Ukraine’s Central Bank chief resigns in protest of demands to “print money,” raise inflation, and devaluate hryvnia

Ukraine’s Central Bank (NBU, Natsionalnyi Bank Ukrayiny) was built in 1911, before the Soviet era; unlike all the other Ukrainian state buildings — the Presidential Office, Parliament, and building of the Government, constructed by Stalin in the 1930s and 1940s. And there is something symbolic about this. Amid the war with Russia since 2014 and populism flooding all branches of power in Ukraine after the government reshuffle in March 2020, the NBU remained an independent island of stability, respected and trusted by foreign investors and partners. Until 1 July 2020, when Ukrainian central bank governor Yakiv Smoliy submitted his statement of resignation because of “systematic political pressure.” That was just a month after Smoliy announced he intended to govern the NBU till the end of his term in 2025, some two weeks after Ukraine received a $2.1 billion tranche from the IMF and five days after it finally agreed on a EUR 1.2 billion loan from the World Bank. According to Smoliy’s speech in the Parliament on 3 June, when the Parliament approved his resignation, the “systematic political pressure” was in the form of rallies sponsored by oligarch Kolomoiskyi against Central Bank policies as well as constant calls from MPs and government to the NBU to start issuing currency and provide additional finances to the state. Although non-professional and leading to inflation in the long term, the NBU already embarked on this policy in May, but on a modest scale.

Is Ukraine turning away from cooperation with western partners?

Zelenskyy says no, ensuring that “the independence of the National Bank of Ukraine remains our unconditional priority.” However, until the situation remains unclear and the new governor of the central bank is not appointed, investors are deciding to postpone their cooperation with Ukraine and Ukrainian companies. Tomas Fiala, head of Ukrainian investment management company Dragon Capital, said Smoliy’s exit from the central bank is a red line.

“We will now postpone all new investments,” commented Fiala. “For the past five months the authorities have been doing the exact opposite of what investors, both domestic and international, expect from them and advise them. This is the last straw. One can only guess what the motives are. It is either complete incompetence or sabotage motivated by Russia.”

Also, Ukraine discarded a $1.75 billion bond sale that had already started just a few hours before Smoliy announced his resignation. Additionally, due to the panic that started on the currency market on 2 June, NBU had to spend $150 million to support the hryvnia. In their statements, the European Union and European Commission stressed that the independence of the NBU is a key condition for the EUR 1.2 billion loan that was already agreed with Ukraine. IMF has also stated that

"the independence of the NBU is at the center of Ukraine’s Fund-supported program, and it must be maintained under [Smoliy's] successor.

G7 Ambassadors stated that undermining the independence of NBU would jeopardize the credibility of and support for Ukraine‘s reforms. The business community has also released a joint statement.

At his speech in the Parliament on 3 June, when MPs approved his resignation, Smoliy explained what exactly the political pressure on the NBU entailed:

"During the last year, rallies have been held near the NBU, at which MPs sitting here were speaking, a month of blocking my house and the houses of my deputies. ...Using the NBU Council to create a corporate conflict within the institution. All these are elements of one chain… There were calls to flood the economy with money, to abolish the principles of regulating the banking system, to set an exchange rate favorable to exporters.”

Speaking at a briefing immediately after the resignation, Smoliy provided more details, stressing that the NBU top management has long been subjected to political pressure and harassment to carry out policies that are not economically justified, that focus on short-term easy victories but could cost the Ukrainian economy and Ukrainians in the longer run dearly. Particularly, he said that there was pressure to raise the inflation rate to 11% (currently it is 2%) and set the [hryvnia to dollar exchange rate] to 30 UAH/1 USD (27.1 at the time of publication). He also told that he was resigning to show that he did not cling to his position, to “fight for the institution,” and to draw attention to the pressure and the consequences that would follow were the NBU to give in. Smoliy clarified that he had the desire to resist the pressure and keep his position, but the “possibilities” for this had run out. Earlier, MPs linked to oligarch Kolomoiskyi, and the NBU Council called on the Central Bank to issue currency in the form of recapitalization of banks and buy state bonds in May and June. The NBU has already started its program of bank recapitalization in May that de-facto achieves this. Such a policy may partially cover the budget deficit but will also cause inflation and the devaluation of the Ukrainian hryvnia.

MPs from the financial committee and NBU Council demanded the Central Bank start "printing money" 

During 2014-2020, the NBU conducted a large-scale banking reform, managed to establish financial stability in Ukraine, and even moderately strengthened the Ukrainian currency and stabilized inflation. The current economic crisis did not destabilize the Ukrainian currency and banking system due to the NBU's balanced and long-term oriented policy. Yet, that was not an argument for several MPs, mostly those who are loyal to Ihor Kolomoiskyi, the former owner of nationalized Privatbank. In April 2020, 18 deputies wanted Smoliy to “report” regarding “his work during [COVID-19] quarantine." The chairman of the economic committee in the Parliament, Dmytro Natalukha, admitted that he was behind the initiative to collect the signatures. Earlier on 9 April 2020 he openly stated:

"I think that we need to use the tool of… 'printing money.' Inflation is a possible consequence. But if we reinvest this money in fixed assets and infrastructure investment projects, we will be able to overcome high inflation more or less. But we can not go this way without the consent of the NBU."

On June 11, the Finance, Tax and Customs Policy Committee of the Parliament adopted a resolution declaring the work of the National Bank unsatisfactory and establishing a temporary commission to investigate the actions of the NBU management. The resolution stated that

"the NBU management, pursuing a rigid monetary policy, ... failed to provide within its powers a steady pace of economic growth and pursue lending to the economy."

Along with MPs, some members of the NBU Council appointed by the President and Parliament and responsible for the assessment of NBU’s work and development of its policy started criticizing the management of the central bank. Their statements were synchronized with statements of protesters from Kolomoiskyi’s companies who demanded an NBU policy favorable for the oligarch, in particular, regarding compensation for nationalized Privatbank. Members of the NBU Council refused to prolong the contract with Oleh Churiy, one of Smoliy’s deputies. This can be seen as pressure on Smoliy to follow the Council’s recommendations from April 2020 that advocate for “printing money” – a highly unprofessional policy that Smoliy opposed. These recommendations are extremely inflexible and resemble direct demands, with a requirement that the NBU provides a report three months later. Particularly, [highlight] the Council demanded the NBU expand the state budget’s financing by buying domestic government bonds (so-called OVDPs) and even directly issuing loans to businesses. [/highlight] The Council recommends "considering the possibility" of introducing targeted long-term refinancing of banks to lend to investment projects, small and medium-sized businesses, and also reducing the collateral requirements for such loans. At the same time, President Zelenskyy “instructed” the Cabinet, although it is out of his authority, to raise the minimum wage in Ukraine. The Cabinet has already presented its plan to increase minimum wage by 35% within a year. Such an increase has little economic basis, taking into account the growing unemployment, but may well be achieved through currency issuance together with inflation.

In May 2020, the NBU already started currency issuance by means of recapitalization, although at a very modest scale

To partially fulfill the demands of the NBU Council, the central bank's management started its program of recapitalizing banks in May. While avoiding other more direct means of issuing currency, NBU provided some funds to state banks. The policy was presented as financial support for the economy at a time of crisis. However, within this policy, state companies can take loans from NBU through state banks, which in some cases means the NBU directly covering some budget deficit and subsequently, possible inflation. Long-term recapitalization loans from the NBU can be used not only for infrastructure projects but also to improve the financial condition of state-owned enterprises, which is prohibited by law. Also, recapitalization gives banks a risk-free instrument for financial and currency speculation. The initial goal of this recapitalization was to allow banks to give loans to long-term infrastructure projects that will help "relaunch" the economy. Theoretically, if cleverly and carefully used, the instrument indeed can support economic development. However, when used just to cover the debts of state companies, refinancing leads only to inflation and deterioration of the crisis. The first recapitalization of UAH 6.9 billion ($250 million) to the state-owned Ukreximbank was more or less innocent, used to finance road construction by the State Agency of Motor Roads that issued bonds for this construction. Moreover, the state-owned company Guaranteed Buyer that distributes electricity from power plants to users has already announced its intention to take a cheap loan from recapitalization to pay its debts, although this is prohibited by the law. The new recapitalization policy of the NBU goes in line with the widespread use of state-guarantees to take loans for state companies. In the short-term perspective, this allows funding for some projects. But in the long run, it leads to growing state debt and growing costs for its servicing that may lead to a collapse.

The last time Ukraine actively used the instrument of state guarantees and NBU recapitalization was in 2012, in particular during the preparation for EURO-2012. This policy ramped up the state debt that Ukraine is still repaying. Finally, the interest rate of the NBU's recapitalization of banks is 6% while the revenue from governmental domestic bonds that banks buy and can use as a pledge is about 10%. This means banks will have direct profits from receiving recapitalization and lending it to the state through the purchase of bonds issued for state projects. NBU will pay for all this through a refinancing scheme, under state guarantees. The only problem is that if uncontrolled and widely used, this policy of banks making profits and the state budget expanding will be finally financed by ordinary Ukrainians, who will have their savings devalued and bear the brunt of rising prices.