By KYIV. Nov 24 (Interfax-Ukraine) – Yuriy Gorodnichenko, a professor of economics at the University of California, Berkeley, suggests starting the transition from a fixed to a floating hryvnia exchange rate with a temporary restriction of daily fluctuations of the exchange rate in a narrow range, he said this in an article on the Vox Ukraine analytical platform.
"By the nature of the fixed exchange rate, as time goes on, potential mis-pricings and imbalances accumulate and one reaches a critical point when another adjustment is necessary. So another correction of the exchange rate in a long war is a near certainty," he said.
"Although the NBU fixes the hryvnia to the U.S. dollar, the main trading partner for Ukraine is the European Union and the euro depreciated against the dollar which further hurts Ukrainian exporters. Given the current environment, a correction of the exchange rate becomes a highly politicized event which likely postpones the necessary adjustments and hence results in worse economic outcomes," he said.
"Given the high sensitivity of inflation expectations to the exchange rate in Ukraine, a free float can generate excessive macroeconomic volatility. Indeed, the hryvnia gyrated violently during the 2014-2015 after the first Russian invasion. Hence, the solution has to be an intermediate option," the expert added.
"Another intermediate option is to limit daily fluctuations in the exchange rate to a narrow band. For example, the exchange rate cannot depreciate or appreciate by more than 0.1% on any given day. In this case, the direction of adjustment is determined by market forces but the speed of adjustment is controlled by the central bank. Note that this regime does not promise to devalue the hryvnia: the exchange rate can appreciate or depreciate depending on the situation," he added.
"The experience of the hryvnia during the COVID-19 crisis underscores how useful this feature is for Ukraine: after the hryvnia weakened in the early days of the crisis, eventually the hryvnia got stronger because demand for Ukraine’s output remained strong. As a result of this flexibility, the Ukrainian economy faired relatively well in 2020-2021," he said.
"Obviously, this policy alone cannot resolve all problems (e.g., the broken monetary transmission mechanism) and it will have to be complemented by other measures (capital controls, alignment of interest rates on NBU deposit certification and the government bonds, etc.) to deliver the desired results," he noted.
