Graham Stack in Kyiv -

Ukraine's hryvnia fell to UAH27.85 to the dollar on February 20, according to the official National Bank of Ukraine rate, with currency exchange booths now selling dollars for over UAH30. The slide in the hryvnia marks a 40% devaluation of the currency since February 6, when tight controls were removed from the foreign exchange market, effectively floating the currency. 

The hryvnia has now fallen by nearly 75% since the ousting of former president Viktor Yanukovych on February 22, 2014, making it the world's worst performing currency. While Ukraine's monetary authorities say the plummet will soon bottom out, many experts believe growing inflation will see it continue.

The current wave of devaluation started on February 6 when in the process of Kyiv reaching an agreement with the International Monetary Fund, the National Bank of Ukraine (NBU) announced that the hryvnia exchange rate would be determined by the market, effectively floating the currency. The IMF and Ukraine then announced a new $17.5bn bail-out deal on February 12.

But despite the IMF injection, pent-up demand for hard currency from the population and importers drove down the hryvnia. The central bank had held its official exchange rate at UAH16 to the dollar since the start of September 2014 using administrative measures, in order to facilitate large payments on sovereign debt.

In a posting on February 19, the NBU claimed the population had started to sell hard currency to the banks, indicating the hryvnia's drop may be bottoming out. “Since February 6, demand has succeeded supply on the market of cash hard currency,” the bank said.

Analysts are sceptical. “We are seeing lack of confidence in hryvnia, people prefer to buy hard currency at any price,” Maksim Serous, head of Stork Advisers, tweeted on February 19. “Trust in the hryvnia will not return without significant appreciation of the hryvnia to the level of 22-22UAH to the dollar," he added.

National statistics show that devaluation has now indeed cut imports, nearly balancing the current account. But production continues to fall, mostly as a result of the armed conflict in East Ukraine, which is likely to drag exports down further and increase pressure on the currency: Ukraine’s industrial output plunged 21.3% in January 2015 on the year, Ukrstat reported on February 18. Also due to the conflict, Ukrainian corporates often cannot roll over international debt, adding to capital flight.

But the main driver of devaluation going forward will be the NBU itself, by printing money to fund the budget - in particular the military operations in the eastern regions - analysts warn.

Defence and security spending will soar in 2015, with defence spending set at 5% of GDP, three times more than in the 2014 budget. The capture by Russian-backed separatist troops of the railway town of Debaltseve on February 18 may now open a new phase in the conflict, which already costs the budget $10mn per day, according to Ukrainian President Petro Poroshenko.

On February 16, Ukraine's finance ministry published its revised budget for 2015 adapted to meet IMF criteria, cutting a planned fiscal deficit of 8.8% of GDP to a deficit of 5.8%. But the new version of the budget contained few cuts in spending, instead increasing predicted tax revenues according to calculations that many analysts regard as unrealistic.

According to Dragon Capital analysts, the budget requires the NBU to print nearly UAH200bn in 2015 to cover the deficit.

With inflation already forecast at 25% in 2015, Dmitro Boyarchuk, head of CASE Ukraine think tank, believes Ukraine could enter a vicious circle of inflation and printing money, with hyperinflation "very probable". 

“The dollar is already trading at UAH30. And the budget year has just started. We are on the brink of a major [hryvnia] emission [to fund the budget]. Are you really sure you want this budget? Perhaps after all you should be revising expenditure?” Boyarchuk blogged on February 20. “Yes, this will be painful, but devaluation at 10UAH [to the dollar] per month is no better than cutting spending,” he added.