Ukraine Market Report — Q1 2019
An election quarter with a currency that strengthened rather than weakened — an unusual combination, and the explanation lies in who was buying Ukrainian government bonds.
Overview
A presidential election was held in the quarter, concluding with a second round in April.
The hryvnia strengthened rather than weakened through the period — the opposite of the pattern observed in every previous Ukrainian election year in this archive.
Why the currency strengthened
The explanation is portfolio inflows into hryvnia-denominated government bonds.
Domestic interest rates were high, inflation was falling toward target, and the currency was stable. That combination produced a large yield differential against developed markets at a time when global rates were low.
Foreign investors bought local currency debt in volume, which required buying hryvnia, which pushed the currency up.
The nature of this inflow
It is worth being precise about what this money was and was not.
It was not foreign direct investment. It did not build a factory, employ anyone or transfer any technology.
It was a carry position: borrowing cheaply in one currency to hold a higher-yielding asset in another. Such positions are highly sensitive to any change in the yield differential or in perceived risk, and they can reverse in days.
The commercial consequence for Ukrainian exporters was immediate and negative. A currency strengthened by financial inflows makes domestic production more expensive in foreign currency terms, which compresses exporter margins with no change in anything they control.
Agriculture, IT services and manufacturing exporters all faced this in 2019: a stronger currency driven by a capital flow that had nothing to do with them.
Macro position
Growth continuing. Inflation falling toward target. Currency strengthening. Reserves rising with the inflows.
Sectors
Exporters generally — margin compression from currency strength.
Importers and retail — benefiting from the same movement.
IT services — growing but with dollar revenue worth less in hryvnia terms.
Agriculture — strong volumes, compressed local-currency margins.
What the quarter settled
That Ukraine had become exposed to a new channel — portfolio capital — that had not been significant before, and that this channel affects the exchange rate independently of trade flows.
For an exporter, that means the currency can move against you for reasons entirely disconnected from your market, and it can reverse just as quickly.
Related in this archive
Share this analysis
Comments