Head of the NBU: Issuing the hryvnia is a road to nowhere, but is there an alternative?

This year, Ukraine faced a significant deficit of the state budget – about 0.5 trillion hryvnias, which must be directed to the country’s defense. Foreign aid can be used exclusively for social needs, financing educational and medical programs, as well as for the maintenance of the bureaucratic apparatus. The financing of the army, on the other hand, should be carried out through taxes or through the issuance of state debt bonds, which today are an important tool for supporting the Armed Forces of Ukraine.
Although most needs will be covered by domestic borrowing, tax increases are likely to be inevitable. In the business community, there is an ongoing debate about whether to raise taxes or whether it is better to conduct a new issue.
Emission is the option of last hope
On August 13, the Chairman of the National Bank of Ukraine Andriy Pishnyi expressed opinionthat “the issue of the hryvnia is a one-way ticket.”
“I am afraid of simple solutions in our very difficult conditions. After all, sometimes there is a temptation to go straight in order to achieve the desired as widely as possible. When I hear that let’s consider an alternative to revising and expanding the tax base in the form of devaluation and inflation, I have a question: have you seen at least one successful country that followed this path?”, the head of the National Bank shared his thoughts.
Andriy Pyshny’s main message: the NBU strives to maintain the attractiveness of hryvnia instruments for savings. The head of the financial regulator is categorically against emission financing of the state budget deficit, i.e. against printing money to patch holes in the budget.
The fears of the head of the National Bank are understandable: if you increase the money supply and do not increase the productivity of the Ukrainian economy, it will start the process of devaluation, and then inflation, which was curbed with great efforts, and thus return to the past. For what? To make Ukrainians even poorer?
And so many factors provoke price growth: the war, the energy crisis, the shortage of workers in the country, the pressure of foreign currencies. Many factors currently prevent the formation of a stable currency market, fuel excise taxes are expected to increase in the near future. And in 2025, the lifting or termination of the moratorium on raising tariffs for communal services is expected.
On the other hand, the economy is gradually starting up, in particular with the help of an international corridor that offers more opportunities for both the import and export of goods and services. Metallurgical plants and the agro-industrial complex are gradually increasing their production, but the energy crisis, of course, greatly hinders the efficiency of these processes. After all, the same metallurgy or construction industry is very energy-intensive. The shortage of electricity exacerbates the shortage of supply in the market, which can also provoke inflation and slow down the pace of export growth.
The world situation has changed, including due to the slowdown of the economy of the People’s Republic of China. IA “FAKT” recently wrote about how the global situation is affected by the decrease in world prices for iron ore and steel. The recession is becoming more and more obvious.
A simple correlation between money supply and prices
In economics, there is a simple equation that explains the correlation between the money supply circulating in the state economy and the price:
MV=PQ
M – money supply
V – speed of their circulation in the economy
P – price level
Q – manufactured goods and services
If the NBU starts the machine, it will lead to an increase in the money supply P=MV\Q. At the same time, the speed of its circulation will not change in the best case, and in the worst case it will increase due to inflationary expectations and increased consumer activity.
In this case, an increase in consumption will be able to stimulate production and the number of services provided. But even under normal conditions, money emission overshadowed all these positive effects and caused a lot of problems in the economy. Now, in a situation of full-scale war, energy crisis and labor shortage, all the more so all these positive factors are minimized, and the launched additional emission will inevitably lead to inflation and make this process uncontrollable.
Therefore, simple arithmetic shows a regularity: additional emission will inevitably provoke an increase in prices, devalue the cash we have, and reduce the purchasing power of the population. Inflation in some sense can also be called a tax. Because if better-off people can enter the currency and provide themselves with some stability, then average Ukrainians, especially those who are below the poverty line, will suffer more than others.
An alternative to turning on the money machine
An alternative to an additional money issue could be an increase in the volume of purchases of bonds of the domestic state loan of Ukraine by banks. Since the latter already experience a significant surplus of liquidity, simply put, there is now a surplus of money in bank accounts due to an increase in state taxes, and this money is not used for lending due to high risk.
State-owned banks deserve special attention as beneficiaries who receive large profits. Banks now pay a higher tax rate and their liquidity can also be channeled into the economy. This would only partially solve the budget deficit problem, but such an alternative is, of course, better than money emission, but it also has a lot of disadvantages.
Let’s imagine that banks would credit the state budget by lending it 300 billion hryvnias. Thus, at the expense of their liquidity, they would patch a hole in the state budget. But there are several “buts” in this scheme. First, the low quality of bank funding and the banking system due to the complex history of the latter. Bank deposit portfolios are characterized by low urgency of deposits. 2/3 of deposits are “demand” deposits that can be withdrawn by depositors at any time, so it is impossible to issue loans against them. Because the domino effect will work: if depositors massively withdraw their savings on demand, banks will have to ask their borrowers to repay their debt obligations early. That is, without a sufficient mass of long-term deposits, both affordable and long-term loans are impossible.
The second “but” is a consequence of the first. Most of the liquidity surplus is the same scandalous certificates of deposit, funds on current accounts and demand deposits. Purely legally, it will not be possible to invest in OVDP just like that, except by increasing the rate of mandatory reserves and allowing them to be placed partially in OVDP, which the NBU did at the beginning of last year.
The third “but”: the funds raised from the OVDP will pass through the budget and settle in the accounts again, so the multiplier effect will be smaller than in the case of money emission, but it will still be there. In this way, the amount of liquid money supply will increase and inflation will accelerate. That is, even more channeling of banks’ liquidity surplus to the budget has similar properties to the emission of money, although it brings less harm.
According to the chairman of the National Bank, the hryvnia as an asset should be attractive. The domestic currency has a complicated history. Yes, once upon a time the NBU printed roubles, and their devaluation as a result of inflation was simply colossal. With the introduction of the hryvnia, the rate of devaluation decreased, but it has signs of shock. This is a natural reaction to a series of defaults. 1998 – the default of Muscovy, as a result – devaluation, 2008 – the world crisis and devaluation, 2014 – the beginning of the war and devaluation, finally, in 2022 – a full-scale invasion and devaluation again.
With the help of the reserves created during the Revolution of Dignity with the financial support of Western partners, Ukraine managed to smooth out the devaluation, but the population’s confidence in the hryvnia is very fragile. It will not be easy to restore the confidence of Ukrainians in the hryvnia as the main financial instrument. But the NBU is working on it.
Another important goal of the NBU is to increase the quality of bank funding. This is the key to raising taxes.
Alternative options for combating the state budget deficit
Some economists suggest conducting a military levy on the turnover of commercial structures. Others object to them: they say that this is a failed option that will lead to inflation and bankruptcy of businesses, many of which are already breathing incense, in particular, due to the energy crisis.
Simply increasing VAT is a much better option, although it will also accelerate inflation.
But it will not be possible to close the hole in the state budget at the expense of OVDP. Taxes will still have to be paid. It is worth mentioning the effectiveness of current tax collection under the pressure of Western partners. The effectiveness of the Bureau of Economic Security of Ukraine has increased, and the shadow market for fuel and tobacco products has decreased.
The situation is such that you need to choose the lesser of evils. One of the problems of Ukrainian business is the impossibility of obtaining affordable debt financing. The reasons are simple – the lack of long-term money to lend from banks, due to the insufficient number of long-term deposits, as well as the insufficient level of the accumulative pension system. In fact, accumulative pension funds are normally the basis for any stock market, providing investments for domestic companies. But in the current realities, being an entrepreneur, you cannot take a cheap loan for the energy autonomy of your business, you cannot place bonds, attract funds to enter a new market, you cannot simply stay afloat in difficult times.
As a demonstrative example, we can mention the case of Nova Poshta. The company had to take funds from the EBRD, and not from domestic banks, because the latter did not offer attractive terms. They simply could not offer favorable conditions due to their weak funding (see above), and were also forced to reserve part of the funds, which increases the demands on business and the population.
The need for military risk insurance
Naturally, the war was also to blame for why business did not want credit. After all, in a situation of business uncertainty, it is not always justified to take on financial obligations, and to lend to banks. By the way, the NBU and the government are currently discussing the need for military risk insurance.
Therefore, the government and the National Bank should work on the quality of bank funding, the creation of a state savings system, and the creation of prerequisites for Ukrainians to trust the hryvnia and buy military bonds. The problem of the state budget deficit is complex, and it cannot be solved with the help of simple solutions.
It will not be an exaggeration to say that the emission of money will kill the monetary transmission, which is already breathing incense, that is, the effectiveness of the discount rate on the rates for deposits and loans of individuals. The provision of bank liquidity through OVDP will lead to a further increase in bank liquidity. A total increase in taxes will simply kill business. The government and society need to communicate more, and the government and the public sector need to plan their actions in the long term.
Tatyana Morarash