KIEV Ukraine's parliament voted on Tuesday to give the central bank legal powers to force exporters to convert at least part of their foreign currency earnings into hryvnias, indicating Kiev aims to keep its currency pegged at current levels.
Other emerging market central banks have introduced forced currency conversions, a partial form of capital controls, to defend their currencies during crises, but such measures had been eschewed by Ukraine since 2005.
The hryvnia has been under pressure recently, forcing the central bank to intervene repeatedly to defend the peg, as financial markets have bet the government will let the hryvnia depreciate by 10-20 percent to boost exports now that national elections held last month are over.
Analysts say forced conversions would make a hryvnia depreciation less likely, at least in the short term. They would support the currency by increasing foreign currency supply and also help the central bank maintain its reserves, which have been depleted by interventions.
"It is becoming pretty clear that the central bank is planning to introduce even stronger capital controls on the hryvnia," Citi analyst Luis Costa said.
"If the law is approved and the situation in the market does not improve, the central bank might use this right in the near future, in our view," VTB Capital said in a note.
The central bank asked parliament in August for the right to introduce mandatory foreign currency sales for the first time since 2005, but parliament only approved it on Tuesday after speculation of a currency depreciation mounted since national elections on October 28.
The bank has not indicated when it might exercise its new powers but may be hoping even the threat of such measures could stem speculation on the currency.
"This might provide short-term support to the hryvnia exchange rate, but would not address the hryvnia's fundamental weakness, which stems from the widening of the external trade gap, a tight debt maturity profile, and high devaluation expectations."
DEBT TARGET RISES
The hryvnia, which is pegged at around 8 to the dollar and hit a three-year low of 8.19 per dollar this week, showed little reaction to the vote in parliament. It was trading at 8.18 late on Tuesday.
Non-deliverable forwards on Tuesday put the hryvnia rate at 9.27/9.57 per dollar in six months and 10.21/10.61 in a year's time.
President Viktor Yanukovich's Party of the Region's claimed victory in the election and the leadership on Tuesday blocked a bid by the opposition, which says the vote was rigged, for a partial recount.
The central bank has used market interventions to keep the hryvnia trading at around 8 per dollar since early 2010 but market players say the pressure for depreciation is mounting as Ukraine's trade gap widens and its economy its being hit by shrinking demand for its steel exports.
In a move certain to boost government debt, Ukraine's parliament separately voted on Tuesday to increase the 2012 budget deficit by 7.68 billion hryvnias ($960 billion) to cover gas and heating price subsidies for households.
The cost of insuring Ukrainian state debt against default increased to 622 basis point on Tuesday from 614 bp on Monday, according to financial information services company Markit.
The central bank's foreign reserves fell to $29.3 billion (18.3 billion pounds) as of September 30, 2012 from $34.6 billion at the start of 2011.
The currency peg, backed by a tight monetary policy, has also led to a credit crunch, compounding problems faced by Ukraine which registered its first quarterly contraction since 2009 in July-September this year.
The bill adopted by parliament on Tuesday needs to be signed into law by President Yanukovich.
(Editing by Susan Fenton)