Regarding the cost of the hryvnia funding, the fight against inflation, and the recovery of Ukraine’s economy

The rates set by the National Bank of Ukraine (NBU) serve as a guideline for the banking market regarding their tactics and strategies in deposit policy through the adequate/inadequate monetary transmission mechanism. Different rates on 3-month certificates of deposit and overnight certificate rates actually show a difficult dual choice that the regulator faced: to maintain consistency in managing expectations of inflation and the key policy rate on the one hand, and on the other hand, to make the monetary transmission mechanism work even during the war. I do hope that this compromise is justified from the point of view of the NBU’s policy consistency and will work to support the Government’s debt sustainability.

The issue of the value of the hryvnia resource is once again coming to the fore. It is already obvious that this is not a problem that can be solved with a single stroke once and for all, but needs to be addressed on a daily basis. After all, the issue of the value of the hryvnia resource is the basis of monetary policy, price and currency stability, and, at the same time, financing the country’s budget deficit.

Step 1: Raising the key policy rate as a guideline for banks

In some ways, our financial market was satisfied with the NBU’s decision to tighten the requirements for mandatory reserves: the regulator significantly raised the standards, but allowed banks to form up to 50% of their reserves from domestic government bonds (DGBs), which are part of the NBU’s benchmark. On the one hand, the NBU was pushing banks to equalize imbalances in their liabilities and to increase the share of time deposits, which had dangerously fallen from 41% in early February 2022 to 33.4% in January 2023. Banks were expected to take market-based measures, i.e., to raise deposit rates. After the key policy rate was raised (from 10% to 25% in June 2022), banks were perfectly aware of the benchmarks, but unfortunately, not all of them were striving for them. Especially government agencies, which form their resource base mainly through budgetary payments to the population.

But there was another aspect too, one that was the subject of much controversy and opposing opinions. I am referring to the coverage of the state budget deficit by the government’s regular placement of new government bonds. In 2022, banks were not very willing to buy new government bond issues, and the NBU had to do it for them. Initially, it was clear that this measure was necessary and would be limited to the agreed amount of UAH 400 billion. The NBU repeatedly urged the Ministry of Finance to bring the yields of domestic government bonds to market values, which would have balanced the situation. However, the government refused to address the issuance risks to the economy.

Step 2: government bonds – up to 50% of required reserves

At the beginning of 2023, the Ministry of Finance received a concession – the NBU’s permission for banks to include government bonds in their required reserves. This step by the regulator helped the government significantly, but it did not solve all of its debt problems completely.

Earlier this year, thanks to this decision, the Cabinet of Ministers was able to place its debt securities with great ease. Something that was a problem in 2022. Domestic government bonds from the National Bank’s benchmark were sold out like hotcakes. Sometimes there was even a real rush, during which demand for these government bonds exceeded supply (the Ministry of Finance’s limit) by 6 times. This allowed the government not to increase, but even to decrease the profitability of its securities. The most illustrative example here is the benchmark government bonds maturing in December 2024, where the rate dropped from 19.59% to 18.51% per annum during three placements.

Banks could no longer be accused of ignoring the Ministry of Finance’s auctions. At the same time, they reduced their investments in NBU certificates of deposit by almost 30%, comparing UAH 477.5 billion as of January 2 with UAH 336.2 billion as of March 20, 2023. All the factors had an impact: both tighter reserve requirements and more intensive purchases of government bonds.

Step 3: market yields on domestic government bonds

But initially, it was quite clear that the demand for NBU benchmarks is not infinite and is limited to 50% of the required reserves. This is about UAH 100-110 billion. The regulator’s goal in this situation is to reduce these reserves. The banking system needs to improve the structure of its resource base by increasing the share of hryvnia funds in term accounts and reducing the amount of demand deposits. And then everything goes according to the classics: the more funds are generated on hryvnia deposits and the zero (preferential) reserve rate is applied to them, the lower the reserves. The quality of liabilities should be systematically improved, of course, without distortion by banks.

As a matter of common sense, the government should have realized this. Therefore, they had to work on building an adequate interest rate policy for new government bond issues. And this should have been Plan A. And, of course, it would be desirable for the responsible persons to have at least a plan B.

This will come in handy in the near future, as many banks are already reducing their activity at the Ministry of Finance auctions. I believe that the government should again think about aligning its rates with market levels.

Step 4: deposit rates

As for deposit rates, they have risen significantly since the beginning of 2023, and, for example, the UIRD-12 index was at its highest level of 14.09% per annum by March 20. By the way, this was not without the efforts of state-owned banks, which increased yields on medium- and long-term retail deposits. The maximum rates on 12-month retail deposits in medium and small banks have already reached 18% per annum. The NBU’s monetary policy change last year has begun to bear fruit, even after a difficult swing. These are the fruits that will not only stabilize inflation, but will also contribute to a significant reduction in the price index.

The regulator’s launch of its 3-month certificates of deposit in April plays also a significant role. 

25% per annum is an interesting yield, especially against the backdrop of declining inflation. I expect it to receive a wide response in the financial market, especially in the context of the restrained lending policy of many financial institutions and the formation of excess liquidity in our banking system. Thanks to the stable demand for 3-month certificates of deposit, the NBU will be able to tie up excess liquidity even more effectively and fight price increases.

This is a key function of the NBU – the fight for price stability, which will form the basis of Ukraine’s economic recovery in difficult wartime. This is especially crucial now, as it will bring our victory closer.

I would like to believe that the government also understands the significance of this, so it will adjust its interest rate policy on domestic government bonds and start making efforts to develop the secondary market for its securities. This will definitely help to fulfill the goal of reaching 100% of the rollover of government bonds in 2023, which has been repeatedly declared by the Cabinet of Ministers.


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