NBU Introduces Managed Flexibility of Exchange Rate to Strengthen Resilience of the economy and the FX Market

• In view of the steady progress in reducing inflation, the accumulation of a significant level of international reserves, the increase in the attractiveness of hryvnia deposits and domestic government debt securities, the NBU is moving to a regime of managed flexibility of the exchange rate.
• The NBU will continue to monitor the situation on the FX market and will remain a key player in it, compensating for the structural deficit of foreign currency. Thanks to this, the exchange rate will change in both directions. However, the NBU will significantly limit these fluctuations, preventing both a significant weakening and a significant strengthening of the hryvnia.
• The new regime will strengthen the resilience of the Ukrainian economy and FX market, promote their better adaptation to domestic and external shocks, and reduce the risks of accumulating FX imbalances that can be generated by a long-term maintenance of the exchange rate peg. 
• The official exchange rate under the regime of managed flexibility will be determined by transactions in the interbank FX market. 
• At the same time, the exchange rate in the cash FX market, where individuals can buy and sell foreign currency, will be set according to the same rules as before. This market has been operating in such a mode for nearly a year and a half now, during which the cash exchange rate has gone both up and down significantly. The NBU will continue to make efforts to promote the proper operation of the cash FX market, in particular by minimizing the difference between the cash and official exchange rates.
• As before, the NBU’s policy will focus on making sure that hryvnia-denominated instruments remain sufficiently attractive. This approach will enable households to protect their funds from devaluation thanks to hryvnia deposits and domestic government debt securities and contribute to limiting the demand for foreign currency, maintaining exchange rate sustainability, and reducing inflation further.
• Maintaining the stability of the exchange rate will continue to be one of the NBU’s priorities.
• The shift to managed flexibility of the exchange rate comes as one of the steps in implementing the Strategy for Easing FX Restrictions, Transitioning to Greater Flexibility of the Exchange Rate, and Returning to Inflation Targeting.

Effective 03 October 2023, the NBU is shifting to the regime of managed flexibility of the exchange rate continuing to implement the Strategy for Easing FX Restrictions, Transitioning to Greater Flexibility of the Exchange Rate, and Returning to Inflation Targeting (hereinafter the “Strategy”). As per the new regime, the official exchange rate will be shaped by the exchange rate used for transactions in the interbank FX market instead of being set by the NBU under Resolution 18, as has been the case since 24 February 2022.  

At the same time, the central bank will continue to control the situation in the interbank FX market on a regular basis by eliminating the structural deficit of foreign currency that will persist over the forecast horizon because of the specifics of how Ukraine’s economy operates. Because the NBU will be covering the structural FX deficit, the exchange rate in the FX market will be allowed to go both up and down as it responds to supply-and-demand changes.

In addition, the NBU will significantly limit exchange-rate fluctuations, preventing both a significant weakening and a significant strengthening of the hryvnia.

No changes will be made to how the bid and ask rates of foreign currencies are set in the FX market’s cash segment or to how card-based exchange rates are set by banks.

As before, the ask price in the cash segment of the FX market, where individuals buy and sell foreign currency, will be determined by market supply and demand. The cash FX market has been operating in such a mode for nearly a year and a half now. During this time, the cash exchange rate has been fluctuating freely, allowing the hryvnia to weaken and strengthen. Specifically, in the summer of this year, it strengthened to UAH 37.2 against the dollar.

The setting of exchange rates by banks for card-based transactions will also take place according to the same rules as before.

As with previous months, while putting the Strategy into practice, the NBU will make efforts to promote a proper functioning of the FX market, thereby minimizing the spread between the cash market rate and the official rate. The NBU has the necessary experience, sufficient resources, and the right tools for this. Whenever necessary, the NBU has the ability to ease a number of restrictions to meet demand in the cash FX market and to expand the supply of both cashless and cash foreign currency to the public.

The transition to the regime of managed flexibility of the exchange rate became feasible because the macroeconomic preconditions are met and fundamental preparatory work has been done.  This enables us to ensure a controlled transition and minimize risks to the financial market, the economy, and households.

When making decisions about the transition to managed exchange-rate flexibility, the NBU took into account the progress made in the development of appropriate preconditions. Specifically, as per the Strategy, the NBU assessed the indicators such as the inflation and inflation expectations, the level of international reserves and the sustainability of the FX market, real interest rates and financial stability parameters.

Inflation has been declining steadily. In the first eight months of 2023, it slowed to 8.6%, down from 26.6%. Exchange-rate and inflation expectations of different groups of respondents have improved significantly. Throughout 2023, the FX market situation has remained sustainable. The NBU has additional tools to ensure such sustainability going forward. Ukraine’s international reserves have consistently remained at a sufficiently high level, enhancing the NBU’s capacity to maintain the sustainability of the exchange rate.

Furthermore, the NBU has made tangible progress in ensuring attractive interest rates on hryvnia-denominated instruments. The level of interest rates on term deposits in the system has been close to 15%, making it possible to cover both expected inflation and the anticipated change in the exchange rate, according to different surveys. The banking system continues to operate stably, despite the challenges posed by the full-scale war.

The NBU has also done thorough work to gear up for the transition to managed exchange-rate flexibility with the involvement of international experts and due consideration of global best practices.

The presence of these prerequisites makes the NBU well-equipped to facilitate a transition to managed exchange-rate flexibility in a controlled manner while minimizing the risks of sudden exchange rate changes that could have undesirable effects on the financial market, the economy, and the public.

Managed flexibility of the exchange rate will be an additional mechanism through which the economy can adjust to changes in the domestic and external environment, as well as an important prerequisite for a return to inflation targeting going forward.

In contrast, a long-term fixing of the exchange rate could lead to an accumulation of risks for the economy and the financial system. Because of exceptionally high uncertainty when the full-scale war broke out, the introduction of the exchange rate peg has up until now ensured the stable operation of the financial system and helped businesses and households adjust to wartime conditions. However, as the experience of Ukraine as well as many other countries shows, fixed exchange rate regimes are only optimal in a limited timeframe.  Over time, exchange rate pegs become increasingly less effective, allow FX risks to accumulate, and cement existing micro- and macroeconomic distortions. All of this can weaken the economy and the financial system now and make it difficult to restore business activity during Ukraine’s reconstruction.

With this in mind and because the preconditions have been met, the NBU has decided to switch to managed exchange-rate flexibility. This regime should not only preserve the sustainability of the economy and the financial system against the backdrop of the full-scale war, but also subsequently bolster that sustainability through higher resilience to external and internal shocks.

This is also one of the steps towards reaching the NBU’s long-term goal of returning to inflation targeting with a floating exchange rate. This makes it possible to simultaneously achieve the goals of price and financial stability and sustainable economic growth in the long run.

Exchange rate sustainability will continue to be one of the NBU’s priorities. It stands to be instrumental in the further deceleration of inflation and in bringing it to the medium-term target of 5%.

With this in mind, the NBU will continue to actively participate in the FX market by offsetting the structural component of the net demand for foreign currency and by significantly limiting exchange rate fluctuations through FX interventions. By maintaining the sustainability of the exchange rate, the NBU will ensure that inflation continues to decelerate and achieves its medium-term target of 5%.

Going forward, the flexibility of the FX market will gradually strengthen as relevant conditions are met, helping mitigate shocks to the FX market and the economy.  A gradual increase in exchange-rate flexibility will put the NBU in a position to press forward gradually with the second stage of the relaxation of FX restrictions. Both at the current stage and further on, the NBU will continue to focus on maintaining exchange rate sustainability as per the Strategy.

The NBU’s monetary and FX policy will continue to be guided by the principles of the Strategy. During all stages of its implementation, the NBU’s policy will ensure the sufficient attractiveness of hryvnia-denominated instruments. This will help households protect their hryvnia savings from losing value.

Specifically, despite the easing cycle, the yield on hryvnia retail term deposits and domestic government debt securities will stay attractive given the expected deceleration of inflation. This approach will reduce the demand for foreign currency and help ensure exchange rate sustainability and a further easing of inflation, which is especially important for the sustained implementation of the Strategy.   

The introduction of managed flexibility of the exchange rate was approved by NBU Board Resolution No. 121 On Amendments to NBU Board Resolution No. 18 dated 24 February 2022 dated 02 October 2023, which takes effect on 03 October 2023.