Currency rate prediction. Part 1. Ukrainian currency market.
Before making currency prediction we will make general overview about currency market of Ukraine. To make optimal prediction model we need to know the factors currency rate depends on.
It is worth mentioning that I am not a financial analyst and do not work in financial area. I am just a software engineer who is interested in usage of machine learning for currency rate prediction for own pet project. Well, I would like to share with you my knowledge that I have got during the last 3 months.
Let’s take a look into the theory of currency market in Ukraine.
The main currency in Ukraine is hryvnia, hryvna, or sometimes hryvnya which has been the national currency of Ukraine since 2 September 1996 [1]. From 1996 till 2020 the value of hryvna to US dollar became cheaper from 1.7 to 23.98 UAH.
In Ukraine there are two entities that establish currency rate: Central bank and Interbank market. Central bank is National Bank of Ukraine that is responsible for unified state policy in the field of country’s monetary circulation, including strengthening of national currency unit — hryvnia (UAH). Official regulation document [2] on establishing the official hryvnia exchange rate to foreign currencies and precious metals says that the official hryvnia (UAH) exchange rate for foreign currencies and precious metals should be calculated:
- To the US dollar — as the average of hryvnia to the US dollar for its purchase and sale on the terms “Tod”, “TOM” and “spot” on the day of establishment of the official exchange rate for all concluded agreements between market entities and between sub’ market acts and the National Bank according to the System of Confirmation of Agreements on the Interbank Currency Market of Ukraine of the National Bank;
- Other Currencies on the daily fixing of the exchange rates with the European Central Bank. If there is no daily fixing of the exchange rates of these currencies to the European Central Bank, the official rate of hryvnia to foreign currencies should be calculated on the basis of the information on the hryvnia to US dollar established in accordance with point 1 of this Regulation, and the rates of national currencies to the US dollar, established by the respective central (national) banks;
Formally there are two currency pairs UAH/USD and USD/other currencies. Now in Ukraine the main criterion that reflects economic growth or stagnation is UAH/USD value established on interbank. Also NBU does not manage currency rates but it has tools for the influence on interbank market. The main tools can be divided into two parts. The first part is influenced by financial news, as the rate of UAH/USD is changing very fast. For example, on December 26th the Central bank announced an auction to buy foreign currency immediately for $ 1 billion and as a result the next day demand for the purchase of currency on intermarket increased significantly. At the same time NBU had bought only ~$700 million.
The second part is another tool which is official interventions. NBU is the largest currency buyer and seller on interbank, so now it is the most influencing tool. It can stop the decrease in the value of dollar to hryvnia. Also NBU can use other tools like printing more money etc.
Well, UAH/USD rate in Ukraine is very dynamically changing. In 2019 we saw how USD rate decreased from 27 to 23 in 4 months and it was not because of economic growing, but because of good sale of government bonds.
In 2019 interest in government bonds rose due to the increase in the National Bank’s discount rate to 18%. This value was approximately equal to interest rate on government bonds. As a result an attention to Government bonds in UAH increased.
Everyone who has bought Government bonds in hryvnia exchange USD to UAH and ~$500 million may enter the Ukrainian market in just a few days. This is a lot of money: the usual trading volume on Ukrainian interbank market is ~$600 million. Accordingly, the amount of USD is growing and the value of this currency is falling. Dollar fall was held back by NBU via buying overdue dollars. On the other hand, Ukraine will be in debt hole due to high payouts of government bonds next 4–5 years. Well, how will it influence USD rate in future?
Now in Ukraine everybody wants to know what rate will be in future for getting best moment to buy or sell dollars. Also economy in Ukraine is dynamically changing. For example, many financial experts predicted rate 25 UAH to 1 USD at the end of 2019 but at the end of that year the rate was 23 UAH for USD.
In this part we learned that the main currency pair is UAH/USD. There are multiple parameters that we need to take into our model: Official reserve assets, Monetary policy, government bonds and financial news. All this directly influences supply and demand on interbank market and as a result has impact on currency rate.
In the next part we will get closer to the technical overview of prediction model and the selection of prediction algorithms.
