End of QE spells

DIVE FOR HRYVNIA

Cash-strapped investors will leave Ukraine to grapple with its debt problem

The era of cheap money on global financial markets is drawing to an end. The U.S. Federal Reserve Board is thinking about curtailing quantitative easing programs. Such a decision could be made at the next meeting of the Federal Reserve Board in September-October. So far, the FRB is investing USD 85 bn a month to purchase mortgage papers and T-bills in order to maintain near-zero interest rates. But the situation could soon change

The unprecedented campaign for stimulating the economy could be cut back at any moment. According a survey by Blue Chip Economic Indicators, 35.1% of economists expect the FRB will cut back its program of buying up government bonds by September.

In this case, the global economy will be deprived of its driving force, cheap money. Such a prospect will make investors nervous. Up until recently, they gambled on buying up highly profitable assets on developing markets in an attempt to turn a decent profit from high-risk investments. The threat of a reduction in the infusion of central banks could reverse the situation on markets by 180 degrees. Capital will pull out of developing markets, which will pose a threat of another wave of crisis for their economies in the form of a reduction in production volumes to a crash of currency exchange rates. Such a scenario could slam the door to Ukraine’s window of access to foreign debt markets, which have long become a customary source of replenishing the country’s hard currency reserves. "The profit margins of Eurobonds will be quite high, which means there is a risk that Ukraine’s credit rating will be reviewed downward and, in turn, the number of potential investors in Ukraine’s Eurobonds wffl narrow," head analyst of the Investment Capital Ukraine group Valchyshen forecasts. International agencies have already begun threatening Ukraine of reviewing its assessments. A negative outlook reflects the possibility of downgrading the long-term credit ratings of Ukraine over the next 12 months with the probability of a ratio

of 1:3," S&P said in a release. Such a situation is highly undesirable if to take into account that the government manages to successfully repay slightly more than half of its debts that were scheduled to be repaid this year. Vice Premier Serhiy Arbuzov stated that since the start of the year Ukraine repaid USD 4 bn of the USD 7.5 bn it took out as credit. Moreover, the money was exhausted mainly on repayment of foreign debt markets. Despite this, the high demand of investors for Ukraine’s sovereign securities was not enough to safeguard the National Bank of Ukraine from spending its reserves. In May of this year the reserves of the NBU fell a record-high 2.8% or by USD 697 mn to USD$24.54 bn. On the whole, from the start of 2013 the central bank’s reserves fell by 0.02% or USD 5 mn.

Ukraine will have to pay back another whopping USD 1.4 bn this August. If the fever on the market does not subside, the Ukrainian government wffl be forced to borrow money at an interest rate that is three times higher or back down from the placement of bonds. "The risk of the closure of foreign lending markets significantly increases the probability of uncontrolled devaluation of a currency. Of course, it cannot be ruled out that the policy of supporting the hryvnia by applying all possible efforts that were quite effective for a while will work right up to the next presidential elections in 2015. But we all understand that in order for such a policy to be successful the government must find a substitute for the placement of Eurobonds or sew a guaranteed parachute for safe landing," an expert at Concorde Capital says. A reorientation towards domestic investors could be an alternative solution to extending hands to foreign creditors. "T-bills in hard currency can easily serve as a lifesaverT says Serhiy Fursa with the Dragon Capital, "though the demand for hard currency T-bffls in Ukraine is also not unlimited. After December 2011 Kyiv placed hard currency T-bffls to the tune of more than US $6.2 bn. The major question is whether or not banks will invest in them in the previous volumes. As a result, the government wffl have no other way out but to repay debts from the reserves of the NBU, which wffl once again put serious pressure on the value of the national currency. Signing of an agreement on the conditions of the IMF of fulfilling all its terms and conditions could be an alternative for Ukraine. On.the other hand, by demonstrating excessive diligence in maintaining the exchange rate of the national currency Ukraine could fall into another trap. "Introducing the FRB policy on the backdrop of stagnation and recession in other major economies of the world will joggle other countries to weaken their currencies," says Valchyshen. All things considered, the devaluation of the hryvnia seems inevitable.