By Emma O’Brien

March 31 (Bloomberg) — Ukraine and Kazakhstan, home to two of this year’s worst emerging stock markets, are driving away investors by attempting to prevent capital flight.

Ukraine ordered banks this month to buy and sell the hryvnia at a rate no weaker than a floor policy makers set each day. Kazakhstan’s parliament is preparing to give the president power to force exporters to sell the government their foreign- currency earnings for tenge.

“If you’ve got money in a country that introduces some sort of controls, that’s an issue and so we’re steering pretty clear of that area right now,” said Andrew Bosomworth, a fund manager in Munich at Pacific Investment Management Co. who helps oversee more than $50 billion in emerging-market debt for the world’s largest bond-fund manager. “The best way to attract private money that’s going to stay there is to provide a coherent environment to invest in.”

The two nations devalued their currencies and took over struggling banks in the past six months as the first global recession since World War II slashed demand for exports at the same time that frozen credit markets drove away foreign investment.

Ukraine’s PFTS stock index fell 26 percent this year and the Kazakhstan Stock Exchange Shares Index lost 28 percent, ranking among the worst emerging-market performers with Costa Rica, Nigeria, Serbia, Qatar and Bosnia, according to data compiled by Bloomberg.

Slumping Currency

Ukraine’s foreign-currency reserves were reduced by a third in the six months to February, with most of that $12 billion drop due to the central bank’s purchases of hryvnia, said Ivan Tchakarov, an economist in London at Nomura Holdings Inc. The currency has slumped 37 percent versus the dollar since September as sales of steel, the nation’s biggest export, fell 50 percent in the year to February and the governing coalition collapsed over the handling of the economic crisis.

President Viktor Yushchenko, a former central bank governor who led the peaceful overthrow of a pro-Russian government in 2004, opposes Prime Minister Yulia Timoshenko’s moves to fire current bank chief Volodymyr Stelmakh and to negotiate with Russia for a $5 billion loan.

Ukraine has received the first $4.5 billion installment of a $16.4 billion bailout from the International Monetary Fund. The IMF has delayed the second loan installment of $1.9 billion until the former Soviet state cuts a 2009 budget deficit equal to 5 percent of gross domestic product. The IMF will accept a budget gap of 3.1 percent of GDP, Yushchenko said March 23.

Minimum Rate

The central bank’s mandatory minimum hryvnia rate was 7.9489 per dollar when it was last updated on March 27. That’s 4 percent stronger than the 8.28 per dollar spot rate currency traders at Galt & Taggart Holdings Inc. saw quoted yesterday, said Nick Piazza, head of sales at the Kiev-based brokerage.

Countries like Ukraine and Kazakhstan need capital controls so they can stop hemorrhaging money, said Douglas Polunin, who manages about $200 million in emerging-market assets, including Ukrainian and Kazakh equities, at Polunin Capital Partners in London.

“They help the economy because you don’t have this sudden flow of money rushing out of the country that has such a destabilizing effect on company balance sheets,” Polunin said. “Overall capital controls are a good thing, though foreign investors do get frightened because of concerns they won’t be able to withdraw their money.”

Held Responsible

The central banks’ currency regulation department told lenders on March 17 that chairmen would be held responsible for the hryvnia exchange rates quoted on their bank Web sites and on information systems such as Bloomberg and Reuters, according to Natsionalnyi Bank Ukrainy’s head of external relations, Serhiy Kruhlik.

The hryvnia’s drop is rooted in “psychological and speculative factors” and authorities will leave “no stone unturned” in investigating possible currency speculation Yushchenko said in a statement on his Web site.

Yushchenko promised Ukraine would emerge from the crisis with a revived economy, saying March 25 the government has formed a “clear response.”

“Clearly the level of foreign currency depletion is politically highly sensitive, and there’s an idea that speculators have ripped them off,” said Tim Ash, head of emerging-market economics in London at Royal Bank of Scotland Group Plc.

‘Bloodbath’

Moscow-based Prosperity Capital Management, which oversees $1.9 billion in former Soviet assets, has been selling Ukrainian equities. Its fund managers have been unable to get money out of the country because banks are unwilling to lose dollars from their stockpiles by converting hryvnia-denominated proceeds, said Ivan Mazalov, a Prosperity director.

“It’s a bloodbath,” he said.

Ukraine’s central bank has taken control of 11 local lenders since requesting the IMF loan. The Washington-based fund estimates the country will need to spend about 4.5 percent of its GDP to recapitalize the banking sector.

The yield on 4.95 percent euro-denominated Ukraine government bonds due 2015 doubled to 24 percent in the past six months. Russian dollar-bonds due 2018 yield just 6.61 percent.

Credit-default swaps insuring Ukrainian government debt are the most expensive in emerging Europe, according to prices from CMA Datavision in London. They cost 60.5 percent of the amount covered upfront and 5 percent a year. That means investors must pay $6.1 million in advance and $500,000 a year to protect $10 million in bonds for five years. Six months ago, that same protection cost $567,000 a year and nothing upfront.

‘Outright Taxation’

Yaroslav Lissovolik, chief economist in Moscow at Deutsche Bank AG, said Ukraine may impose “outright taxation on withdrawals leaving the country” or require exporters to sell some or all of their foreign-currency earnings to the central bank at rates it dictates.

In Kazakhstan, the government is preparing to block foreign currency from leaving. The Majilis, the lower house of parliament, has twice given preliminary approval to a measure that would let President Nursultan Nazarbayev compel exporters to sell foreign-exchange earnings to the government for tenge.

Kazakhstan’s exporters include Irving, Texas-based Exxon Mobil Corp, the world’s biggest oil company; Courbevoie, France- based Total SA, Europe’s third-largest oil group; and San Ramon, California-based Chevron Corp, the second-biggest U.S. oil producer.

‘Painful’ Possibility

Those companies wouldn’t be able to pay dividends to international shareholders or repatriate profits under this type of capital control, said Tatiana Orlova, an economist in Moscow at ING Groep NV. “It would be painful,” she said.

The Kazakh bill, which needs Senate approval before the president considers it, would also ban companies and citizens from making foreign-currency transfers overseas.

National Bank of Kazakhstan allowed the tenge to weaken 21 percent versus the dollar on Feb. 4 after Russia let the ruble depreciate 36 percent in the previous six months as oil prices fell 67 percent. Oil is the largest export earner for both Russia and Kazakhstan.

The tenge will be held at 150 per dollar for the rest of the year, central bank Governor Grigori Marchenko said on Feb. 18 and again a month later.

The Almaty-based central bank didn’t respond yesterday to questions e-mailed to spokeswoman Aigul Amankulova.

Economic Contraction

Kazakhstan, which holds 3.2 percent of the world’s oil reserves according to BP Plc, is facing its first contraction in economic growth in a decade as the government vows to spend as much as $4 billion bailing out banks. The state is the majority shareholder in BTA Bank, the country’s biggest lender, and may take a 76 percent share of Alliance Bank, the fourth-largest, said Margulan Seisembayev, its chairman, on March 2.

Credit-default swaps for Kazakhstan government debt have more than tripled to 1,114 basis points, or 11.14 percent of the amount covered, in the past six months, making them the second most expensive in the ex-Soviet and eastern European region. It costs $1.1 million a year to protect $10 million in debt from default each year for five years.

To contact the reporter on this story: Emma O’Brien in Moscow at eobrien6@bloomberg.net