The International Monetary Fund recently completed its annual article IV assessment of Ukrainian economy. The visit to Kiev surfaced with rather weak recommendations in economic policy as especially continuing currency float and income policy only poorly accommodate the country’s industrial re-structuring with inflationary pressure and mounting foreign currency exposure in households and private enterprise.

In this fashion, activity rebounded profoundly last year as GDP growth, despite renewed energy price hikes and attributable to considerate credit expansion, strengthened from 3.0 to 8.9 percent third quarter of 2006 from same quarter previous year with a resulting and welcoming decline to unemployment. Following currency appreciation, Ukrainian foreign exchange rate nevertheless depreciated in 2006 as an eroding current account surplus combined with increasing financial account volatility. Demonstrated by increasing export revenue growth on near and large markets in Poland and Turkey – and with export commodities increasingly centring on food processing and basic wood products – the country’s trade balance nevertheless largely remains on a healthy trend purporting an argument of currency stabilization as a means of improving financial placidity.

In this vein, Ukraine’s current account balance exhibited anticipated turnaround from a surplus of USD 2.6 billion first three quarters of 2005 to a deficit of USD -0.3 billion same period past year in reacxtion to natural gas price adjustment near 65 percent same period. On this background and despite robust inflows of investments from abroad - growing risks to financial stability resulted into considerate exports of assets abroad resulting in declining foreign reserve holdings at Bank of Ukraine as renewed currency weakening resulted into mounting transaction and savings demand for foreign currency - especially American dollars.

The IMF further envisaged declining real wage gains for 2007 amid persistent inflationary pressure and emerging income policy. Government spending remains further affected by reform efforts to advanced public wages in line with private sector counterparts and effort to curtail corporate tax breaks. On this background, the organization fail to recognize acute spending needs when requesting deepening of spending cuts already underway in government budget.

Mounting corporate debts further needs take cornerstone in Ukrainian currency policy as both banks and remaining of her enterprise sector attained substantial debts during times of current account surplus. With households beginning to supplement corporate entities in domestic debt acquisition – not only is economic recovery nevertheless expected to extend into 2007 – also banks’ foreign currency exposure is likely to continue increase as well. At present stage, having the country’s large corporate debts in mind – further currency depreciation only build debt exposure, when foreign currency denominated, only add to future repayment burden with only little effect to export competitiveness that endure well performing. Especially, large current account surpluses in the past combined with quasi capital controls to form a lucrative debt markets for corporate Ukraine that could distil substantial risks in an open market environment such as mounting interest rates and foreign currency risks.

The organization further anticipates declining real wage growth in result from persistent inflationary pressure during 2007 despite the one-off nature of ongoing price adjustments from higher energy prices.

On the background of mounting currency risks, further stabilization of Ukrainian foreign exchange rate – in contrast, by creating placidity to external capital flows and diminish near term price pressure - could well contribute to curtail dollarization of the economy that intensified during 2006. In this fashion, re-enforcing currency risks leading currency mismatches on private sector balance sheets could warrant a policy orientation towards stabilization of Ukrainian currency. For same reason, IMF board recommendations on further foreign exchange rate flexibility surface as counter productive. And the organization’s officials needs better justify recent recommendation for wage regulation as a measure to ensure price stabilization as the introduction of nominal price regulations run risks of creating additional rigidities to Ukrainian re-industrialization.

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