It looks like the crisis is finally over for Ukraine’s embattled currency.

After its 40 percent plunge in fall 2008 led to panic, the hryvnia is strengthening amid an improved economic outlook and political stability.

We forecast that it will hit Hr 7.5 to the U.S. dollar by the end of the year. For the last five months the exchange rate of the hryvnia has been stable with slight appreciation in June and July.

At the same time, foreign currency has been in strong supply on the back of exports’ recovery and growth in sales of dollars from the population.

Meanwhile, the National Bank of Ukraine bought the excessive supply of foreign currency from the market, reducing sharp changes in the hryvnia’s rate.

There are two factors that will determine the hryvnia’s future dynamic: one fundamental – the performance of the balance of payments; the other political – the NBU’s policy in terms of inflation and exchange rate.

Both accounts of the balance of payments are likely to improve this year after turning and remaining positive since April.

Improvement of the current account has been driven by growth in exports, particularly exports of metallurgical products such as steel prices and export volumes almost returned to record levels.

Despite the recent cooling of global metallurgical markets in May, exports of goods remained unchanged and were supported by recovery in exports of engineering products.

Moreover, imports are still depressed as recovery in internal demand is limited by a rather moderate growth in disposable incomes and a lack of new retail loans. All these positive trends look set to continue during the second half of the year and will likely see the current account turn positive for the full year.

The dynamics of the capital account are also no longer a cause for concern, in our view, because debt restructuring and refinancing have greatly relieved pressures, while we expect sales of foreign currency by households to continue.

Ukrainian banks’ foreign debt was reduced by $8.7 billion over 2009, reaching $30.8 billion at the end of the year, about $11 billion of which was short-term debt as of April 1.

Corporates’ external debt grew by $3.7 billion in 2009, due to an increase in short-term borrowings, to $24 billion on April 1. This new debt consists mostly of trade loans – the volume of which is likely to increase further on the back of increased foreign-trade activity.

The rush by the population to convert hryvnias into foreign currency at the end of 2008 and start of 2009 put great pressure on Ukraine’s capital account, and, subsequently, on the country’s foreign reserves.

Demand from the population for foreign currency is strongly correlated with expectations of the hryvnia’s dynamic; therefore after the first signs of stability in the currency market, households have started to sell their foreign currency from their savings.

Given that the population accumulated rather substantial amount of the foreign currency during the crisis, the supply of foreign currency from households should continue to support the hryvnia in the near future.

The planned external borrowings of the government will also support the capital account greatly.

Ukraine has already received $2 billion from Russian state bank VTB to cover its budget deficit, and expects an additional $2 billion from Russia to finance state projects in the nuclear power sector.

Despite the recent delay, the Ukrainian government could tap the external markets with a new Eurobond issue of $1.5-2 billion.

Also, more than $1 billion in loans is expected soon from the European Union and the World Bank. We estimate that public external borrowings, excluding the International Monetary Fund loan, may reach $6 billion this year.

The IMF’s funding is not included in the capital account, at the same time it directly impacts the inflows of the foreign capital in Ukraine.

The government already received $1.9 billion from the fund and there is a high chance that the second tranche under the new program will be received this year.

Overall, we expect that the consolidated surplus of the balance of payments may exceed $5 billion and, added together with funds from the IMF, may result in about $7-10 billion net inflows of the foreign currency to the country. We believe the NBU’s main policy line will be to keep the maintenance of a stable currency as a key priority this year.

The step away from this policy in 2008 – when the hryvnia was first allowed to appreciate in the first half of the year, and subsequently allowed to devalue in the second half – must have been painful for a regulator seeking to maintain a stable currency.

Furthermore, Ukraine needs to re-monetize its economy and recover international reserves.

These factors, in our view, make NBU interventions – against an expected surplus supply of dollars and euros – the most likely outcome.

At the same time, renewed cooperation with the IMF could result in further gradual liberalization in the exchange-rate policy of the NBU.

The new program with the IMF suggests a shift to inflation-targeting that envisages a more flexible exchange rate. With the hike in gas tariffs and comparably high growth of producers’ prices bringing risks of inflation growth, the NBU may allow the hryvnia to appreciate slightly close to the end of the year in order to curb inflation.

The slight appreciation – which we forecast will see the rate at Hr 7.5 to the U.S. dollar by the end of the year – will be mostly positive for the population and banks. Its negative impact for exports will be less visible in the light of improving of the global environment.