The fate of Ukraine's hryvnia currency hangs by a thread. Will that thread break?
The hryvnia's crawling peg has so far held as the central bank has dipped steadily into its reserves to support it. But the reserves are dwindling and political unrest is growing. Forwards markets are therefore betting on quite a sizeable depreciation (See graphic below from brokerage Exotix).
The thing to remember is that the key to avoiding a messy devaluation lies not with the central bank but with a country's households. As countless emerging market crises over decades have shown, currency crises occur when people lose trust in their currency and leadership, withdraw their savings from banks and convert them into hard currency. That is something no central bank can fight. Now Ukraine's households hold over $50 billion in bank deposits, according to calculations by Exotix. Of this a third is in hard currency (that's without counting deposits by companies). But despite all the ruckus there is no sign of long queues outside banks or currency exchange points, scenes familiar to emerging market watchers.
So what are the reasons? First, households and businesses seem confident of a muddle-through scenario (this view is shared by most, though not, foreign analysts). Possibly, the optimism is based on the central bank's track record this year on defending the hryvnia. It also seems likely that with some foreign aid (bits and bobs garnered from Russia, China and the EU) and by using the remaining reserves, Ukraine can hold it together until 2015 elections are past and the government can finally knuckle down to the rigours of an IMF aid programme.
Second, people will not find it easy to turn their backs on the 14-25 percent annual rate they can earn on their bank deposits. In smaller, lower quality banks, bank deposits might earn up to 27-28 percent a year. Inflation meanwhile is running below zero. David Hauner, head of EEMEA fixed income strategy at BofA-Merrill Lynch Global Research, says: