On May 22, 2023, the National Bank of Ukraine presented its new strategy "Financial Fortress of Ukraine" . The word "fortress", of course, obliges.
In terms of monetary policy, fortification is 1) long-term price stability (~2% per annum for at least 10 years), 2) a freely convertible currency in a liberal current and financial account regime, 3) no interest rate spread between EU countries and in the national economy, 4) an open, competitive field of financial services, 5) a developed market for a variety of financial instruments and securities.
From the point of view of the European Central Bank (criteria for convergence with the standards of the euro area) are clearly spelled out:
1) price stability: stable average annual inflation, not exceeding 1.5 percentage points of the inflation rate of the top three countries in the euro area. Over the past 20 years, this figure has been ~2%.
2) Long-term interest rates: no more than two percentage points above the rates in the top three countries in the euro area for price stability. In the 21st century, this is ~5% per annum.
3) Exchange rate stability: participation in the European Exchange Rate Mechanism (ERM II) for at least two years without significant strain, especially in the form of devaluation against the euro.
The fourth criterion concerns fiscal policy – the sustainability of public finances. The budget deficit should not exceed 3% of GDP, and public debt - 60% of GDP. The National Bank is not responsible for the implementation of these parameters, but the government, together with the parliament, is obliged to ensure the coordination of monetary and fiscal policy.
Then we can confidently say that, from the point of view of monetary policy, the country is a fortress. Ukraine is a candidate for EU membership. To join the EU, it is necessary to harmonize legislation on 35 chapters. Here are the sections of legislation that directly relate to the National Bank:
Chapter 17 - economic and monetary policy,
Chapter 9 - financial services,
Chapter 4 - free movement of capital,
Chapter 3 - the right of establishment and the freedom to provide services,
Chapter 8 - Competition Policy,
Chapter 29 - Customs Union
It is logical to assume that all strategic documents of Ukraine will be focused on the norms and standards of the European Union. The parameters of macroeconomic stability are not bureaucratic whims or political whims of the wealthy West. These are the norms of monetary hygiene necessary for all.
They should be regardless of the level of prosperity and development, because it is in this state that they stimulate economic growth. And without it, poor countries will never become rich. Let's see how the adopted Strategy reflects the norms / standards of the EU and those countries that have the best indicators in the world in the field of monetary policy.
In Ukraine, it is customary to present strategies not in the form of a detailed text based on clear arguments, scientific conclusions, valid methodology, conclusions from economic history, with links to sources, but in the form of Power Point presentations.
“Financial Fortress of Ukraine” is 36 slides, if we take away two introductory and two last ones (branding of the National Bank itself). Perhaps somewhere in the depths of the National Bank there is a large, detailed document on the basis of which the pictures were made, but it is not in the public domain. Therefore, we analyze what is.
Orientation towards pictures, presentation, performance is a reluctance to ensure the inclusiveness of the process on the part of experts, business and society, as well as an orientation only towards those who perceive scientific, complex information in the form of cartoons and pictures.
Even the very name of the strategy - financial fortress - is a mixture of styles that is not accepted in the strict world of monetary policy and money science. Imagine that the Swiss central bank publishes its monetary policy strategy called "Alpine Stronghold" or the US Federal Reserve calls its strategy document "American Bastion".
It's one thing to listen to the beautiful song "Fortress Bakhmut". It is completely different when the word "fortress" appears on the country's most important economic document. Especially in the context of the latest monetary theory of Ukraine over the past 20 years.
Let's recall the parameters of Ukraine's "financial fortress" for the period 2003-2022. In 2003-2012 average annual inflation was 10.9%, in 2013-2022. – 14.0%. Average annual inflation of 12.4% over the past 20 years is not a financial fortress, but a passage yard. During this period, Ukraine is on the 13th place in the world in the list of the most disadvantaged countries in the world in terms of inflation.
Let me remind you that the key, main function of any central bank is to ensure price stability. In Ukraine, the demand for a quality monetary policy has not been formed.
Presidents, prime ministers, deputies and heads of the National Bank are changing, and monetary policy remains a victim of the Big Banks-National Bank-Government syndicate. They turn inflation, devaluation, severe currency and financial restrictions into sources of their enrichment - at the expense of everyone else.
The second parameter of the quality of monetary policy is the cost of credit. It is directly related to the refinancing rate of the National Bank. In the period 2003 - 2022. the average annual refinancing rate in Ukraine was 11.5%.
The spread between Ukraine and the world's central banks, which set the trend by 3-4 times, is a convincing indicator of poor-quality monetary policy. There is plenty of free money in the world economy, but a dense monetary iron curtain has been erected between the world and Ukraine.
Note that inflation for 2003-2022. in Ukraine is higher than the refinancing rate, which is a violation of the basic rule of monetary hygiene. At that time, the refinancing rate of the main central banks of the world was at the level of ~1.5 - 2%, because inflation was also approximately at this level.
The extraordinary monetary policy that the Fed/ECB/BOE has been experimenting with over the past 15 years has destroyed the quality standards of monetary circulation. There has never been civilized monetary normality in Ukraine. Hence the prohibitive price of a loan, the underdevelopment of the financial market in the regime of strict credit and foreign exchange regulation, as a result, the restriction of economic growth.
The third parameter of the quality of monetary policy is the dynamics of the exchange rate of the national currency. Here the possibilities of the National Bank are limited, since the balance of supply/demand for money (national and foreign currencies) is determined not only and not so much by the National Bank.
Therefore, the stability of the exchange rate of the national currency against the $-dollar, €-euro or a basket of currencies only partly reflects the quality of monetary policy, i.e., the work of the National Bank. Nevertheless, the contribution of the National Bank to currency regulation, ensuring confidence in the national currency is indeed very large.
In 2003 the average annual official exchange rate of the hryvnia against the $-dollar was ₴5.33/$1, in 2022. - was ₴32.34/$1. For 20 years, the hryvnia has devalued more than 6 times. This is another indicator of the poor quality of monetary policy. No currency with such a rate of devaluation can become an instrument of savings and preservation of value. Its suitability as a means of payment is also limited.
In other words, for ~30 years the hryvnia has become a source of additional regulatory and transaction costs, primarily for the Ukrainians themselves. It worsened the competitiveness of Ukrainian producers of goods/services, contributed to the expansion of poverty and hindered the formation of a new economic structure. Here is the history of the currency stability of other European currencies.
In 2003 $1 cost 3.85 Polish zlotys. Average exchange rate for 2022 amounted to $1 = PLN 4.06. The devaluation of the Polish currency over 20 years amounted to 5.5%. In 2003 $1 was 8.7 SEK. In 2022 the rate was $1 for 9.0 crowns. Devaluation for 20 years - 3.4%. In 2003 the euro was worth $1.06, and in 2022. €1 = $1.13, and in the first half of 2023. - $1.08. And this is for 20 years.
Finally, the exchange rate of the Swiss franc in 2003 was $1 - 1.38 Swiss francs, and in 2022. - 0.92 Swiss francs. The firmness of the Swiss currency is undeniable.
Against the backdrop of Poland, Sweden, Switzerland and the euro area, the Ukrainian hryvnia is, in fact, a junk currency (junk money), because it is inconvertible, unstable, and even functions under severe currency restrictions on the current and financial accounts of the balance of payments.
Taking all these facts into account, indeed, Ukraine needs a fundamentally new monetary policy, a deep reset of the mode of functioning of the National Bank in the money and financial markets as a whole. What did the National Bank offer us in its “Financial Fortress” of May 2023?
At the very beginning, there is a description of internal and external factors affecting the economy of Ukraine in general and the fulfillment by the National Bank of its goals in particular. The external economic context is very sketchy.
It does not include such important parameters as monetary tightening by the G7/euro area countries, increased demand for a jurisdiction with an open financial market, high risks for more than 100 countries that pursued poor-quality (as in Ukraine) macroeconomic policies.
Among the strengths of the country, the NBU referred, among other things, “a stable banking system”, “maintaining a high level of trust and reputation of the NBU among international partners”, “the possibility of further development of the analytical expertise of the NBU”. Don't praise yourself, no one will.
It is hardly possible to seriously talk about the stability of the banking system, in which approximately every third loan is problematic / toxic, and the lion's share of the banks' earnings comes from operations with government securities. Especially in the context of prohibitions and severe restrictions on the current and financial accounts. Tellingly, the NBU did not indicate a high level of confidence on the part of Ukrainian business and investors. The reason is known. There is clearly no such trust.
Among the weaknesses of the NBU notes:
- significant political pressure and high expectations regarding non-NBU functions,
- internal bureaucracy and low corporate culture,
- low financial literacy among users of financial services,
- weak development of the bank lending and insurance market,
- underdeveloped stock market,
- incomplete structural reforms in Ukraine, including the judiciary,
- weak protection of creditors' rights,
- high dependence of the budget of Ukraine on international financial assistance.
One cannot but agree with all these characteristics, but why does the National Bank rightly criticize the government and the Ministry of Finance, but does not itself point to the quality of monetary policy for at least the last 20 years? We see systemic defects. To move forward, you need to recognize them. Unfortunately, the NBU did not do this. On the other hand, he secured a high-risk multifunctional mandate in the new Strategy.
The NBU sees the main goals as follows: 1) ensuring price stability, 2) promoting financial stability, 3) promoting sustainable economic growth. There is a conflict in this formulation of the “main goals” of the National Bank. The classical function of each central bank is only one - price stability. It is with it that he makes the greatest contribution to economic growth, the development of financial and commodity markets.
This is the monomandate that for decades has provided fame and popularity to such currencies as the German mark, the $-dollar, the Swiss franc or the British pound. As soon as the theorists and ideologists of the General Interventionist State expanded the mandate of the central bank, to impose full employment and economic growth on it, problems with price stability began.
If the central banks of the developed countries (G7) cope crookedly with their polymandate, then in developing countries it has become a real disaster. We can clearly see this in the example of the National Bank of Ukraine. Unfortunately, this theoretical mistake has been transferred to the new strategy of the NBU.
The National Bank of Ukraine presented its "strategic idea". It consists of vision and mission. Vision: “The National Bank is a modern, innovative, open, independent central bank capable of fulfilling its mandate in any conditions.
It is a leader in the development of the financial ecosystem, takes care of users of financial services, integrates into the European community of central banks, has the trust of society and international partners.”
Mission of the NBU: "Ensuring price and financial stability, promoting sustainable economic growth to increase the potential of Ukraine both on the path to victory and during the post-war recovery."
All these beautiful, correct words are written as if the National Bank is participating in an institutional beauty contest. The Ministry of Finance, the Verkhovna Rada, the Ministry of Economy and the Office of the President also take part in it. And now, like for Eurovision, you need a short business card in the form of a vision / mission.
Let's once again ask ourselves the question aloud: "Why do we need the National Bank?" It was a time of great price stability when there were no central banks and there was no inflation. Then the money was real, and everyone understood that inflation is printing money. That is what the process was called. Printing money drove prices up.
Through semantic manipulation, the concept of "inflation" began to mean "rising prices", and the original phenomenon was somehow lost in the semantic leapfrog. Okay, let's not demand historical rigor from the National Bank, but the meaning must be emphasized. Look at the mission of the European Central Bank. “The main goal of the euro system [the ECB and national central banks] is to maintain price stability.”
Thus, for taxpayers, for citizens of the country, the National Bank should perform one central / key function - to ensure price stability. This means annual inflation should be ~2%. This is a very specific, unambiguous, clear goal. It cannot be interpreted in any other way. The performance indicator of the National Bank is inflation.
What is the mission, for example, of the Barcelona football club? Be champions of the Spanish league, win the Champions League. This is the task set by the owners of the club before the coach. You can write, of course, that the team should be stylish, create many scoring chances, have more opponents to possess the ball and have a better ratio of goals scored and conceded. But the main thing is victory. Dot.
The same logic applies to the National Bank. You can promise people to be modern, innovative and fashionable, but the main thing is price stability. Dot. The erosion of this goal in the context of the quality of Ukraine's monetary policy over the past 30+ years is the conservation of unfavorable, toxic practices that the National Bank has been regaling the economy with all this time. Unfortunately, the new Strategy suffers from verbosity, and does not stand out with specifics.
If the old walls of the monetary system are decorated with ruffles and lace, called a “financial fortress”, then some aesthetic entities can, of course, appreciate the artistic taste of the NBU leadership, but for ~40 million Ukrainians and ~2.5 million legal entities and sole proprietorships, a price stability. There is no certainty that it will appear in Ukraine in the coming years. The content of the NBU Strategy reinforces this confidence.
It is at the institutional beauty contest that you can caress the ear with the 5P values of the NBU and add the sixth P to the list: Patriotism, Professionalism, Integrity, Visibility, Partnership and Pidtrimka. Perhaps such a monetary semantic vaudeville distracts the country's leadership and those who should monitor the state of economic security from specific answers to the main questions to the NBU:
When will Ukraine finally have price stability?
When will Ukrainians rejoice in the free movement of capital?
When will foreign investors stop experiencing difficulties with the withdrawal of their legitimate money from Ukraine?
When will Ukrainians be able to directly use the services of foreign financial institutions, including investment/pension funds?
When will the cost of a loan in Ukraine be the same as in civilized market countries?
When will Ukrainians be able to invest their savings in their national stock market?
Clear, specific answers to these six “whens” are much more important for business and society than six “Ps” from the NBU.
The National Bank defines its main goal as follows: price stability and exchange rate stability. In one vial. These are different goals. Achieving one may be in conflict with the other. Exchange rate stability implies the synchronization of monetary and fiscal policy. This is no longer a mandate of the National Bank, but a wish to colleagues from the Ministry of Finance and the Cabinet of Ministers. Such a formulation of the main goal weakens the monetary policy of the country as a whole.
In the Strategy, in describing the achievement of Goal I “Sustainable hryvnia”, it refers to “moving towards a gradual weakening and removal of foreign exchange restrictions that were introduced at the beginning of the war, the transition to flexible exchange rate formation and a return to an inflation targeting monetary policy.”
Obviously, we are talking about the hryvnia exchange rate, but where is the description, in fact, of the behavior of the National Bank in relation to the main monetary aggregates (M0, M1, monetary base, M2 and M3)? Or the National Bank thinks that the increase in the money supply (M2) in 2022. by 21% with a fall in GDP of more than 29% - is this normal?
For the period 01/01/2020 - 01/01/2023, the volume of cash in circulation increased by 73.3%, the monetary base increased by 66%, the money supply (M2) - by 74.2%, broad money supply (M3) - by 73, 9%. In the period 2020-2022. the average annual rate of change in GDP amounted to minus 9.8%.
With such a balance of the number of hryvnias, foreign currency and GDP, it is impossible to ensure price stability, except to introduce strict price restrictions, that is, switch to the regime of manual, socialist price regulation.
In this scenario, it is impossible to maintain exchange rate stability, except to severely limit external currency flows and introduce manual control of the hryvnia exchange rate. This is exactly what the National Bank did in 2022. This regime will continue into 2023. It does not solve the economic, investment, production problems of the country, but exacerbates them.
In the Strategy of the NBU "Financial Fortress of Ukraine" one should expect at least an indication of the understanding of the nature of inflation and tension in the financial/currency markets. I would like to see how the NBU will change the money supply regulation regime, what measures it will propose to increase the demand for the hryvnia and expand the access of capital to the country. Unfortunately, there is nothing like this in the “financial fortress”.
The NBU fears that with currency liberalization, billions of hryvnias will end up on the foreign exchange market and blow up the exchange rate. Then why is there no answer in the Strategy to the question why the National Bank threw so many hryvnias into money circulation, even before the war. Without clear answers to these main questions, the “financial fortress” will be left with only six “Ps” and the desire to someday reduce inflation to below 15%.
The National Bank of Ukraine presented a performance document, not a science-based strategy for a deep rethinking of the monetary policy of a warring country.
There is neither an honest, objective analysis of one's own failures and mistakes, nor an understanding of how to correct them in the future. The NBU has been and will remain, within the framework of the adopted Strategy, a body that dampens economic growth, extinguishes the entrepreneurial spirit and stifles economic freedom.