NBU’s new governor Shevchenko creates uncertainty around Ukrainian currency and bonds as the question of Central Bank Independence remains unanswered.

(Arnav Barry)

Ukraine’s central bank crisis seems to have come to an end after 2 weeks of turmoil. Bond prices jumped on Thursday as President Zelensky chose to appoint Kyrylo Shevchenko, former head of Ukrgasbank to head up the NBU after the shock resignation of Mr Smolii in tumultuous circumstances. Mr Smolii resigned after citing continuous political pressure on the central bank as a key factor, saying that he was not confident he could sincerely maintain its independence. The NBU has been one of the few Ukrainian institutions that have maintained the trust of the G7 and IMF, due to Smolii’s efficient handling of the financial reforms that nationalised many banks and took considerable power away from the hands of influential oligarchs such as Igor Kolomoisky who is still fighting his case against the government for nationalising PrivatBank that was previously owned by him. Ukrainian markets suffered great uncertainty this week as the IMF warned Zelensky that he must maintain central bank independence in order for Ukraine to receive the $5bn stimulus package agreed earlier last month. Smolii’s work has been largely commended as restarting the Ukrainian economy through numerous financial legislation reforms and there are fears that the new governor may not enjoy the same level of independence as Zelensky pushes for currency devaluation and looser monetary policy. Ukraine is anxious to issue new debt to help fight the looming recession as they had to abruptly cancel the launch of a new $1.75bn bond after Smolii’s resignation. However markets seem to have responded well to Shevchenko’s appointment with the currency and bond markets improving in outlook. It still remains to be seen what will come of this controversial decision by Zelensky as many question whether the NBU will be able to perform as well as previous years, under a man who’s background is still unknown by many.  

Bond Analysis  

Source: Highcharts.com

The Ukrainian yield curve has flattened since the appointment of Shevchenko , after a sustained sell off following Smolii’s resignation. This had initially made the yield curve inverted which was a strong indicator of the lack of confidence. The inverted yield curve often indicates that investors have low expectations for interest rates in the long term compared to now, suggesting that a recession could also be on the rise. In Ukraine’s case the inverted yield curve is more likely to represent the uncertainty surrounding the IMF stimulus package of $5bn due to the central bank crisis. However the flattening of the yield curve, shown by the fact that the spread between 2Y and 1Y is only 12.5bp. This can often signal a move back to a normal yield curve from an inverted one, showing that investors are confident of the IMF honouring their stimulus package; the short term outlook of the Ukrainian economy looks promising.  Ukrainian bond prices gained significantly after Shevchenko’s appointment as the 2Y bond yield fell by 62.5bp again showing that the market is confident of Ukraine’s central bank stability in the short term. Another key factor is the slight fall in the value of Ukraine’s Credit Default Swap’s from 557.6 to 548.8   which suggests investors are erring towards optimism for the stability of the economy and integrity of government. However it can also be argued that the flatter yield curve signals poor expectations for economic growth in Ukraine. The NBU is expected to cut rates and potentially devalue the currency in order to boost exports and stimulate growth. However the flat yield curve indicates that inflation expectations are similar to the current situation, indicating that there is still a lot of uncertainty over the future of the economy, much of which will be determined by politics. The launch of a new bond perhaps later this month, will provide clarity as to investors views on Shevchenko’s appointment, as Ukraine will have to pay a premium for cancelling debt issuance earlier this month.  

Currency Analysis – USD/UAH 

Shevchenko’s past criticism of Smolii’s policy of allowing the currency to appreciate suggest he may be open to Zelensky’s idea of devaluing the currency, although this could be seen as largely political as it would boost exports. As a result, the decision to devalue could be implemented in order to improve Zelensky’s approval ratings, which would signal to the IMF that the NBU is not as independent as previously thought. This means that Shevchenko and Zelensky may have to carefully navigate these decisions in order to maintain both political and economic stability. The USD/UAH exchange rate has risen consistently from 27.02 to 27.41 showing a weakening of the hryvnia and perhaps an expectation that the central bank will now continue to pursue devaluation. The RSI of 70.61 for USD/UAH however suggests a downturn is impending as momentum in the market changes. In the future, it is likely that the USD/UAH rate will be influenced by the political relationship between Shevchenko and Zelensky rather than the state of Ukraine’s economy. The IMF rescue package will be crucial to boosting Ukraine’s currency but the uncertainty around it makes it a risky investment to make.  

Ukraine’s Political Outlook  

The key question remains as to whether the NBU will be independent under Shevchenko as he was not seen as the obvious choice to succeed Smolii. Having demonstrated considerable aptitude in working with international institutions such as the IFC and World Bank, Shevchenko is seen as responsible and competent. His experience working with Ukrgasbank also points to him being the correct person to head up the NBU. However the new governor’s allegiance towards Zelensky is unknown. He has previously pleased Zelensky by making lending more affordable to borrowers while at Ukrgasbank but was not seen to be the obvious choice as Bogdan Danylyshyn and Elena Scherbakova were prime candidates having been close to Ukrainian Oligarch Kolomoisky. However it could be likely that Danylyshyn who is head of the NBU council will use his position to influence Shevchenko, making him an independent governor by title only. This could be catastrophic for the Ukrainian financial sector as Zelensky, a close ally of Kolomoisky is pushing for privatisation of banks, with Privatbank first on the list. This would signal to the IMF that the oligarchs are still in control of the economy and is likely to negatively impact chances for future packages. The intense political pressure makes it likely that Shevchenko is not as independent as previously thought, as Zelensky’s campaign to exert political pressure on the NBU is likely to continue.  

Prediction  

In the short term it seems likely that markets will accept Shevchenko’s position although the uncertainty around him means that the new 12Y bond to be issued soon will fall in price initially. The grim economic outlook for Ukraine in the next 2 years means that bond yields are also likely to rise at least until next year, when their path to economic recovery will become clearer. Although Shevchenko’s independence is easily questionable, it is very probable that the IMF will confirm the rescue package in the next month which will provide a short term boost to the central bank and the financial sector. This could potentially boost Ukrainian equity markets as well. However, Kolomoisky’s growing power and Zelensky’s interference with the NBU makes a currency devaluation much more likely in the next year than before. This could also mean a decline in the stability of the Ukrainian banking sector despite the negative consequences it could have for approval ratings and IMF loans. Ultimately, the uncertainty around the political future of the NBU will create volatility, making Ukraine a risky but potentially rewarding place to invest.  

Key terms  

RSI – Relative Strength Indicator is a technical indicator that measures momentum changes in a market. An RSI of 70 or above suggests it is overbought while 30 or below suggests it is underbought. This can be useful in predicting corrections or other changes in the direction of the market  

Currency Devaluation – an intervention in the currency market by either the central bank or government to weaken the currency. This is often done to boost exports but can make imports expensive and trigger inflation. Governments often devalue currencies in times of recession  

IMF – the International Monetary Fund aims to promote financial stability in countries by offering them loans and rescue packages to help avoid default. This often comes with a set of stringent criteria for economic reform to promote a stable government.  

Inverted Yield curve – this is often a signal of a recession as investors want a premium for the riskier short term debt as opposed to long term debt. The fact that the risk of default is greater than the liquidity premium demanded by investors for holding bonds shows that recession is imminent, with inverted yield curves having predicted 9 out of the last 10 recessions.  

IFC – International Finance Corporation – the private arm of the world bank which seeks to invest in developing countries through private funds in order to help reduce poverty. They offer advisory and asset management services to help private sector firms in emerging markets drive development  

References  

World Government Bonds. 2020. Ukraine 5 Years CDS – Historical Data. [online] Available at: <http://www.worldgovernmentbonds.com/cds-historical-data/ukraine/5-years/&gt; [Accessed 17 July 2020]. 

Ft.com. 2020. Ukraine Appoints Central Bank Chief After IMF Warning On Crisis. [online] Available at: <https://www.ft.com/content/79c932f1-8cf3-4e92-8fc0-ff5523f09a6e&gt; [Accessed 17 July 2020]. 

WKZO. 2020. Ukraine Parliament Approves Shevchenko As New Central Bank Chief. [online] Available at: <https://wkzo.com/news/articles/2020/jul/16/ukraine-parliament-approves-shevchenko-as-new-central-bank-chief/1040167/?refer-section=business&gt; [Accessed 17 July 2020]. 

Atlantic Council. 2020. Will Ukraine’s New Central Bank Chief Be Independent? – Atlantic Council. [online] Available at: <https://www.atlanticcouncil.org/blogs/ukrainealert/will-ukraines-new-central-bank-chief-be-independent/&gt; [Accessed 17 July 2020]. 


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