Page 75 - bne Magazine August 2022

bne August 2022
Opinion 75
High inflation has the potential to quickly erode the value of the incomes and savings of broad swathes of the Ukrainian population. Owners of real assets, foreign currency and other valuables reap short-term benefits, as do exporters of goods and services.
The state budget may also experience a short-lived relief: the inflationary growth in the tax base will for the time being exceed the need for financing fixed hryvnia-denominated expenses.
But in the end, everybody loses, because an economy without a reliable unit of currency has no way of growing, let alone recovering.
Exporters will have to buy production inputs at higher prices, and pressure to raise the wages of their workers will rise.
The government will struggle with unrelenting pressure to have its expenditures indexed as the amount of money required to meet the same needs grows.
So, how is monetary financing working so far? Increasing batches of the “issued” hryvnias are finding their way into the FX market, driving up pressure on the exchange rate. The NBU is taking some of this pressure off the market by making FX interventions.
Specifically, the central bank in February-May had to sterilise, through FX interventions, about 70% of the “issued” hryvnia injections. Meanwhile, the ratio between interventions and issuing reached 1:1 in May, up from just 2:3 in April. In other words, 1:1 means that the NBU in May “printed” as many hryvnias as it then took out of the FX market by selling foreign currency.
The NBU sells foreign currency it takes from international reserves, which are limited. The depletion of international reserves leads to the deterioration of exchange rate and inflationary expectations, which feeds into the next wave of demand for foreign currency and imported goods.
As a result, an increasingly large volume of hryvnia liquidity drives up FX demand through the government spending channel and the worsening expectations channel.
The real yield on hryvnia instruments, primarily deposits and domestic government debt securities, is going deeper and deeper into negative territory, incentivising economic agents to look for ways to safeguard their savings, in particular by purchasing foreign currency and imported goods, including those unrelated to their primary needs.
As a consequence, each round of “money printing” only acts to reinforce the dollarisation of the economy and the withdrawal of savings from the financial system.
The longer this trend persists, the greater the pressure on the hryvnia to depreciate and on the international reserves to decline, and the higher the risk of households gradually losing
confidence in the government, the hryvnia and the NBU. The farther out that the negative expectations spread, the faster the price growth.
The non-linearity of the growth in the inflationary risks associated with a monetary expansion within the limits of monetary financing is corroborated by the IMF’s research.
Unfortunately, the world’s and Ukraine’s experience shows that the loss of control over inflation is far from being the only possible consequence of large-scale monetary financing.
Learning from the mistakes of others is always a good idea
We are already making plans for our economy’s post-war recovery, which is the right thing to do as we ponder the risks associated with the stepping up of the monetary financing effort.
The past episodes of fiscal dominance are still fresh in our memory. Ukraine’s efforts, in particular in the 1990s, to ensure the financing of state expenditures and the needs of enterprises by issuing money, had catastrophic consequences for both the economy (inflation in 1992-1994 galloped to 2,000%, 10,155% and 401%, while real GDP plunged by 9.7%, 14.8%, and 22.8% respectively) and the well-being of households.
The monetary financing of public debt in 2014-2015 had a similar fallout, with inflation accelerating to almost 25% and 43.3% respectively.
The experience of economic revivals in the aftermath of the wars that raged in the past century reveals a multitude of facts about the adverse implications of printing money to cover budget deficits.
Let’s take a look at a few cases that stand out the most. After the Second World War, the Bank of Japan actively bought bonds issued by the government in order to accumulate funds for the restoration of production facilities destroyed during the war.
Monetary financing was precisely what experts believe sent Japan’s inflation sky-rocketing into the triple-digits. What is more, it took almost five years for inflation to return to moderate levels.
In a more recent example, the Serbian central bank financed the growing budget deficit after the end of the war. In addition, the regulator and private banks extended direct loans to state-owned companies and agricultural businesses in order to keep prices for food and housing services low.
As a consequence of this grand-scale monetary financing splurge, inflation in the 2000s ended up surging past the 100% year-on-year mark.
Monetary financing experiments often result in the dollarisation of the economy, the loss of domestic currency and the forfeiture of monetary independence.
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