Kazakhstan’s wise devaluation

I am in Stockholm today, but it is not the Swedish economy which is on my mind – rather it is Kazakhstan. On Tuesday the Kazakhstani central bank devalued the Kazakh tenge by 19%. This is what I have said about the issue another place:

 The latest ‘news flash’ in the still-ongoing emerging market turmoil was the decision of the National Bank of Kazakhstan (NBK) to devalue the Kazakhstani tenge by around 19% on Tuesday. In line with other emerging market currencies, the tenge has been under pressure for some time. The central bank has been intervening and the foreign currency reserve has been in steady decline for some time. However, the pressure on the tenge has been fairly ‘light’ and therefore Tuesday’s large devaluation was a surprise. We believe the devaluation was a pre-emptive move rather than the NBK caving into pressures.

It should also be noted that since the NBK has been intervening to keep the tenge stable, it has only weakened moderately against the US dollar. Most other emerging markets’ more freely floating currencies have been weakening significantly over the past year.

If we compare the development in the tenge with the Russian rouble since early 2013, we see that the devaluation has just brought the tenge more or less in line with the sell-off in the rouble over the past year. Hence, over this period, the rouble has weakened by around 15% against the US dollar, while the tenge had only weakened a couple of percentage points prior to Tuesday’s devaluation. Therefore, the 19% devaluation could be said to have more or less aligned the tenge with its ‘peers’.

The decision to devalue the tenge does not come without some cost. First, it is likely to push inflation up – at least in the short term. Even though we do not expect a major spike in inflation, it is unlikely to make the decision to devalue more popular among Kazakhstanis. Second, the drop in the value of the tenge also means that we will see an increase in foreign-denominated debt – something which will be not welcomed by the Kazakhstani banking sector, which continues to struggle with large debt problems.

However, overall we believe that the NBK made the right decision. With risk remaining on the downside in oil and gas prices – Kazakhstan’s main exports – and emerging market outflows continuing, it is likely that the tenge could come under more pressure in the future, particularly taking into account that the currency had become significantly overvalued versus peers such as the rouble. Therefore, the NBK would have been forced to continue its policy of FX intervention to prop up the tenge. This does not come for free.

Hence, FX intervention is effectively monetary tightening. When the NBK sells foreign currency to prop up the tenge, it is effectively reducing the money base. The cost of this is a potentially sharp reduction in economic activity and a pronounced risk of financial sector distress, which could spark another banking crisis. Hence, the cost of having tried to maintain an artificially strong tenge would be significantly bigger than the short-term cost of the devaluation. In this light, we think the devaluation was a wise move. Furthermore, a devaluation seems preferable to the kind of draconian capital controls seen in Ghana and Ukraine (two other commodity exporters) recently, or the steep interest rate hike introduced in Turkey.

Going forward, we think it is fairly clear that Kazakhstani growth is likely to soften on the back on the capital outflows seen over the past year. However, the decision to pre-emptively and aggressively weaken the tenge is likely to soften that blow, which should help support growth towards the end of the year.

However, now the big question is what the NBK will do going forward. We believe that the right thing to do would be to move closer to a more freely floating tenge or at least a currency regime that is more flexible than has been the case in Kazakhstan. On the other hand, we are not sure that Kazakh policy makers are ready to take that step yet. A lot is dependent on overall EM sentiment and the development in commodity prices going forward. Events could force the NBK towards a truly freely floating tenge, but if capital outflows die down, we believe the NBK will try to keep the tenge fairly fixed around current levels against the dollar.

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