Is National Bank financing the shadow economy with International Aid Funds?

The current situation reveals that the National Bank of Ukraine’s (NBU) currency policy poses a risk of a currency crisis due to its semi-manual, “managed flexibility” approach. In reality, this has become an additional factor in stimulating the shadow economy using international aid funds.

As a proponent of strict monetary policy, I believe that high interest rates and liquidity restrictions are necessary tools to curb inflation and stabilize the financial system. However, under current Ukrainian realities, this policy is ineffective due to deep-rooted imbalances in the currency market.

Instead of allowing the hryvnia to stabilize naturally, the NBU’s regulation creates artificial demand for foreign currency, leading to record outflows of reserves.

The "managed flexibility" regime introduced in October 2023 is presented as a market-based mechanism, but in practice, it is far from a floating exchange rate. The market remains under manual control, distorting macroeconomic policies and leading to unprecedented consumption of currency reserves, primarily funded by foreign aid. This also skews currency expectations.

This is the harsh reality that needs to be acknowledged and corrected urgently.

“Managed Flexibility” – A Mask for Administrative Currency Regulation

Strict monetary policy is failing due to administrative currency controls.

Classical macroeconomic models rely on two key mechanisms in tight monetary policy:

• Interest Rate Channel – Increasing borrowing costs and limiting access to liquidity.
• Currency Channel – Reducing the money supply, decreasing demand for imports, and encouraging the strengthening of the national currency.

But in Ukraine’s case, these mechanisms simply do not work. Why?

The NBU administratively controls the currency market, rendering the interest rate ineffective in strengthening the hryvnia. The volume of hryvnia liquidity remains high, continuously fueling demand for foreign currency, regardless of monetary policy measures.

As a result, NBU's monetary policy does not naturally strengthen the hryvnia. Instead, the NBU is forced to spend its reserves to compensate for structural market imbalances.

Currency Reserves: Depleting Without Replenishment

Supporting the hryvnia through interventions is unsustainable. The NBU relies heavily on foreign reserves to maintain the administrative exchange rate, but these reserves are being spent without equivalent replenishment, increasing the risk of macroeconomic instability.

The scale of interventions has already crossed rational boundaries. The NBU is effectively replacing market mechanisms with itself, burning through reserves at an unprecedented rate.

NBU’s Currency Interventions:

2014 – $12.6 billion
2015 – $3.6 billion
2016 – $+2.2 billion
2022 – $22.9 billion
2023 – $28.83 billion
2024 – $34.57 billion

In total, from 2022 to 2024, the NBU spent $86.3 billion on interventions – 7 times more than during the 2014-2015 crisis.
A similar scenario unfolded in 2011-2013, ending with depleted reserves, a $3 billion loan from Russia, and a massive crisis.

Ukraine’s critical reserve level is $20 billion. While foreign aid still helps maintain an acceptable level, shifting global realities signal that this support might soon end. Without equivalent inflows, the NBU will quickly drain its reserves, pushing Ukraine toward a deep currency crisis.

In 2025, this trend continues – in January 2025 alone, net interventions totaled $3.75 billion, with $1.48 billion directed to the retail market, including $1.29 billion in cash.

NBU’s Interventions Fuel the Shadow Economy

The main channel for NBU’s currency spending is the cash market.

Despite strict monetary policy, demand for foreign currency continues to grow. In 2024, the cash market absorbed 2.5 times more currency than in 2023.

Net Retail Currency Purchases:

2022 – $880 million
2023 – $4.79 billion
2024 – $12.2 billion

A worrying imbalance lies in the fact that currency purchases occur without significant withdrawals from bank deposits. Essentially, the NBU sells foreign currency in exchange for hryvnia, but this hryvnia does not leave the banking system.

This is further evidenced by growing deposit volumes alongside increased currency purchases:

2022 – +9.6%
2023 – +9.5%
2024 – +12.7%

With lending remaining limited, shadow funds are the likely source of excess hryvnia liquidity. This means that NBU’s currency interventions indirectly finance the shadow economy – using international aid funds.

Ukraine Needs a Market-Based Exchange Rate

To avoid a catastrophic scenario, Ukraine must take immediate steps:

• Transition to a fully floating exchange rate.
• Limit currency interventions.
• Implement effective measures to bring the shadow economy into the legal framework.
• Establish transparent currency policies.

Ukraine cannot afford to keep “burning” reserves in uncontrolled currency conversions. It’s time to shift to a real market model – or face an inevitable currency crisis.