front, and not at Institutskaya (the location of the NBU).
PS Yesterday, a number of entrepreneur acquaintances who created brilliant companies in Ukraine told me that they honestly tried to structurally adapt their business to wartime conditions, but after the decision of the NBU, they will most likely relocate to Poland.
In a war, the NBU should target confidence, not a speculative rate of 25%...