I’ve been trying to figure out what happens to a modern financial system in a global wartime framework, especially a financial system as interconnected and extended as the Western one.
How would the system cope with national-scale food, energy and good shortages during a period of martial law? How would the transfer capital away from peacetime activities to wartime ones? What would happen to domestic debt, corporate, mortgage and personal? And what would happen to the foreign exchange market?
Unfortunately, we only have a Keynesian guide for how to move out of a wartime economy into peacetime one. Not vice versa.
I’d be interested to hear from any finance professionals who are already thinking about these factors. Especially with regards to how the system might handle national-scale mortgage payment suspensions and foreign exchange controls.
In the meantime I found this interview with the governor of the National Bank of Ukraine, Kyrylo Shevchenko, very enlightening, especially with respect to how FX markets might operate. Here’s a key bit:
What is happening in the FX market? What are depreciation expectations?
The FX market is now operating under significant restrictions imposed due to martial law. Authorized institutions are in fact prohibited from trading in currency valuables, except in a number of cases. Most transactions in the interbank market, both to purchase and sell foreign currency, are taking place with the NBU’s participation. We have already seen some banks conclude some agreements, but those are few and far between.
Regarding the exchange rate, we have fixed it at the level of 24 February 2022, the day the Russians invaded. As for where the exchange rate will end up after the war, this will depend on many parameters, meaning that it is impossible to predict now. But I can reiterate that when the situation has gone back to normal, we will restore the full-fledged operation of the FX market as soon as we can, and we will lift the currency restrictions imposed in wartime. As soon as market-based monetary instruments become operational, the central bank will step into the market to smooth out exchange rate fluctuations and stabilize the situation by eliminating supply and demand imbalances. To this end, the NBU has USD 27.7 billion in international reserves as of 7 March 2022 (according to preliminary data), which is sufficient for the purposes noted above.
Significant volumes of international aid will help normalize the FX market conditions.
How much international reserves has already been spent?
Between the start of the war and 7 March, international reserves actually rose by 1.15% or USD 315.6 million. This increase was primarily driven the NBU’s purchase of foreign currency from banks (about USD 680 million) and the disbursement of funds from the International Bank for Reconstruction and Development (USD 60 million). As you know, Ukraine does not plan to stop meeting its commitments to creditors, so since the beginning of the war, the government has spent USD 342 million to service and repay FX-denominated debt. In addition, we have repaid a USD 100.5 million loan granted by Sveriges Riksbank.
Unlike Russia, Ukraine is doing everything it can to maintain the normalcy of market operations — as well as everything it can to meet creditor obligations.
A further update from the bank on March 14 notes:
In a sign that the Ukrainian FX market is going back to business as usual, the NBU this week has seen banks starting to make transactions with each other. These activities have so far generated as little as the equivalent of USD 10 million in volume, but this is an important stepping stone towards the resumption of full-fledged market mechanisms.
Other developments to note:
- Ukraine has loosened the AML rules on accepting cash for war bond investments during the period of martial law.
- But it has heightened “proof of source” verification standards on funds flowing out of Ukraine.
- The February inflation report clocked a 27.5% rise in fuel prices, amid a general rate of 10.7 per cent.
- The NBU also waived fees on its BankID system, which is relevant in the context of the central bank having initiated its own CBDC pilot for dispensing e-hryvnia in December, 2021.
