Public Version of the Strategy for Easing FX Restrictions, Transition to Greater Exchange Rate Flexibility, and Return to Inflation Targeting
Mykola Siutkin
You do business, we mitigate risks | Business Investment Risk Advisor | Co-founder of S&P Agency | Attorney | Co-publisher LDaily | Ironman
The development of the Strategy for easing foreign exchange (FX) restrictions, transitioning to greater exchange rate flexibility, and returning to inflation targeting aims to align Ukraine's monetary and exchange rate policies with its evolving economic landscape. This strategy emerges from a combination of factors, including the need to adapt to changing economic conditions following a period of martial law, commitments to the International Monetary Fund (IMF), and the goal of maintaining price and external stability.
The purpose of this strategy is to outline the priorities, principles, and preconditions that will guide the process of returning to inflation targeting with a floating exchange rate. Simultaneously, the strategy aims to ease currency restrictions in a controlled and consistent manner that minimizes risks to price and financial stability while fostering sustainable economic recovery. The implementation of this strategy is contingent upon specific conditions, as detailed below.
Motivation
During the period of martial law, a fixed exchange rate regime with stringent FX restrictions helped stabilize inflation and exchange rate expectations, thereby reducing inflationary pressures. However, the benefits of this regime have waned over time, potentially leading to increased market distortions, reduced productive business activity, and the accumulation of currency risks. Moreover, a prolonged fixed exchange rate regime can hinder adaptability to changing external and internal conditions. Thus, there is a motivation to transition back to inflation targeting with a floating exchange rate, which allows for both price and financial stability as well as sustainable economic growth.
Prioritization
The strategy is divided into three main pillars: easing FX restrictions, transitioning to greater exchange rate flexibility, and returning to inflation targeting. These pillars will be implemented in a sequence that supports the economy and maintains external and financial stability. The process will involve gradual changes, with the removal of fixed exchange rates preceding the liberalization of capital flows. Exchange rate flexibility will follow the easing of most FX restrictions, allowing the FX market to function more efficiently. Throughout this process, maintaining a tight monetary stance will be crucial to ensure the attractiveness of local assets and to stabilize the exchange rate during the transition.
Principles
The strategy will be implemented gradually, with each step informed by careful analysis of its impact on the foreign exchange market, international reserves, macroeconomic stability, and the potential risk of re-imposing FX restrictions. These steps will be determined by macroeconomic preconditions rather than specific timeframes. Additionally, the strategy acknowledges the need to manage risks and make adjustments based on the prevailing circumstances.
Preconditions and Risk Assessment
The implementation of each step in the strategy will be based on a set of established macroeconomic preconditions. These conditions ensure that the necessary prerequisites are in place to support the successful execution of the strategy while maintaining macroeconomic and financial stability. This includes considerations of inflation, FX reserves, interest rates, and financial stability.
Joint Assessment with the IMF
Given the complex nature of these changes, a joint assessment with the IMF will ensure alignment with broader program objectives. This collaborative evaluation will consider the implications, potential impacts, and risks associated with the strategy's implementation.
Easing FX Restrictions
The strategy outlines a roadmap for gradually easing FX restrictions. This roadmap prioritizes minimizing distortions in the market and supporting economic recovery. The easing of restrictions will focus on trade transactions, capital flows, and the stages of liberalization. The sequencing of these steps can be adjusted based on economic conditions.
Greater Exchange Rate Flexibility
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The strategy will gradually introduce greater exchange rate flexibility. Initially, the exchange rate will remain a nominal anchor, and over time, it will transition to a corrective mechanism. The NBU will maintain a tight monetary policy to minimize shocks and ensure a smooth transition.
Return to Inflation Targeting
The NBU's key policy rate will continue to stabilize the exchange rate regime during the initial stages. Gradually, as conditions improve, inflation targeting will regain its role as a nominal anchor. The key policy rate will play a central role, and a return to full-fledged inflation targeting will be achieved over time.
The strategy presents a comprehensive plan for transitioning Ukraine's monetary and exchange rate policies toward greater flexibility and stability. By carefully considering macroeconomic conditions, policy preconditions, and international collaboration, the strategy aims to ensure a smooth and successful implementation that supports sustainable economic growth while maintaining stability in the face of uncertainties.