Independence Day 2009: counting the cost of a fixed exchange rate
Eighteen years on, output is down by roughly a seventh, the currency has lost about 40 per cent against the dollar, and a generation of borrowers is learning what a foreign-currency mortgage actually was.
The eighteenth anniversary is being marked in the worst year since the early 1990s. Output will contract by something close to fifteen per cent, industrial production in metallurgy fell by more than a third at the trough, and the exchange rate that was held at 5.05 for four years now sits near eight. Every warning that was tedious to repeat in 2007 has been settled by events.
The mechanics were exactly as textbooks describe. External demand for steel collapsed in the last quarter of 2008. Foreign parent banks stopped rolling over funding to their Ukrainian subsidiaries. The central bank defended the peg until reserves made that impossible, then let the currency go in a disorderly move that destroyed more confidence than a managed adjustment would have. Households and companies holding dollar debt against hryvnia income saw their liabilities rise by 60 per cent overnight.
What the devaluation did to balance sheets
The banking system is the transmission channel and it is where the damage sits. Non-performing loans have risen sharply, concentrated in foreign-currency mortgages and car loans issued between 2006 and 2008. Several banks have been placed under temporary administration. Nadra and Rodovid, both substantial, required state intervention. Prominvestbank changed hands in distress.
The policy response has included a moratorium on foreign-currency mortgage foreclosures and a ban on new foreign-currency lending to unhedged borrowers. The second measure is correct and should have arrived in 2006. The first is politically inevitable and creates a problem that will take years to clear: loans that cannot be enforced but are still on bank balance sheets at something near face value.
For anyone doing business here the practical consequence is that credit has simply stopped. Working capital facilities are not being renewed. Trade finance is available only against cash collateral. Companies that survive this year will do so on their own liquidity, and the ones that emerge strongest will be the ones that spent 2007 and 2008 keeping their currency exposure matched — a small minority.
The IMF programme and the fiscal problem
The stand-by arrangement agreed last November is the reason the state is still paying salaries. It is also under strain, because the conditions include a gas tariff increase for households and a deficit ceiling, both of which are politically impossible in a presidential election year. Reviews have slipped. The programme will probably go off track before the January vote and be renegotiated after it, which is the standard pattern.
Beneath the headline, the fiscal problem is structural rather than cyclical. Naftogaz runs a deficit because it buys gas at import prices and sells it to households at a fraction of that, and the gap is covered by the budget or by bond issuance. Pension spending is above sixteen per cent of GDP, one of the highest ratios in the world, driven by early retirement rules inherited from the Soviet system and never revised.
What is not broken
Three things held. Exports adjusted through volume and price rather than stopping — steel found buyers at lower prices, and agriculture had a strong year that partly offset the industrial collapse. The sovereign did not default; every coupon was paid. And the WTO framework agreed last year meant that Ukraine's trade partners could not respond to the crisis by raising barriers arbitrarily, which is precisely the value of binding commitments.
Agriculture deserves particular note. The grain harvest has been strong, world prices have held up better than steel, and export logistics through Odesa and Mykolaiv have worked. The sector that was treated as a legacy problem through the 2000s is the one cushioning the fall. That signal will be read properly by investors within about three years.
Eighteen years in
The lesson of this year is not that Ukraine is uniquely fragile. It is that a fixed exchange rate with an open capital account and unhedged foreign-currency lending is a structure that fails, and that it fails in the same way in Kyiv as it did in Bangkok, Buenos Aires and Budapest.
The country will recover, and faster than the mood today suggests. What matters is whether the recovery rebuilds the same structure. The evidence from the next four years will be mixed, and the archive will follow it.
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