Tuesday, July 01, 2008

Ukraine Use Currency Appreciation To Curb Price Inflation

I recently told you about the alarming increase in price inflation in Ukraine, which risked sending the country into a hyperinflationary spiral.

It now seems that the National Bank of Ukraine have started to notice and deal with the threat. Interest rates have been raised and money supply growth slowed. However, real interest rates are still very much negative and money supply growth at 50% year over year (down from 54% in January) is still way too high. The most important tool instead appears that it has finally allowed the Ukrainian currency, the hryvnia, to appreciate. If you look at this graph, you can see that the hryvnia was basically flat against the U.S. dollar until just a few months ago at roughly 5 hryvnia per U.S. dollar. But since April, the hryvnia is up about 10% so that a U.S. dollar now only cost about 4.5 hryvnia to buy a U.S. dollar.

The problem is of course that this appreciation combined with the high inflation rate means a massive real appreciation of the hryvnia, which in turn will further aggravate another problem, namely Ukraine's massive current account deficit of over 10% of GDP. That is why the central bank should focus on other measures to restrain money supply growth. Still, intervening to suppress the exchange rate would have of course have fueled monetary expansion, so permitting the currency to appreciate is still a good thing in itself. Especially since the prevention of a hyperinflationary spiral is of greater importance than containing the current account deficit.


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