In July 2023, the NBU published the Strategy for Easing FX Restrictions, Transitioning to Greater Flexibility of the Exchange Rate, and Returning to Inflation Targeting (“the Strategy”). The document contains a lot of specialized terms and may be difficult to understand. This page was created to let anyone easily grasp the NBU’s plans regarding its exchange rate and monetary policies.
Why did the NBU move to more exchange rate flexibility, and why is it gradually easing FX restrictions?
The NBU was forced to fix the official exchange rate and introduce strict FX restrictions on 24 February 2022. The central bank has consistently emphasized that these decisions are temporary and justified.
The decisions made it possible to prevent panics, ensure the stable operation of the financial system, and helped businesses and households adjust to the full-scale war. However, the fixed exchange rate regime and FX restrictions comes with both benefits and costs, and over time, the costs could outweigh the benefits.
For example, FX restrictions are gradually losing their effectiveness, and the society might question the adequacy of the current exchange rate. All of this may lead to attempts to avoid capital outflow restrictions and cause growth in the shadow economy.
Most Ukrainians remember well the currency crises of 2008 and 2014–2015, when the national currency weakened significantly. The depth of these crises was substantially aggravated by the long-term fixing of the exchange rate. Keeping the exchange rate at the same level for many years usually ends in the same way, resulting in the accumulation of FX imbalances, the depletion of international reserves, forced deep devaluation, and a significant economic downturn. This is why most countries do not use fixed exchange rate regimes and tight restrictions and why the NBU switched to managed flexibility of the exchange rate in October 2023 and plans to continue easing FX restrictions.
Ukraine has already had positive experience with a floating exchange rate. After the 2014–2015 crisis, the NBU switched to the floating exchange rate regime. Over the following years, and until the full-scale invasion, the hryvnia exchange rate fluctuated in both directions, weakening and strengthening in line with market trends. The NBU, by selling or buying foreign currency in the market, only smoothed out excessive exchange rate fluctuations, neither counteracting nor reinforcing the underlying exchange rate trends.
Thanks to this flexibility, Ukraine did not accumulate FX imbalances and no longer experienced FX crises as before. Despite some fluctuations, the exchange rate remained relatively stable throughout the entire floating exchange rate period. In addition, the NBU has been steadily accumulating international reserves during this time.
This time returning to a more flexible exchange rate regime will also help strengthen the resilience of the economy and the FX market to external and internal changes.
Does it mean the NBU returned to the same floating exchange rate as before?
No. The NBU first moved to managed exchange rate flexibility. This is due to the specifics of how the economy is functioning amid the full-scale war.
As the country's export capabilities, as well as inflows of investment to Ukraine, are limited due to the war, the FX market is constantly experiencing a significant shortage of foreign currency. In view of this, it is too early to return to a floating exchange rate whereby the NBU only smooths out excessive fluctuations in the market.
Instead, the NBU uses managed exchange rate flexibility to cover this structural shortage of foreign currency in the market. This will allow the hryvnia to weaken (when the shortage increases) as well as to strengthen (when the deficit shrinks). In addition, the NBU smooths out excessive exchange rate fluctuations.
Thus, the NBU’s FX sales will help maintain the sustainability of the FX market, while high interest rates on hryvnia deposits will continue to protect savings from inflation (more on this below).
Should we expect the hryvnia to weaken sharply while under managed flexibility of the exchange rate?
The public often associates any decisions the NBU takes with regard to its exchange rate policy with a sharp depreciation of the hryvnia. This is due to Ukraine’s bitter experience, when the NBU was forced to let the hryvnia float due to the depletion of international reserves and the inability to maintain a fixed exchange rate.
But now the situation is different. Precisely why is that?
First, in previous years, the NBU:
Second, the NBU made thorough preparations for the transition to managed exchange rate flexibility. The central bank took this step, as required macroeconomic and financial preconditions had been met. So, the transition was a controlled one.
The transition to managed exchange rate flexibility does not mean that the NBU has completely let go of the hryvnia exchange rate. The NBU maintains its presence in the market and covers the structural deficit of foreign currency. Thanks to this, the hryvnia can not only weaken, but also strengthen. The greater flexibility of the exchange rate will bolster the FX market’s ability to self-balance.
One of the NBU’s important tasks will remain to preserve exchange rate sustainability, a pattern of exchange rate developments that will not disrupt measures to keep inflation moderate and bring it to the NBU’s 5% target in coming years In 2024, inflation will pick up, in part because of the fading of temporary factors that drove its considerable decrease at the start of the year (including the significant harvests last year and a warm winter). The NBU will maintain exchange rate sustainability to keep inflation subdued this year and ensure that it accelerates only slightly, as well as to bring it to the 5% target in coming years. Exchange rate sustainability also means that no exchange rate fluctuations can be large enough that they become a threat. On the other hand, absence of any exchange rate fluctuations implies that the regime is more a currency peg than exchange rate sustainability. The NBU deliberately abandoned the exchange rate peg, considering the totality of adverse effects generated by it.
Which FX restrictions will the NBU ease first?
The strategy envisages that this process will take place in three stages.
At the first stage, the NBU’s efforts are aimed at minimizing the multiplicity of exchange rates. This involves narrowing and/or keeping the spread between the cash and official exchange rates low. To this end, the NBU has already taken a number of measures aimed at both increasing the ability of the banks to meet clients’ demand for cash foreign currency and expanding the ability of clients to purchase cashless foreign currency, thus reducing the pressure on the cash exchange rate.
The NBU is also gradually increasing opportunities for businesses to conduct trading operations. Significant progress has already been made in this area. In particular, as early as mid-2022, businesses were allowed to import any goods from abroad. Since May 2024, they have also been able to import works and services. The only condition for making such transactions is that the delivery of goods, the receipt of works, and the provision of services has to have been done after 23 February 2021. The NBU has also enabled businesses to transfer funds abroad under leasing and rental agreements.
The third area is facilitating new investments. To this end, the NBU has already enabled the repayment and servicing of loans issued jointly with an international financial institution or an export credit agency, including with guarantees by such institutions. It is also allowed to service and partially repay “new” debts to creditors based abroad. In addition, the NBU has granted permission to transfer abroad the dividends received by foreigners in Ukraine, within a limit. All of this is instrumental in encouraging businesses and international companies to invest in Ukraine.
All easing measures at stage one apply specifically to new loans and dividends, meaning those received shortly before or after the respective decisions were taken. This is necessary to prevent the depletion of international reserves and maintain the sustainability of the FX market.
At this point, the NBU has completed most of the steps it had planned for the first stage of easing the FX restrictions. However, some transactions are allowed, provided they stay within the limits. This means the implementation of stage one of relaxing the restrictions is still underway.
Concurrently, as the appropriate conditions have been met, the NBU in May 2024 has been able to launch in parallel the second stage of easing the restrictions. In particular, the NBU enabled businesses to partially service their “old” external loans.
Specifically, the NBU’s plan for the second stage of loosening the FX restrictions includes:
At stage three, the NBU will slowly roll the FX restrictions back to where they were before the full-scale war broke out. The regulator will authorize repayments on all of the loans and investments, while households will be able to conduct more transactions, such as transfers to foreign-issued cards from hryvnia cards. The NBU will also gradually authorize transactions with derivatives, including swap and forward transactions (more on those here), make it possible for foreigners to take out loans, and allow investments abroad.
The steps within the stages may be reshuffled to help the economy recover and to increase the FX market’s and the financial system’s performance.
When does the NBU plan to continue to ease FX restrictions?
The NBU does not set any specific dates for the easing of restrictions. Any steps in this direction will be taken only when the appropriate sustainable preconditions are in place.
The NBU will take into account the following indicators:
If all indicators are at normal levels, the NBU will continue to ease FX restrictions. At the same time, the NBU will act gradually and cautiously to maintain the sustainability of the FX market. Before taking each next step, the NBU will analyze whether all the necessary preconditions have been met. This will help minimize the likelihood of reintroducing the restrictions.
What if something goes wrong?
The level of uncertainty associated with russia’s full-scale aggression is still high. If risks rise, the implementation of the Strategy might be paused or even some steps might be cancelled.
Maintaining exchange rate sustainability will remain one of the NBU’s priorities. This is important for sustainable disinflation and the resilience of the financial system.
How will the switch to inflation targeting take place?
Returning to inflation targeting with a floating exchange rate, a regime that was in place prior to the full-scale war, is the ultimate goal of the Strategy’s implementation. This regime is precisely what will enable the NBU to simultaneously ensure price and financial stability in the long run and to support sustainable economic growth.
The NBU’s return to inflation targeting with a floating exchange rate will also be spaced out in time and will only occur if the prerequisites are met. This is not something to be achieved in short order.
In the early stages of the Strategy’s implementation, the NBU’s key policy rate will continue to play the role of an auxiliary tool to maintain the sufficient attractiveness of hryvnia assets as a guarantee of exchange rate sustainability. In other words, the NBU policy will continue to be aimed at ensuring that by making hryvnia term deposits, households can protect their savings from losing value. This is important in restraining demand in the FX market, which in turn will make it possible to maintain exchange rate sustainability and ensure a further decline in inflation.
Going forward, inflation will gradually take over as the anchor of macrofinancial stability, as was the case before the onset of the full-scale war. The key policy rate will regain its status as the main monetary instrument.
Eventually, the NBU will return to the monetary regime it was operating prior to the full-scale war.
What will happen to the NBU’s key policy rate during the Strategy’s implementation? How will it affect interest rates on hryvnia retail deposits?
Thanks to the faster-than-anticipated pullback in inflation, the sustainability of the FX market, and the record level of international reserves, the NBU has already switched to the cycle of key policy rate cuts.
However, at every stage of the Strategy’s implementation, the NBU will maintain a level of the key policy rate that will allow households to protect their funds from inflation by putting them into hryvnia assets (term deposits and domestic government debt securities). This is important for maintaining the attractiveness of hryvnia savings and reducing the demand for foreign currency, and thus for protecting Ukraine’s international reserves.