Official restrictions and levies on currency purchases just increase dollarization and support the currency black market in Ukraine

The Ukrainian economy is significantly dollarized. This fact complicates monetary policy and reduces the potential amount of funds available for investment. In 2014-2015, due to the country-wide crisis, the demand for foreign currency increased significantly. However, as a result of the expansion of the black market, foreign exchange transactions have become a blind spot for official statistics. All the following key players would benefit from the reduction of the informal market: the government, the National Bank, commercial banks, legal businesses and households. For this reason, it is necessary to put real effort into reforming the market.   

The Centre for Economic Strategy conducted research “Dollarization and the black market in Ukraine: foundations, scope and effects on the economy and politics”. The aim of the research is to fill in gaps left by official statistics, to discover the main characteristics of shadow currency transactions, to come up with realistic hypotheses of reasons for the emergence of the informal currency market, its connections with the official and unofficial economy, and formulate recommendations on how to improve the situation based on the results of the research.

Emergence and scale of the black market

According to official data of the National Bank of Ukraine (NBU), the population bought $1.6 billion per month from banks on average in 2013, before the introduction of the army levy and Pension fund levy, and also before the severe currency restrictions were introduced. In 2015, this figure fell to only $57 million per month (or meagre 3.6% of the 2013 level). Officially, the amount of foreign currency purchases declined almost 30-fold in only two years. These official data are unlikely to correspond to the realities of the backdrop of the financial crisis, traditional and expected behavior for periods of devaluation, mass dollar purchasing, and multiplication in the number of street currency exchange offices.

The Centre for Economic Strategy assessed the scale of the black market using a mathematical assumption: in 2014-2015 the volume of foreign currency that was used as a means of exchange increased from $3.7 to $7.3 billion (thus it competed with the local hryvnia as a means of payment). The actual turnover of the currency exchange market in cash per month was $1 billion. This was less than in the time before the crisis. For example, in 2011-2013, currency exchange market turnover was $ 2.1 billion per month. This exceeds the data from official statistics considerably.

The informal currency market generates the following negative consequences:

• The Government does not receive taxes and levies in full amounts from foreign trade operations
• Lower efficiency of NBU monetary policy complicates the furtherance of its goals on inflation. It undermines economic agents’ trust in achieving target the inflation rate and the capabilities of the Central Bank
• Banks have problems with attraction of deposits and current deposits As a result, loan services have become more expensive, credit periods have reduced, and liquidity risks have been on the rise. During 2014-2016, private deposits in foreign currency (measured in dollars) have declined by half.
• It forces legal businesses (exporters-importers) to hide substantial amounts of their operations on the black market
• Households lose unearned interest when they keep cash and they are at risk to lose their money in illegal currency exchange operations (the risk of becoming a victim of foreign exchange fraud and robberies while keeping money outside banks).

The population accounts for most small day-to-day currency transactions. Therefore, people’s demand is one of the major “distribution” channels of black market for cash dollars. The reduction of this channel would decrease liquidity on the black market and, consequently, dampen its attractiveness for other operations.

Policy options aimed at reducing black market operations

It is important to understand that it is necessary to fight the root sources which led to the current situation, and not just the consequences. There following strategies might be effectively utilized:

1. Simplification of official currency exchange transaction operations including abolishment of the Pension Fund levy of 2% on purchasing foreign currency in cash operations;
2. Further transformation of the main priority of the National Bank’s policy from the currency exchange rate to other indicators (primarily, inflation) and further relaxation of the restrictions on foreign currency trade operations;
3. Decrease interest in foreign currency as a means of saving money with the help of creating attractive alternatives, in particular, hedging instruments and cancellation of restrictions on deposit withdrawals.

«We consider that all key players, except black market operators,  will benefit from abolishment of the Pension Fund levy, which will rein in the informal market», – Maria Repko, deputy director of the Centre for Economic Strategy, chief expert of the Reanimation Package of Reforms group for overhauling the financial sector, comments. «This can entail negligible negative result for the budget (approximately 200 million hryvnia per year taking into consideration the 2016-year plan). However, it can be balanced out by an increase of banks’ earning power as they reclaim their share of the currency exchange business».

To download the full version go to https://ces.org.ua/chornyi-rynok-valiuty-masshtaby-problem/. If you want to get more details about the research, do not hesitate to contact Maria Repko, deputy director of the Centre for Economic Strategy: (044) 492-7970, office@ces.org.ua).