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Over the weekend we highlighted Ukraine’s geopolitical weight on the global macro stage based on its relationship as an energy intermediary between Russia and the European Union. The decline and incredible volatility of the Ukranian currency, the hryvnia, has served to underscore the impact this country has on relations in the region.

Ukraine’s currency was hammered earlier this week, falling 15% in two days to a record low of 9.4625 against the USD. The currency is finally rallying this morning due to the Central Bank raising interest rates to 22% from 18% for its benchmark refinance rate. This move highlights the severity of the situation in the Ukraine and the government’s response to take necessary measures to support the hryvnia.

Here are some of the factors that have sent the hryvnia and the Ukrainian economy crashing down:

Commodities- Ukraine is heavily levered to commodities and commodity products. Specifically, steel represents 40% of exports. Ukrainian steel production has dropped some 48% in November in response to demand declining on the global market. As a result, European prices for a metric ton have fallen 47% since August. The net result of this is that Ukrainian industrial production shrank by a record 28.6% last month as steel, machine building and oil refining slumped. In addition, with the country’s deep dependence on transit fees for Russian oil and gas servicing Europe, Ukraine has been hammered by the precipitously fall in price for these commodities.

Central Bank – Ukraine’s Central Bank said it will attempt to manage the hryvnia’s decline by buying and selling foreign-exchange reserves. Buying up the hryvnia could strengthen the currency by limiting supply, but it is not clear that the Central Bank is effectively managing this function. Confidence in the Central Bank is low. So low in fact that Ukranian Prime Minister Yulia Timoshenko recently demanded that the National Bank of Ukraine Governor Volodymyr Stelmakh be dismissed.

Interest Rates- President Viktor Yushchenko has called for the Central Bank to aggressively raise interest rates, yet the outcome may be negative. For one, increasing the interest rate will limit access to capital, which will dampen lending and the ability to borrow. Ukraine desperately needs access to capital to compensate for global destruction of commodity demand and price. Ukraine’s annual inflation has been running around 7% since 2000; estimates suggest that raising the interest rate would slow this number to 2% for 2008.

Loans- The IMF provided $16.4 Billion to Ukraine to shore up its depressed economy. The unintended consequence of the devalued hryvnia means the country—should it not be able to appreciate the currency through interest rate hikes—will have a larger loans in US dollars to repay. Further, it’s estimated that nearly half of all loans from domestic lenders in Ukraine are in dollars so appreciating the currency is essential to meet parity in repayment.

Debt- A substantial debt of $2.4 billion is currently owed by Ukraine’s state-controlled Naftogaz Ukrainy to Russia’s Gazprom in the form of back payments on gas. Should this loan not be paid off, Gazprom may send a message in turning off supply. In total Ukrainian companies owe some $4.1 billion in debt in December.

Politics- Since the arrival of the Orange Revolution five years ago that brought a “democratic” coalition to power, disagreements have afflicted the main party heads, Prime Minister Timoshenko and President Yushchenko. Conflicting issues have included appropriate measures to stabilize the currency since its initial slide in October and how to handle political ties with Russia and Europe.

According to the WSJ, “new central bank data showed the country’s external debt increased by $7.4 billion in 3Q to $105.4 billion, or 60% of gross domestic product, with short-term liabilities estimated at $30 billion.” These numbers are huge and signal that the Ukraine is in a world of hurt if they can’t find support for their currency.