The past and the future of Ukrainian national currency

We fully agree with those who insist that the currency reform was an epoch-making event in the newest history of Ukraine. Its importance for the formation of Ukrainian statehood can be compared with the adoption of the Constitution. However, a brief review of the chronology of events reveals a significant difference between the age of the state and its currency. Ukraine has recently celebrated its 15th independence anniversary. At the same time its national currency hryvna is 5 years younger than the state. These 5 years were not a successful period: Ukrainians survived a terrible hyperinflation as a result of which the overwhelming majority found themselves below the poverty line.

Expert opinions differ considerably. It is hard to say which of them is closer to the truth. Every opinion is rather subjective because many authors of present-day memoirs were directly involved in those events either as decision making or supporters of certain point of view. Every anniversary is not only a good reason for issuing another set of booklets, memorable coins and anniversary medals but a reason to make a critical review and analyze the past experience in order to make fewer mistakes now and in the future.

When preparing this anniversary publication we addressed two persons whose involvement in the currency reform of 1996 was decisive. They are the then chairman of National Bank and current President of Ukraine, Victor Yushchenko and the then advisor of the President for macroeconomic issues and a longstanding head of the National Strategic Researches Institute, Anatoliy Galchinskiy, who lead the working group on the development of laws and concepts of currency reform.

Every expert received the same, rather impressive, list of questions.

1. Was hyperinflation during the first 5 years of Ukrainian independence the result of strategic mistakes in its economic policy or was it an objective fact, unavoidable due to the need for numerous serious transformations?

2. If it was an objective fact, why did the transformation crisis in Ukraine turn out to be harder than in the most of the neighbor states?

3. Was it possible not to introduce the transition quasi-currency kupono-karbovanets, meant to take the blow of structural transformation on itself? Or should we have introduced an effective currency unit much earlier to mitigate the painful transformation process?

4. Why did the transition process take so long and Ukraine was practically the last of the post-Soviet states to carry out currency reform? What prevented the introduction of hrivnia in October 1995 as was planned?

5. The so-called technical aspect of hryvnia introduction was implemented at a high level. Yet were there any alternatives to the currency reform from the point of view of the strategic interests of the Ukrainian economy, which resumed growth only in 2000?

6. Some experts sharply criticize the purely monetary approach to the regulation of cash circulation adopted in Ukraine after the currency reform, since it resulted, in their opinion, in shortage of resources for the development of the economy. What can you say on this point?

7. Is the Ukrainian national currency system ready for the transition from the exchange rate targeting to the inflation targeting? Is full convertibility of hryvnia feasible?

8. Do you support the idea that certain decrease in the nominal hryvnia exchange rate may be needed to eliminate disproportions in foreign trade?

9. Would you comment on recent nomination of Serghiy Klyuev, Borys Kolesnikov, Ihor Prasolov, Vasyl Horbal, Mykola sRudkovsky, Olexandr Tkachenko and Vasyl Tsushko to the NBU (National Bank of Ukraine) board?

10. What are the most serious threats to the current stability of the national currency? What has to be done for its further strengthening?


Professor, ex-chairman of the NBU Council

1. I am deeply convinced that in a strategic context we did not make any mistakes in pursuing this economic policy. This policy was aimed at the dismantling of the failed command-administrative system and laying the foundations of the market economy. It is impossible to make such profound transformations without any losses. Add to these the previous crisis state of the Soviet economy (the GDP drop reached 2.4% in 1990, and 8.7% in nine months of 1991) and the collapse of two huge geopolitical formations, the USSR and the so-called world-wide socialist system, that resulted in a sweeping break of the economic ties.

Also add to this situation the extremely difficult problems of strengthening Ukrainian statehood, and it will become clear that such point of view is correct. As an expert in currency relations (my doctors thesis, which I defended in 1980 dealt with the problem of the currency), I insist that it was impossible to avoid hyperinflation in the early 1990s. It was a component of transformation to the market economy that was allied with price liberalization. In the former Soviet Union governmental subsidies for food prices exceeded 20% of the budget expenditures. Every year more than 5 billion dollars was spent for grain import. That was the economy without an economy.

Price liberalization was meant to overcome systemic contradictions. These were complicated by the problems related to the transition to world prices for energy sources. The Central European states, where the inflation rate was lower, did not face such a problem.

The problems in the energy sector that the Yanukovych Cabinet is tackling now, could absolutely not be compared to the problems of that time. During the first years of independence, the prices for energy sources increased by several thousand times. In Soviet times, gas and gasoline were supplied to Ukraine for kopeks; we explored the Tyumen deposits at our own cost, in exchange, Tyumen supplied energy sources to us. This was a kind of a Socialist barter, which we necessarily had to destroy during the establishment of independence. I could go on with a list of similar problems.

2. Indeed, in those years, the hyperinflation in Ukraine grew on a large scale. In 1993 we set a world record according to this index. According to the official statistics, in Ukraine the retail prices grew 102 times in 1993. Why did this happen? Perhaps, some people may have certain objections against my position, but I am convinced that contradictions in the monetary policy account for the lions share of the achievement of this world record. I mean the obvious: the belated implementation of the monetary reform.

3. I know this problem very well. Before the cupon-karovanets currency was launched in circulation, I had a serious talk with the then Prime Minister Vitold Fokin. In 1992 Ukraine faced a profound crisis of payment. Due to the hunger, caused by cash shortage, which was provoked by Russia, Ukrainian economy stopped. Different options were being discussed. A decision was made to introduce a quasi-monetary unit, cupon-karibovanets, into circulation for three or four months as a forced action.

4. We had objective preconditions for the currency reform as early as 1992. We needed political preconditions for that. In the summer of 1990, the Verkhovna Rada approved the epoch-making Declaration of the state sovereignty of Ukraine and the Law on economic independence, both of which talked about the introduction of hryvnia. The program Basics of the national economic policy of Ukraine, submitted by L. Kravchuk and approved by the constitutional majority in March 1992, set out currency reform as an essential component of economic transformations. At that time I was a member of the social-economic council at the President of Ukraine and to a certain extent was involved in the development of this issue.

I must also say that there were several reform drafts at that time. Back in March 1991, the newspaper Voice of Ukraine published the Concepts of introduction of state Ukrainian currency, in the development of which, I was also involved. This document treated the currency reform as a fundamental principle of transformations and processes of stabilization. It relied upon international experience. I mean that it relied upon classic currency reforms carried out in 1895 1897 in Russia. I mean, primarily, the reform of Count Vitte, which significantly speeded up the then Russian economy.

The same could be said about the reform of Ludwig Erhard, in 1948 in Western Germany, that started the well-known German miracle, as well as about the currency reform of 1922-1924 in the former USSR that initiated the new economic policy (NEP). Right after World War II, practically all European states carried out currency reforms to begin revive their economies.

We turned out to be unprepared to begin market transformations with probably the most important step currency reform. The main obstacle was a subjective factor, that is, the position of the NBU leadership. Now matter how regrettable it is, we have to admit it. In fact, there were no specialists on the NBU staff who had at least elementary (to say nothing about sufficient) knowledge about the mechanisms of the currency reform. The position of the IMF turned out to be strange. During currency reforms in the Baltic States, the IMF specialists took the major burden related to the preparation and implementation of the reform upon themselves, while in Ukraine they took absolutely opposite stand, trying to convince the political leadership of the state in the irrationality of leaving the ruble zone.

As for an almost one year delay in introduction of the hryvnia, I know well all the details of that situation. I was the member of the State commission on the reform and at the same time I headed the workgroup preparing legal documents to carry out this reform. This group included well-known experts, M.Savlik, A.Moroz, A.Danilenko, V.Terpylo, etc. We spend more than a month on the mission in the Kochan-Zaspa health center in an illegal status. President Kuchma supported our position the need to carry out the reform in October 1995. But due to the NBU chairman, who had the opposite point of view, the reform was cancelled right at the start. Prime Minister Marchuk, who headed the State commission and initially supported the dates of the launch of the reform, also made a mistake.

You know the result. Of all the states of former USSR, Ukraine was the last who carried out currency reform. Latvia and Estonia introduced their national currency in May and Lithuania in October in 1992; Kirghizia, in April 1993; Moldova, Azerbaijan, Kazakhstan and Uzbekistan in the end of 1993. In June 1993, Russian completed the process of introduction of its own currency unit, while Belarus finished it a bit earlier.

In Ukraine we had cupon-karbovanets in circulation up until September 1996. As a currency unit it failed to fulfill all its functions and did not raise any trust in itself. That is why it could not be a reliable basis for stabilization processes, in particular for price stabilization. When we say that during the transformation crisis Ukraine suffered perhaps the biggest economic loss, the main reason for that was the currency factor.

5. There are several mechanisms of currency reforms of different complexity. The currency reform of Ludwig Erhard, in post war Germany, when there was a terrible hyperinflation and it was necessary to annul a lions share of depreciated banknotes with the help of the reform, is one thing; while our currency reform, when hyperinflation was practically curbed by the time of its implementation, is quite another.

Yet, God only knows what the price for such a result was. This is the difference, the reform in Germany was of a confiscation type, while in Ukraine the so-called reform was of a formal type. As for the implementation mechanisms, this reform could be carried out in white gloves. There were no objections concerning the last point.

6. To defend the then chosen approach, one would probably need to write not just an article but an entire doctors dissertation. However, the final results testify in its favor. Just look at the statistics: after the initial curb of inflation, for the last five to six years the money supply has been growing at a rate significantly exceeding the rate of GDP growth. As a result, the level of monetization of the economy has increased by more than three times. This is an excellent result.

7. I do not support either the first, or the second position. But inflation targeting could be effective only in case of an adequate economic policy of the government. Inflation targeting is an element of a liberal model of economic policy. This is not only the NBU prerogative. A profound coordination of efforts of the National bank and the government as well as combination of the monetary and non-monetary tools is required.

As for full currency convertibility, we gradually move in this direction. We should not hurry. I believe that to ensure a full currency convertibility there should be two pre-conditions: first, a favorable investment climate in particular for non-residents and second, a reliable political stability. Russian introduced full convertibility, while having currency reserves exceeding 270 billion dollars (as of August 1, 2006) and a positive trade balance at almost 10% of GDP. All of the above should be taken into account.

8. In my understanding such appeals are the set-back of the post-communist ideology and a manifestation of the low culture of economic thinking. We are constantly facing this phenomenon. I, as a former NBU chairman, have always had to struggle with this.

What purposeful devaluation of hryvnia can we talk about, if, according to the purchase power parity, the market value of hryvnia remains devaluated and depreciated? Moreover, probably the most serious disproportion in our economy is a dangerous narrowness of our internal market. In Ukraine, export accounts for 60% of GDP, while its internal market for only 40%. What should be stimulated in this case?

Ill tell you more; the key task of the current stage of economic development is technological modernization. This requires stimulation of the import of investment products. To this end, various tools should be used, in particular a high level of the real exchange rate of hryvnia, which is favorable for the importers. It is necessary to curb the prices for energy sources the same way. Those who do not understand these simple macroeconomic aspects have no business being in the government.

On the whole, I see a much bigger problem, which is the lack of clear macroeconomic position of the new government. In 2003 2004, the Yanukovych government did not tackle the problems of macroeconomic strategy. That was the presidents prerogative. Currently the situation is different. All the details, which the Cabinets members started to review right on the second day of their appointment, could turn out to be destructive in the absence of macroeconomic targets, clear to the national and international community. In the end, we have to learn to work for the future. We cannot do this. In my view, this will be the main maturity test for the Yanukovych Cabinet. I regard your question in such a context.

9. I do not want to mention any specific names. I have a deep respect for this respect for these people. However, the principle of formation of the NBU council is importation. What is currently being done does not stand up to criticism. The president set an example when made the appointments according to his quota, by depending only on the political loyalty. Nobody is interested in the professionalism of the appointee, if he knows, for example, what is the difference between M1 and M2, money supply and money base, nominal and real exchange rate, etc.

These are the issues, with which the NBU council has to deal with constantly. The council does not deal with the distribution of the loans. We develop stereotypes according to which a person, who learned to press buttons in the session hall in parliament, can do anything.

Given such principles of formation, the NBU council, which has and exclusive right to determine major principles of the monetary policy, can become a body destabilizing the hryvnia. I believe that Viktor Yanukovych, whose parliamentary faction has most representatives on the list of candidates, should realize this. Such issues should be well considered, since bad decisions can cause a big disaster. On the whole I believe that we need more accurate definitions of the issues concerning the formation of the NBU council in the Law on NBU.

10. The Ukrainian economy has perfect prospects. This year it proves its efficiency. The hryvnia also has good prospects. These are two interdependent positions. As for the risks, in the context of our talk I would like to raise only two issues.

The first is the issue of a real independence of NBU. I feel that there is a problem in this key point of the monetary policy, especially in the context of your previous question.

The second is the stability of the international financial market, including the stability of the dollar. The dollar is increasingly loosing its attractiveness. There is a threat of the recurrence of the financial crisis of 1997 1998. We must be ready for such threats.

Viktor YUSHCHENKO, president of Ukraine, in 1993-1999 National Bank head

1. Every transition economy had to go through a crisis period. Every nation with its own historical, political, economic, and other peculiarities found its way to overcome it. To Ukraine, this way was extremely difficult for many objective and subjective reasons. But the most important of them was a formidable resistance to market reforms by the political and business elites and a very slow pace of reforms. Besides, this country had no monetary, financial, customs, taxation, and banking systems, the basic attributes of a national economy that generally determine any countrys economic infrastructure.

The entire economic system of this country was organically integrated with those of the other former USSR republics and its total restructuring naturally entailed losses. It is very distressing that these losses told most heavily on the older generation.

2. Ukraine had the most developed economy among the former USSR republics and post-communist East-European countries. It had a huge military-industrial potential and the most power-consuming and environmentally hazardous industries that worked for the entire Soviet Union. In particular, about 40 percent of Ukraines industrial capacities worked for the weapon production sector. But after independence such colossal capacities became redundant.

The transition period began with disruption of traditional economic ties with the other USSR republics and East-European countries. In the early 1990s a mere 20 percent of Ukrainian industrial enterprises had a complete process cycle within the countrys geographical limits.

At the same time, light industry and the food processing industries as well as services were developed very poorly.

The USSR economy had practically exhausted the productive deposits of coal in the Donetsk basin, leaving the newly independent country with outdated technologies, depreciated and worn-out industrial facilities, and a heavy burden of social problems.

The Chornobyl nuclear disaster was not only a national calamity. It blew a vast hole in the national budget and its aftermath still weighs heavily on the country.

Ukraines key role in the former USSRs economy became an additional burden in the process of market transformations.

3. The Karbovanets coupons the provisional currency bore the whole brunt of the hardest stage of transformations that involved the growing budget deficit, production setback, hyperinflation, currency devaluation, etc.

In 1992 inflation rate exceeded 2,000% and in 1993 it reached the worlds record-high 10,000%. In 1994 GDP dropped below 60% of the 1991 level. In 1993 and 1994 Ukraines budget deficit was rather high 7% and 9% of GDP respectively.

Naturally, it was premature to introduce a national currency unit under such circumstances, because it would have been doomed.

4. In 1995 there were no prerequisites for introducing the hryvnya. GDP and industrial output decreased at an annual rate of 12%. The consequences of hyperinflation were still heavy: consumer prices grew threefold and the budget deficit was still way far from optimal. Mutual debts among industrial enterprises grew twice faster than in 1996.

Hasty introduction of the hryvnya would have been a complete failure and would have stalled the economic revival. That is why we carried out the monetary reform only after we overcame hyperinflation and slowed down the crisis processes. Very importantly, the people did not lose much because of the monetary reform and so trusted the new national currency and the national banking system.

In June and July of 1996 two months prior to the reform, inflation stood below 0.1%. Consumer prices practically stopped growing and macroeconomic parameters began to improve.

The experience of this decade proves that the time was chosen correctly. Today the hryvnya exchange rate is a reliable benchmark to entrepreneurs. It is trusted by the people, and international experts refer to the currency reform in Ukraine as one of the most successful in the world.

5. The economic recess and devaluation that followed should be attributed to external factors. In 1998 the young Ukrainian currency withstood a severe global financial crisis and Ukraine survived it with minimal losses.

6. In 1996 this country had only just recovered from hyperinflation and the risk of its recurrence, especially after the 1998 global financial crisis, was rather high. The National Banks hard-line monetary policy contributed to financial stabilization in the country and helped it overcome the consequences of hyperinflation. Now, inflation is bridled and there are sufficient reserves.

7. Our strategic task is to make the hryvnya fully convertible. This task necessitates faster development of the national financial system and the pension insurance system. We also have to attain a positive balance of the national budget and make pricing independent on exchange rates. The sooner the Government and the National Bank improve the market mechanisms, the sooner Ukraine will cope with this task.

8. The current account balance doesnt necessarily have to be always positive. For example, the innovative investment model relies on considerable imports of equipment, altering the balance but providing for higher growth rates in the long-term perspective. That is why the current balance should be maintained basically through qualitative transformations: higher production efficiency, development of new technologies to replace imported equipment, and better structured and diversified exports and imports.

Today inflation rate is the lowest since 2002. In June 2006 exports of goods and services grew faster than imports (16.4% versus 12.8%). As a result, the negative trade balance reduced and the current payment balance became positive ($101M in June).

Over the first semester of 2006 direct foreign investment in Ukraines economy was estimated at $2.3 billion 3.7 times more than in the first semester of 2005. Under such circumstances it would be inexpedient to lower the hryvnyas exchange rate.

Moreover, its forced devaluation may lead to serious negative consequences: higher inflation and interest rates, outflow of capital, an increased share of the US currency in transactions, shrinking deposits in banks, and complications for the banking system due to mounting currency imbalances.

If the government manages to work out a target-oriented economic strategy and improve the environments for investors, financial flows will stabilize and subsequently create prerequisites for a higher exchange rate of the national currency.

This year exporters benefit from the devaluation of the real exchange rate versus its nominal stability.

Exchange rate dynamics should be determined by progress in improving the investment climate, technical upgrading and re-equipment of industrial facilities, higher competitiveness of national products on the domestic and international markets, faster development of the stock market, and effective energy saving.

9. In accordance with the law on the National Bank of Ukraine, its board is due to undergo a scheduled rotation. Whoever the lawmakers elect to the NBU board, their choice must be respected. But I would like to see there more professional bankers, economists, and experts in financial law. International experience shows that the management of any central bank must not be politicized. The banking system must be managed exclusively by professionals.

10. The situation in the currency market is stable today. Ukraines macroeconomic performance is generally positive: between January and July GDP grew by 5.5%, inflation rate remained low 3.8% (last year it was 6.7%), the National Banks currency reserves totaled $18 billion, and the budget deficit was within optimal limits.

Of course, there are risks, as always. The negative payment and trade balances remain a serious problem. Ukraines economy is quite open: the export/GDP ratio exceeds 50%. Thats why any external shocks like sharply raised prices for fuels or sharply lowered prices for metal products pose serious risks to Ukraines macroeconomic stability. There are also internal threats posed by too slow improvements in the investment environment and, subsequently, shrinking investments.

Even when the exchange rate is stable, growing prices for fuels, meat, and other products lower the peoples real incomes and affect businesses. Therefore, a stably low inflation rate is the main prerequisite for sustainable economic growth. The governments economic policy must not be passive. It must actively respond to external challenges.

Thats why we need faster economic and social reforms. Transparent privatization, organized markets of land, industrial and agricultural products and services, legalized businesses, eradication of corruption, and good order in the payment and taxation systems would only make the national currency stable and strong.

It is very important to me, as the President of Ukraine, to ensure political stability, accord, and consolidation. Important steps have been taken in this direction. The implementation of the provisions stated in the Universal of National Unity is underway. In the nearest days I will submit a package of relevant bills to the parliament for consideration so that these provisions become legally binding.

Now that the major political forces have reached consensus, Ukraine has a historic chance to successfully develop as a sovereign state, in which the national currency is one of the most important attributes.