26 September 2017
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InterviewNBU Deputy Governor Dmytro Solohub: "If you want a loan at 3%, deposit at 1%"

The deputy head of the National Bank of Dmitry Sologub in an interview with UNIAN has talked about the IMF mission in Ukraine, the upcoming first international conference to be held in Ukraine on the transformation of the central banks, the regulator’s forecasts and plans on forex liberalization.

It’s been the second week since the International Monetary Fund’s mission has started its work in Ukraine. The outcome of its visit can influence whether the country gets the next $1.7 billion tranche of an IMF loan and another $5 billion in loans associated with this funding program from other creditors, including the European Union and the U.S. Government. According to some experts, the fund may make concessions on some parameters of the program, given that the Cabinet of Ministers on May 1 increased gas prices to market levels ahead of schedule, set under the program of cooperation with the IMF.

In an interview with UNIAN deputy head of the NBU Dmytro Solohub spoke of the main issues being discussed with the IMF mission and the chances for the inflation forecast to be revised in the view of increased gas tariffs; he also talked about whether there are grounds for further liberalization of the foreign exchange market and easing of monetary policy, as well as about the terms for the loan rates to drop in Ukraine.

Photo from NBU
Photo from NBU

You have met with representatives of the International Monetary Fund. What are the first results? Will Ukraine continue its cooperation with the IMF? What innovations are possible in the updated memorandum?

The NBU governor has already said that the National Bank had been fulfilling all the conditions of the cooperation program with the IMF. We maintain the dialogue with the representatives of the Fund on a permanent basis, not only during the mission’s work. There is an ongoing discussion of various technical aspects, so there should be no surprises for us in the new memorandum.

It is clear that Ukraine needs to increase its reserves. But there is no universal formula to calculate what is the volume of reserves the country actually needs. Two years ago, in 2014, our reserves were at $18 billion. Some said it was not enough – equaling only three months of imports. Now we have $13 billion in our reserves. And this covers a little less than four months of imports, while just a year ago, it was $5 billion covering less than two months of imports. That is, it is difficult to say at what level it should be.

We discuss monetary policy, the transition to inflation targeting, the policy in the forex market, and the financial sector. We have carried out stress tests and negotiations with the banks on capitalization. We discussed what supervision rules should be changed, what the strategy of the banking system should be, and what the banks must do today not to "sleep away” their future.

One of our priorities is improving the situation with lending to related parties and the identification of bank owners.

Besides the issues that are within the competence of the NBU, the IMF program includes the issues of fiscal policy, state-owned enterprises, anti-corruption and pension reforms. But it is the competence of the Ukrainian government.

Can the IMF make concessions on some parameters of the program, given that we have increased the tariffs for gas ahead of schedule?

Gas tariffs are certainly an important signal. But life does not end with this, and the increase in tariffs does not mean that we can do nothing in the next 10 years. Given the crisis we have lived through, we will be pulling ourselves out of this swamp for quite a long time. The growth rates raise the question of subsidies and energy efficiency. The reduction of the unified social contribution raises the question of the Pension Fund deficit.

There is an actual progress in implementing the program, and the IMF understands it. But to continue the cooperation, not only the Fund’s will is needed, but also the movement from our side. We remain optimistic. With the optimistic scenario, it is quite possible to obtain the tranche in the coming months.

With regard to the pessimistic scenario, we also feel confident enough. Remember February and March – the situation was quite tense, the expectations were bad, the rate was skyrocketing. But then the situation has leveled off. The floating exchange rate helps to smooth out the peak periods. In 2011 and 2012, every autumn, the market was expected to plunge, and this hassle lasted for several months. Now, thanks to a floating rate and an effective system of auctions, we have these fluctuations smoothed. The inflation has slowed down. People are really starting to get used to the fact that our main task is to deal with inflation,  and in respect of the currency rate – to smooth excessive fluctuations. The world prices for metal are more or less stable. And the Ukrainian business revives.

The economy is a very complex system, and it is important for the central bank to make decisions, not hurting it. And it is not true that we do everything the Fund tells us to do. We're talking with the IMF on an equal footing. And the fund supports our steps. Had we not had support from the international community, could we ever be able to organize such an unprecedented event for Ukraine as the upcoming conference on the transformation of central banks?

Can you tell us more about this conference?

It will be held in Kyiv on May 19-20. There will be more than 200 participants from over 15 countries, including representatives of central banks, international financial organizations, Ukrainian and international academic and expert community. Among the participants is Poland’s Central Bank governor Marek Belka; chief economist of the International Monetary Fund Maurice Obstfeld, vice president of the International Investment Company Black Rock Philipp Hildebrand, deputy head of the Bank of Sweden Per Jansson. The event will be opened by the NBU governor. It will be a professional discussion of current issues and the future of central banks. We are embedding the National Bank of Ukraine into an international community of central banks, break a stereotype that Ukraine is a lagging state.

Maurice Obstfeld, the chief economist at the IMF, is a significant figure in a global economy. In fact, he is the head of research at the Fund. For example, the IMF has a regular product named the World Economic Outlook. It is drafted by the research department, and Maurice presents this report to the public. Together with Paul Krugman, he wrote the world's most popular textbook on international economics, which, in fact, is a required reading for anyone who is studying economics. Before the IMF job, Obstfeld worked as the head of a group of advisers at the White House. He has also worked for many years at the University of California at Berkeley, together with Yuriy Horodnichenko, a graduate of the Kyiv School of Economics and the founder of VoxUkraine. That’s how we managed to bring him to the conference. So I personally believe it will be a very significant event – guests of such weight don’t visit our country often. For example, if we talk about economists, we cold only remember a visit two years ago of Roger Myerson, a Nobel prize winner in economics.

What hopes does the National Bank hold to this conference?

First of all, it will help the National Bank feel accomplished as a central bank. Such conferences are a common practice and the norm for central banks around the world. We organize the event in collaboration with the Central Bank of Poland, which has a vast experience in this field. They have an annual conference, a special Research Work Shop, and other activities. We have almost had no such practice. This is the center of the economic debate, where people gather and talk about important things. The world is rapidly changing, and so do the economic theories. In a dispute, a truth is born. And in order to understand where and how to move in a changing world, we need a professional discussion. All the talk about "money from a helicopter" and negative interest rates – the world has never gone those places, and the discussion must be held.

Through the conference, we offer a platform for debate and declare that we have something to show in terms of our experience and the decisions that we have taken over the past year and a half. Foreign colleagues are sometimes surprised with our success in the direction of the transformation of the NBU. But Ukraine was in a situation when we needed to change both the banking system and the NBU’s functioning model. When all goes well, it is difficult to find arguments for the actual radical reform. But the Ukrainian crisis was unusual. Just like Greece, we had imbalances accumulated, but the war has added to this, cutting 25% of Ukraine’s production. And there was this sharp reorientation of foreign trade. After the previous 30% of Russian share in Ukraine’s turnover, now it is less than 10%. And these shocks were almost simultaneous. Thus, it is also a great experience to share with the international organizations that they might want to learn from, as there are no guarantees this will not repeat anywhere else in the future.

On the other hand, when it comes to monetary policy and regulatory policy in the banking sector, we are still catching up with what many have done many years ago. But things are changing globally, and the 20-year-old approaches are no longer applicable today. It is impossible to target the past. That is, the monetary policy of the National Bank of Ukraine should not target the monetary policy of the Central Bank of the Czech Republic of 1997. It does not make sense, the world has changed. This is our key challenge – we are introducing inflation targeting, build decision-making procedure on the patterns introduced by the Poles, Czechs, Canadians, and New Zealanders, but we can’t do what they were doing back in the 90s.

Will we be able to promote our anti-crisis recipes across the world and transform the IMF requirements in view of our experience?

In fact, this is already happening. For example, a program recapitalization of the Ukrainian banks, which is designed for three years and provides for the gradual path of the banks toward a normal level of capital. There were really no such examples in other countries – there is this norm of capital adequacy of not less than 10%. It turns out that when all the shocks strike at the same time, the banking system may be left with no capital at all. There used to be a theory that if the banking system remains with no capital, it dies. And we see that it does not die. In the first quarter, a number of banks have shown very good financial results. These are deposits coming in, and they start to lend.

There is also our control and our approach to stress testing. This methodology was not easy to come up with. We consulted with international organizations and consulting firms. We consulted with bankers. As a result, both the banks and international experts have recognized that our methods are correct. And I know that the IMF is already applying these methods in other countries. The National Bank could well act as a consultant in other countries, just like other consultants work in Ukraine.

The central bank of the Czech Republic is now considered one of the best in Europe. But it was not always so. We can say that in the Czech Republic, there was no central bank as a subject of market economy, when the country reemerged after the socialism. And there was no such bank in Romania. They also traveled and studied in England and other countries. And now, for example, the Czechs come to Canada and help them build a macroeconomic modeling system. There will be no outsiders or leaders in the world, for 20 years ahead, it all depends on your stance. In terms of its intellectual potential, Ukraine is not worse than the countries of Central and Eastern Europe. So we do have something to offer to the rest the world.

And what is the situation inside the country? At the beginning of the transformation of the NBU and the cleansing of the banking system, there was a huge market resistance. How are things going now? Do you feel the support of the bankers?

If we analyze the image of the central bank, it has improved in a professional community. There is an ongoing dialogue. We invite the experts regularly. And due to the transparency of the regulator, they have fewer questions today.

On the other hand, most of the regulator’s steps are painful. You can’t call a banking system reform a popular one. To some extent, the National Bank as a doctor. We discussed the rating of central bankers once and joked that it really is a rating of people who do hurt you so that you get better in the long run – just like dentists or surgeons.

There are two types of tools for implementing economic policy - monetary and fiscal ones. Fiscal policy works fast: you raise or lower the taxes – and within 3-6 months, you get the result. Monetary policy affects the economy with a time lag of several quarters or even years. This means that if we did something today, cleansed the banking system in 2014-2016, the result will be visible in the coming years. There will be no result in the morning.

So it is too early to talk about any results of the NBU reducing its discount rate to 19% in April, isn’t it?

You have to understand how monetary policy affects the economy. The NBU lowered the rate. Thereafter, the rates on the interbank market are reduced. These rates at which banks trade with each other are the basis for rates on deposits and loans. If a customer comes and sees a reduction in the rate, they take a more favorable loan for their project on construction of a plant or upgrading an existing plant. This is an investment. Or when a person buys a car, or a refrigerator – this is consumption. That’s how this monetary transmission mechanism influences the economy. This cycle in a normally operating economy takes up to 12-18 months.

What we see now is that the interbank rates began to decline, even despite the fact that we have reduced the rate just slightly. After all, in addition to changes in rates, there is an expectations channel – not only the actual reduction of the rate is important, but also the expectations of a further decline in the future. With the stabilization of exchange rate and the slowing down of inflation since late March - earlyApril, the deposit rates in some banks have already started to fall – this channel starts working.

Solohub: We are in a cycle of rate cuts / NBU
Solohub: We are in a cycle of rate cuts / NBU

Given the time lag, should we expect another rate cut over the next nine months?

It is an ongoing process. We are in a cycle of rate cuts. I can’t say when we will lower the rate the next time. We will be assessing the rate of inflation.

If the central bank wants to stimulate the economy, it sets a negative rate in relation to the expected inflation. For example, in a normally operating economy, if the expected inflation rate is 5%, the rate is set at 3%, which stimulates the economy to develop. Bids will be at the level of 4% of the loan, and everyone will run for loans, knowing that at this level of inflation, the real cost of the loans is zero.

In our case, the inflation by the end of 2016 is expected at 12%, while the rate at the beginning of the year was at 22%. That is, the actual rate was positive – at around 10%. This is a tight monetary policy aimed at stabilizing the system and reducing inflation.

Stimulating the economy is good, but certain conditions are necessary for that. Had we set the rate at 2-3%, then who would have run to take a loan to build a plant in Cherkasy region? The investor would rather go purchase some dollars in the current conditions of political instability. And despite the fact that there is excessive lending in our economy, there are not so many creditworthy borrowers out there.

We can gradually soften the monetary policy, and that’s what we have been doing. It is too early to say that the rate should be at a zero. But it is important for it not to be as high as it is now.

When will we have the rates on loans at 1-2% annual rates, as in the European countries?

If you want a loan at 3%, deposit at 1%. Are you are ready to put a deposit with such interest rate? I think that Ukrainians are not ready yet. In addition, the rate on the loan is a deposit rate plus a margin, or a bank risk measure, including staff salaries and dividends to shareholders. The higher the risk – the higher the margin.

For the interest rates to be low, low inflation and a stable exchange rate is not enough. Bankers can remember a lot of examples how the loans are not returned. There was a story when local authorities have renamed the street, and the borrower was able to withdraw the pledge because it supposedly was no longer in its previous location. Due to the weakness of the legal system, the banks’ risks are growing, and so do the margins and lending rates.

If we say that the inflation in 2-3 years falls to 5%, and if there is a change in the judicial and tax systems, then in a 5-year term, the rates on hryvnia loans below 10% are actually possible. Then the rates on deposits will be at about 5%, and this will be another challenge for bankers – whether they will be able to attract deposits at such rates.

Since we touched on the subject of inflation, was it a surprise for you when the government decided to raise tariffs for gas? Is there a need to adjust the NBU forecasts for inflation and GDP for the current year?

This increase has been planned since 2015, but it was initially expected that the process will last through 2016-2017. We discussed this issue with the IMF, and we came to a consensus that it is better to cut the cat’s tail all at once, rather than in parts. The solution is right, but there is a question of social stability. A subsidy system has been created, it works well enough. But now we need to encourage people to consume less, for energy efficiency to grow. For example, in England, if you slightly change the settings of a heating battery, you will have to pay extra GBP 20-30. But the British prefer to buy a 10-pound blanket and a pair of warm socks. This is a market mechanism – people make choices. And while there were lower rates, an overvalued exchange rate of hryvnia and the huge deficit of Naftogaz, there was no such choice. Lower utility tariffs eventually cost our people much more.

As for inflation, the other components of the index sank more significantly than expected. This, of course, led to the stabilization of prices for imported goods. In addition, Russia closed its trade with Turkey, which reduced the price of fruit in our country. After the devaluation in Belarus, we had cheaper vegetables. Eggs are cheaper because their exports slowed down, and they were all brought to the domestic market. We projected the increase in tariffs for central heating and hot water at an average of 60% in 2016. Now we see an increase of 75-90%, and 42%, respectively. Of course, due to this component, contribution of the administrative measures to general inflation will be greater (less in 2017, though). But we cannot say that because of this, our objectives must change: if we had a goal of 12% now, for example, it will be 12.5%. This is a landmark. We give ourselves a gap of +/- 3 percentage points. And we are sure that we will remain in this range – between 9 and 15%.

There are no prerequisites so far to worsen our forecasts. In terms of the GDP, there are even prerequisites for improving the forecast. We have a standard cycle of forecast revision. Last time we did in April, next time, we will do it in July.

Cutting the tail all at once regarding the tariffs was right, but when we are discussing with the market our forex restrictions, we assure the players that it is necessary to cut them so that the head does not fall off afterward.

By the way, with regard to restrictions – the National Bank has announced their further easing after the resumption of cooperation with the IMF. In addition to the ban on repatriation of dividends, what does the regulator plan to lift?

In addition to the ban on dividends, we see that a ban on deposits, too, needs to be canceled or mitigated. This causes a lack of confidence in banks. The depositors with a 200,000 deposit, with the limit of 50,000, understand that it won’t take that long to take their money back, but on a subconscious level, they fear that this limit may be lowered again. So they just don’t bring their money into the banking system. It is important to send positive signals after the crisis," said Solohub, responding to a question about the NBU’s plans to liberalize the currency market after the resumption of cooperation with the IMF.

The problem of administrative restrictions lays with the fact that there’s just too much of them, and they are all different in their considerable number and diverse ways they affect the market, and that’s why the businesses have no universal wishes for abolishing certain restrictions.

Most of them are troubled with the restriction on dividends. But there are several companies who have asked not to remove this ban, fearing that they will remain with no currency, as it may all be transferred to the shareholders. Exporters are troubled with the mandatory sale of foreign currency earnings. Importers are troubled with the T+2 rules for currency purchasing. From May 11, we have softened the requirement – it used to be a T + 3 – and the market has reacted on the very first day. There was a bigger flow of foreign currency, and the exchange rate has moved by 15 kopiykas. But the sky did not fall to the ground. This is - an indication that the market will regulate itself.

In addition to the ban on dividends, we see that a ban on deposits, too, needs to be canceled or mitigated. This causes a lack of confidence in banks. The depositors with a 200,000 deposit, with the limit of 50,000, understand that it won’t take that long to take their money back, but on a subconscious level, they fear that this limit may be lowered again. So they just don’t bring their money into the banking system. It is important to send positive signals after the crisis

Speaking at a conference, you called the crisis Ukraine survived a "perfect storm." How would you describe the Ukrainian economy today?

Calm. Remission. Ukraine is a country where you can’t be exclusively right for a long period of time. Sometimes you think that it can’t get worse, but it does get worse, as it was at the beginning of last year with the forex rate.

On the other hand, sometimes you expect worsening, but it gets better, as it does now. We had such a gap in the IMF program, there was no government, the new barriers emerged in our trade with Russia, the metal prices collapsed at the end of the 2015 – the beginning of 2016. But the situation is calm.

This is a short-term stabilization, and we need the internal and external investment to come. To make people believe in their country. But we need structural changes for which everyone has been waiting.

Olha Hordienko (UNIAN)

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