National Bank of Ukraine Governor Kyrylo Shevchenko: We and the IMF are on the same wavelength
Kyrylo Shevchenko
Photo: Press office of the National Bank of Ukraine
National Bank of Ukraine Governor Kyrylo Shevchenko gave an exclusive interview to Interfax.
Question: A question regarding the International Monetary Fund. In the past you said it might be possible to receive three tranches from the IMF this year. It is now clear there won’t be three. How big is the risk we won’t get any money at all from the IMF, and how might that affect Ukraine’s financial state?
Answer: A brief comment on the fiscal side of things. Yes, this year there is still a tendency for a rather significant state budget deficit at the beginning of the year. In February, the state budget deficit widened to UAH 14.9 billion, because spending growth is accelerating. The main expenditures - healthcare, social welfare - are quite logical. That they are financed by borrowing, which is also absolutely natural. This is the Finance Ministry’s ongoing work.
The main assumption in our macro-outlook is that we continue cooperation with the IMF. Given the lengthier negotiating process, we can expect two tranches. Even a decline in volumes (although I am not prepared to speak about volumes just yet) will not be a threat. The funds could be compensated with Eurobonds. You and I know that the IMF is not so much about money, but about confidence in the country. This is a strong message to investors.
We also anticipate the IMF will issue additional Special Drawing Rights. This is a new initiative announced by the Fund. Its purpose is to provide additional liquidity to the global economic system by topping up the international reserves of IMF member states. The total amount announced is $650 billion. We hope that Ukraine will be able to receive additional funding in the framework of this initiative. For this to happen it is first necessary for it to be approved by the IMF Executive Board, then by the Board of Governors.
Q.: How much in the way of additional SDR might be issued to Ukraine?
A.: More than $2.7 billion, in proportion to Ukraine's IMF quota. The exact figure will depend on the exchange rates of the currencies included in the SDR basket. The last time the Fund carried out an operation like this was in 2009. That was a response to the crisis. Such an IMF initiative can become a positive factor for Ukraine.
Q.: How long can the pause in IMF funding continue to be pain-free for the Finance Ministry’s borrowing rates? Finance Minister Serhiy Marchenko has said in an interview that without the IMF, the Finance Ministry is unlikely to tap the Eurobond market, and that he is already feeling uncomfortable without the Fund.
A.: It's certainly uncomfortable to live without the IMF. We have no differences with the Finance Ministry on this score. We expect that after the Verkhovna Rada returns to its normal working routine it will be possible to adopt all the laws needed to continue cooperation with the IMF.
Q.: The finance minister, the prime minister and those above them - do they understand that if there is no IMF, they will not be able to replace that with financing from the National Bank?
A.: There was a lot of speculation about this last year. I can only quote again my favorite Article 54 of the Law on the NBU: “The National Bank does not finance the state budget deficit." The NBU does not plan to deviate from this, nor do I.
Q.: You’ve said the government bond portfolios of banks are already at their limit.
A.: Yes, it's what's called fiscal crowding out. The fiscal crowding out threshold for the portfolio of government domestic loan bonds in the banking system is 35%. Today this threshold has already been exceeded. It is 39.6% of deposits in the banking system. We are on a slippery slope of fiscal crowding out.
Q.: What must the National Bank itself do to obtain the staff level agreement for the IMF second tranche?
A.: As for the structural benchmarks, this is the adoption of a bill to improve corporate governance at banks. In November last year, the NBU introduced this bill to the parliament, and it was registered (No. 4367) and signed by [Chairman of the Rada Committee on Finance, Tax and Customs Policy] Mr. [Danylo] Hetmantsev, and we are very grateful to him for that. After all, we understand that the strengthening of the role and independence of the NBU could cause a mixed response, even among his colleagues in parliament.
During the mission’s work, we agreed to somewhat modify this bill, which we are working on now.
In addition, during the mission we together with the IMF began to draft amendments to the law on the NBU, which have more to do with interaction between the Council and the Board of the National Bank. These changes are not on the list of benchmarks, but they are being drafted taking into account the IMF’s recommendations. This work is designed to implement the IMF mission’s recommendations on the implementation of safeguards an integral part of the Fund's lending policy.
We and the IMF are on the same wavelength. Work is in progress - now the legal teams are finalizing the wording.
Q.: How do you estimate economic growth?
A.: We estimate the negative impact of the January lockdown on annual GDP at 0.2 percentage points, so not much at all. It seemed that it ought to have influenced consumer sentiment, since the previous lockdowns significantly affected the retail, restaurant and hotel businesses. But we have seen growth in retail turnover. And the effect of the lockdown on other industries, such as metallurgy and agriculture, is generally minimal.
We do not expect GDP to have grown for the first quarter; it will likely have been down somewhat in annual terms. Firstly, January-February 2020 was still pre-Covid. Secondly, we were unable to take full advantage of the good foreign markets situation. Thirdly, the difficult situation in livestock farming, partly due to the deterioration in livestock disease and the rapid increase of the price of feed, which affected the sector’s profitability. Output in two months decreased by 6.1% year-on-year, and the difficult situation in livestock farming resulted in a decrease in production of meat and dairy products.
As a consequence of last year's lower harvests and active exports of vegetable oil against the backdrop of high world prices, oilseed stocks decreased, as a result of which the decline in the production of vegetable oil and fats gathered pace, falling 22% year-on-year in January-February. Lower harvests, as well as an increase in production costs led to a decline in the production of flour and milled products by 20.6%, and bread and baked products by 6.6% year-on-year.
Q.: What ultimately will be the lockdown’s effect?
A.: By our estimates, the March lockdown will have a rather negligible impact on GDP, less than in January. The final estimate will depend on the actual quarantine parameters. Of course, the statistical effect of the comparison base will render some support - last year, starting from the second half of March, there was a very strict quarantine throughout the whole country.
Regarding new lockdowns (so-called "red" zones quarantine), we will consider them in our next macroeconomic forecast, planned for April. We’re now taking several lockdown scenarios for our model’s calculations: depending on which scenarios the government picks, we will be guided by such scenarios. In the April forecast we will of course take into account the tightening of restrictions due to a region or city being included in a "red" quarantine zone. This is a realized risk.
At the same time, when assessing the quarantine factor, two aspects must be taken into account. Firstly, quarantine measures have a heterogeneous effect on the economy: they have next to no effect on such sectors as industry, agriculture, but they have a substantial effect on the services sector and transport. Secondly, the economy has already to a considerable extent adapted to quarantine measures, even in the services sector. Accordingly, their impact is not as destructive as in the second quarter of 2020.
Moreover, unlike last year, when the whole of Ukraine went into lockdown, this time 11 regions – or 10 regions and City of Kyiv - are in the "red" zone. We also take this into account in our assessments.
We expect global commodity prices, which prevail in Ukrainian exports, to remain high, while energy prices, by our estimates, will stay relatively stable. An additional factor – there is the likelihood of a better harvest as the weather conditions were favorable in winter and the area under winter crops expanded.
Q.: Regarding monetary policy. The main challenge is inflation, which is higher than forecast. We have seen the first steps - hiking the rate by 1.5 percentage points. On the other hand, as you said, the economic recovery has not yet begun, so the NBU probably needs in its projections to make sure any recovery is not stopped (although we realize there will definitely be some sort of bounce, given the base in the second quarter of 2020). How will you maintain the initial growth and how will you combat inflation?
A.: As I have told you, the rate of inflation is accelerating. Our task at the NBU is to stop this from developing into a dangerous tendency. We have an effective tool for this - the discount rate, and if necessary, we use it without hesitation. We have already put the rate up in March and April.
We need to look at the inflation situation from two angles: what has already happened and will happen in the next few months, and what lies ahead in the longer term. We have talked about what factors have resulted in the current inflation, in particular, global economic recovery, the Chinese factor. This is good news, but the result of the economic upturn is the acceleration of price growth. The role of central banks in curbing inflation in countries that practice inflation targeting is key. Our task is to bring inflation back to the planned target of 5% +/- 1 pp. If the NBU needs to raise the interest rate in order to achieve this goal, we are ready to do it.
The discount rate is a tool. We have no discount rate targets. The goal is to bring inflation back to our target. Our expectations for the trends in the NBU's macroeconomic forecast are that inflation may remain above the target range: until September 2021. But after that, thanks to the actions of the NBU and such factors as the new harvest, we expect a turning point - this is approximately the eighth or ninth month.
Q.: The NBU team emphasized in 2019 that it was helped by a significant strengthening of the hryvnia in the fight against high inflation. To what extent is the possibility of such an instrument as the strengthening of the hryvnia being considered?
A.: When the exchange rate strengthens due to a lot of foreign currency supply, this is one way of suppressing inflation. But foreign exchange supply in the domestic market is essential for the hryvnia to strengthen. And supply and demand have been almost balanced since the start of the year. In the same January 1-March 15 period of 2020, the NBU carried out interventions on 34 occasions, and in 2019 on 39, but this year just 10. That is, the market is balanced, and we are fully committed to a strategy of gradually minimizing the NBU’s participation in the currency market.
The behavior of households is another indicator of the currency market’s stability. The public significantly increased FX supply in March: net sales of cash and non-cash currency by the households was $270 million compared with net purchases of $9 million in February.
Nonresidents have boosted government bond portfolios more than UAH 19 billion or $680 million since the start of the year but they have sold less than 50% or $267 million of the forex, which has not put significant pressure on the exchange rate in terms of the hryvnia’s revaluation.
Foreign exchange purchases for the purpose of repatriating dividends decreased by 34% compared to the beginning of 2020 and amounted to approximately $500 million.
So today the market is quite well balanced. Pushing it one way or another is not our task. If there are excessive fluctuations we can smooth them out.
Q.: Is the task of increasing reserves not so urgent now?
A.: We have topped our reserves up by more than $200 million since the beginning of the year. But for what reason did the NBU do this? To smooth out the fluctuation. Look at the exchange rate dynamics compared to last year. Since the beginning of this year, the hryvnia exchange rate has strengthened by 1.6%, while last year over the same period it fell more than 15%. This shows that the market is more balanced.
During these two months, 85% of the supply in the foreign exchange market was generated not by non-residents but by traditional exporters - mining and metals companies and agrarians.
Q.: Do you personally think that the hryvnia over-strengthened in 2019?
A.: I believe that such excessive strengthening of the hryvnia did not benefit the Ukrainian economy. I’m certain of that.
Now we see no possibility of repeating the exchange rate dynamics of 2019 in 2021. Firstly, the interest of non-resident investors in the government bond market can be characterized as being restrained. Secondly, the economy is gradually recovering after 2020, tourism is highly likely to revive, so demand for forex will be greater. On the other hand, high prices for ore, metals and agricultural products are increasing the supply of foreign currency.
We have no exchange rate "target" or "corridor". I repeat - we remain committed to a floating rate. Our updated foreign exchange intervention strategy effectively duplicates the previous one.
Q.: What trends for deposits and lending rates do you forecast in the new conditions of inflation and discount rate growth? Is there a danger the positive trend last year and such low rates, which Ukraine not seen for a long time, if ever, will go into reverse?
A.: I like a quote from one of the meetings for which the Cabinet of Ministers from time to time gathered major industrialists, bankers and the central bank. At one of them, the NBU chairman was asked by a manufacturer: "When will the banking system give us long and cheap loans?" He replied: "When you give us long and cheap deposits."
It is clear that interest rates depend on inflation. We do not have people who will take their hard-earned cash to a bank for a rate below inflation. So of course there is a connection, that when inflation gathers pace, rates on deposits and loans might grow. But there is also another aspect - the interest margin in the banking system. We see that the banking system is able to at least maintain interest-rate dynamics by narrowing its interest margin.
Secondly, there is confidence that thanks to the actions of the NBU, among others, inflation will return to its target range. So these two factors are able to hold back further possible growth of deposit rates.
Q.: Do I understand correctly that if you remained a commercial banker you could put rates on short deposits and loans up slightly, but you would hardly touch long-term resources?
A.: Considering that I was a commercial banker for a long time, although (smiling) a government banker as well, I would do just that. For resources that go beyond that limit when inflation returns to is target range, this is not economically feasible.
There is one more factor. For the banking system to be able to lower its margin, it is necessary to return to protecting the rights of the creditor, because the size of this margin depends directly on the level of risk. Why are rates the lowest for government bonds? Because this is a risk-free tool. Why are rates highest for consumer loans? Because it is the most risky tool. So we at the NBU simply do something every week, but there are still a lot of questions regarding the protection of creditors' rights, which, unfortunately, are outside the National Bank’s mandate.
As you know, last year we started a discussion about a financial court. This is also outside the NBU's mandate. However, we have started this discussion, and now we are discussing this with the IMF and the professional community. From our point of view, the creation of such a specialized court will significantly improve the situation with payment discipline. Such a court should cover three issues: lender/borrower relations, investor/investments, and access to bank secrecy. This is because today an investigating magistrate from any district makes a decision regarding access to bank secrecy that cannot be appealed. Bankers can give you many striking examples.
Crucially, judges for such a court should be selected transparently, and to ensure maximum trust, with the participation of representatives of the international community. This will have a major impact on the result.
Q.: There have already been proposals to revise the long-term refinancing program. In your opinion, has the time yet come to close the program or abandon it altogether?
A.: A simple answer: there have been a lot of anti-crisis measures and one of them was long-term financing. Obviously, as the economy recovers from Covid-19, the banking system will probably not need a significant amount of long-term liquidity. The gradual easing of systemic risks has already influenced a reduction in banks' demand for refinancing loans. This can be seen in statistics on the growth of refinancing loans in 2021.
The same applies to the interest rate swap instrument. Depending when the economy begins to recover, banks will not need to use such NBU instruments. Then we will gradually scale back these tools. As the economy revives gradually and conditions for the functioning of the financial system get back to normal, the NBU will curtail emergency measures to support banks that were introduced in connection with the coronavirus. This, in particular, is envisaged by the Monetary Policy Guidelines for 2021. Now we are deciding on the timing.
Q.: The interest rate swap has not been very popular. Was this instrument too complicated for our bankers?
A.: Swaps are an interesting tool – they are for me, I once worked in the Treasury as a dealer. It was very well tested by banks at the end of last year, when the volume was limited and auction became more competitive.
This tool is used by a very limited number of countries in the world, but it gives the banking system more confidence in long-term projects, because it is possible to hedge your interest rate risk.
Q.: What’s your forecast? Will banks use this tool going forward?
A.: Yes. We will use it this year, however, like last year, to a limited extent. We’ll start the auctions and see.
We, as the market regulator, have shown that this instrument can work in Ukraine, therefore, we expect that the market will embrace this trend, and interest rate swaps will already be created by the banks themselves without the NBU’s participation.
Q.: In connection with the new lockdown, will there be another postponement of the implementation of banking supervision measures - stress testing, ratios? Last year, the NBU postponed this for a year, but the deadline is already up. You are launching a net stable funding ratio or NSFR of 80% effective April 1 and unsecured consumer credit risk weights are due to go up from 100% to 125% from July 1. Is this still your position or does the situation again require that deadlines are extended or a pause?
A.: The NBU adopted many changes to respond adequately to the Covid-era challenges in the second half of 2020. Today we are also looking at requests from the banking system, we have ongoing dialogue on each issue with banking associations. One of these issues is indeed the NSFR. We will look for ways to respond if we see that the planned introduction of the NSFR is going to have a systemic impact. In general, our approach is as follows: if the introduction of a ratio affects a very limited number of banks and does not have a systemic impact, then we will work with individual banks and require them to solve their problems with capital.
Q.: Are you ready to allow new banks and new owners onto the market and approve M&A in the banking sector? In the last few years there have been many refusals by the NBU, as the regulator. The latest news in this sphere includes the sale of Unex Bank to Dragon Capital and the sale of Idea Bank.
A.: We’ve already given clearance to Dragon Capital, and now we are completing the formalities.
Interest in the banking sector has picked up now.
The banking business is not the leader in terms of rate of return, but certain business models provide a fairly decent level. We consider the growing interest in banking to be a very good signal. This has resulted from putting transparent and comprehensible rules in place for the banking market.
When approving deals, we have two key criteria for the buyer. By "buyer" we mean the beneficiary. The first is an impeccable business reputation, the second is sufficient finances to support the bank if necessary. Today, we are well disposed to ensure that the banking system gains new or changes owners for more powerful and transparent ones.
Q.: About "internal squabbles" in the NBU, as they were called in the President’s Office. What is your vision of how to resolve this issue and make sure that it does not trouble the President’s Office and market participants?
A.: The regulator’s policy should be unified, and this applies to all aspects of work: monetary policy, exchange rate policy - there are many. It also applies to the one voice policy. The NBU Board should consist of a team. We should have the same goals and ways to achieve them.
Negative public rhetoric from any of employees poses a threat to the entire National Bank. I, as the NBU governor, do not deal with personal conflicts and am ready to resolve any controversial issues within the NBU. If, of course, NBU employees want this as well.
I want to make the NBU an even more powerful institution. For this reason we have many ambitious plans that lie even outside the NBU, for example, the creation of a financial court to enhance protection of creditors' rights. At the same time, we also have quite practical intentions. Now I am talking about the privatization of state-owned banks, which is a priority for me. In order to privatize them we must reduce the level of non-performing loans on their balance sheets. It is large-scale strategic projects like this that are the NBU’s goal, not "internal squabbles."
Q.: What are the National Bank’s plans to develop cashless operations?
A.: Among the achievements in Cashless development I want to tell you more about the NBU’s BankID System. Last year, we worked productively with BankID, which already has good coverage - 32 bank identifiers. Virtually 99% of payment cardholders in Ukraine have access to the system The NBU’s task in 2021 is to make it available to all bank clients in Ukraine.
Together with Digital Ministry we have enabled the use of the Diia mobile application for remote identification of clients and receiving financial services by them. This already works in the banking and non-banking markets. Today it is possible to remotely open accounts with the NBU BankID System, Diia applications, video identification technologies. We have plans for the Prostir system.
Q.: Prostir is Ukraine’s third payment system after MasterCard and Visa, although its share is still about 1%. Could the system become, for the sake of argument, what lifecell is for Kyivstar or Vodafone – a cost competitive irritant?
A.: I can agree with that analogy: 98% of POS-terminals accept Prostir today, and after co-badging with the international payment system UnionPay Prostir ceased to be a local system. We are working to improve the security of payments with Prostir cards, in particular, the implementation of the technology of multi-factor authentication of payments on the Internet (3D Secure), to add the cards of the system to a smartphone.
But for banks, servicing this card is almost 10-12 times more profitable than servicing the cards of international payment systems!
We are also looking at the possibility of using Prostir’s technological platform to create a fast payment system in Ukraine (account to account). Such a system will make it possible to combine a high speed of settlements and potentially low cost of payments processing compared to card payment systems.
The national payment system is an element of national security and economic protection of the interests of citizens, including from global monopolies. In Ukraine, we have an example of cash payments to internally displaced persons from the temporarily occupied territories, which are carried out exclusively with Prostir cards. This means we can be confident that the funds received are used exclusively on the territory of Ukraine.
We believe in competition and market mechanisms, therefore we develop Prostir exclusively on market conditions. Administrative levers are taboo for us. We believe that we are able to compete thanks to our tariffs, products, and services aimed at the needs of Ukrainians. Yes, the system’s participants are constantly growing in number, today 56 financial institutions are members of the system. Almost half of Ukrainian banks (37 participants) issue or acquire Prostir cards.
Next is the CBDC, the digital currency of central banks. Today it is more of an R&D area, with the emphasis on research. Why? As colleagues say, we need to find a use-case, that is to find where this e-hryvnia will be more useful for citizens, market participants and the state.
So far, the only live example in the world is that of the Caribbean countries - the Sand Dollar and DCash digital currencies. Why? Because the Bahamas, for example, is an archipelago of 700 islands, and you can imagine the cost of transporting physical cash there. Then there’s China’s example, the DC/EP, which is a pilot project, but the state’s role in the digital currencies is already increasing. There is also the Scandinavian example, Sweden, they also have a pilot. Although their Cashless level is already very high, so the central bank of Sweden is adapting cash to the needs of the digital economy.
We are now working on a set of use-cases for Ukraine, determining where it will be useful to us. We have launched a survey. The European Central Bank also recently conducted a survey on the digital euro, which anyone could take part in. We are still talking with professional market participants: at the end of last year, our team launched a survey and asked experts to answer a number of questions regarding six possible use-cases for e-hryvnia to determine potential demand. They concern areas like retail and corporate payments, targeted social payments, settlements for securities and even cross-border payments.
This is a very interesting area, but everyone should realize one thing, that the National Bank is an institution that must weigh all the risks. So, yes, we are advocates of digitalization, but any instrument, including the e-hryvnia, has an impact not only on digital, but also on monetary policy. Therefore, before implementing it, you need to find answers to the question of the impact on monetary policy and financial stability.
But we have already laid the legislative foundation for issuing e-hryvnia, having included the definition of "digital currency of the National Bank of Ukraine" in the draft Law on Payment Services stipulating the NBU's right to issue it.
Q.: What’s the National Bank’s role in launching commodity exchange spot and futures markets?
A.: The National Bank fully shares the opinion on the importance of introducing the best world practices in the commodity exchange spot and futures markets. We’ll do what is necessary within our mandate to develop commodity exchange spot and futures markets and we are now implementing a model according to which the NBU will keep a hryvnia central counterparty account through which settlements will be made. This model of settlements, which in international practice is called “central bank money settlement,” is used all over the world and is considered an example of the application of best practices.