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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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6 Comments

  1. Excellent analysis. Would it be proper to infer a political stratagem from each distinct (national) central bank policy. I only ask this because of a dominant myopia currently underwriting the vast majority of even qualified economists. I suppose its the cognitive bias of an overt positivism. This underwrites why the medium of TV is inadequate given the nature of the crisis in foreign exchange. Moves by central banks have distinct political overtures. Writers like Von Mises, Hayek, Friedman implicitly understood the value of a synoptic view. I suppose this may be outside the confines of both time & interest; the political is a denominator here.

    Peace,
    Keep Hammering on!
    William J. Holland

    Reply
    • William, thanks for the feedback.

      I certainly think that you are right. I strongly believe that the differences in policy response from one nation to another mostly reflect domestic politics. Hence, for example I think it is pretty clear that the Turkish government has been hugely dissatisfied with the sell-off in the lira because it left the impression locally that the sell-off is the markets’ “thumbs down” to the policies of the Turkish (which it partly is). Therefore the pressure on central banks from the political establishment to “defend” the currency is tremendous.

      Reply
  2. Lars, Lars, you might come here, in Venezuela, you will see the miracle, the government devalues, but it is not devaluation. From January 2013 to today the devaluation accounts for 168%, however, real and financial accounts are deflated for just 56%. How they did that? It happens only under the Socialism XXI century. Even though the country is already into a hyperinflation, forget about the zeroes.
    You have to come here, in Venezuela, you will see the miracle. Government devalues -not Central Bank, we do not have any. Government reports that it is not devaluation; it is something else, we are looking to name it, please you are welcome to this contest.
    From January 2013 to today the devaluation accounts for “just” 168%, however, real and financial accounts are deflated (inflation adjusted) for just 56%.
    How they did that? Well, it happens only under XXI’s century socialism. Even though in a country which is already into a hyperinflation, but in order to understand this forget about the zeroes, hyperinflation in the tropics happens without indexing contracts, so two- high digits is enough to destroy any amount of real income or salary, from the poorest to a high middle class.
    I forgot something more or less important, shortages are accounted for 28% -monthly, January jumped 33%!!; meaning that if you go to supermarket for something, you might have to go about 4 times more until you find what you are looking for. However, if you need it, you must go through “black” markets and you pay 3 or 4 times more for that particular good.
    As expected, non-tradable goods are normal indexed by the price of dollar in the swap -off shore market, something which multiple official dollar price by 12 times.
    So, adding inflation and shortages you will get something which has some meaning, regarding inflation, or devaluation, of if you like it, inflation tax, in a country which still exports some oil, every semester less than de latter, it means oil rent is shrinking, so arrived a situation where at 100 dollars for an oil barrel, international reserves are just 780 million dollars!!.
    Lars, by all means it seems that we are reaching the melting point, however, no prediction at all!!
    Alexander G.

    Reply
  3. Danat

     /  February 19, 2014

    Its strange that a guy calling himself a MARKET monetarist thinks that an arbitrary change in the exchange rate by a bureaucrat is WISE.

    Reply
    • Danat, that bureaucrat that you are talking about was keeping the currency artificially strong (stronger than what the market would have determined) prior to the devaluation. What that wise?

      Reply
      • Danat

         /  February 19, 2014

        No, none of their actions are wise and none of their actions are in line with free market economics. Market determined exchange rates move all the time – up and down. In a pegged currency regime, there’s always preassure to either appreciate or depreciate. KZT was under strong appreciation pressure from 2009-2012 and mild depreciation pressure in 2013-14. Then, at one point in February 2014 they decided to arbitrarily change the exchange rate by a very large (16.5%) amount and repeg at that arbitrary new level. What’s wise about it again?
        FYI January 2014 change in total reserves was an increase of $400mln (don’t forget the reserves being accumulated in the oil fund).
        KZT REER was roughly unchanged for the past 3 years. Current account is +3% GDP and budget surplus is 4% GDP. Why was KZT overvalued?
        RUB before weakening in 2013 and 2014, appreciated 25% between 2009-2011 (2012 was about flat). Then again, why does RUB matter … no seriously, why exactly?

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