Just passing through

Weakening the tenge – and paying the piper

The new customs union with Russia (and, depending on the day of the week, with Belarus) will make Kazakhstan an economic appendage of its northern neighbor, since its economy is less than a tenth as large. Trade barriers between the two countries will fall, and Kazakhstan will adopt the same tariffs against the rest of the world as Russia already has. This particular tail won't be wagging the wolfhound.

This may seem like enough integration for the nonce. But policymakers are discussing a further step – a common currency. Kazakhstan would replace the tenge with the ruble.

Unfortunately, the central bank of Kazakhstan would no longer be free to counter economic downturns peculiar to this country. In a small, open economy like ours, the central bank can salubriously stimulate global demand for our goods by weakening the tenge -– say, from 150 tenge to the dollar to 160. This lowers the cost to foreigners of getting their hands on tenge to buy our exports. For example, the 25% devaluation of the tenge in February 2009 might have kept the economic slowdown that year from being much more severe than it was.

But devaluations can drive up prices in general -– that is, they can engender inflation. The world demands more of our goods, forcing Kazakhstanis to compete for them by bidding higher prices. If exporters can sell Caspian oil to China for the new high price of $70 a barrel, then they will demand at least $70 from a Kazakhstani buyer. Also, the increased demand for our goods raises the demand of home producers for workers. Wages will rise, propelling prices anew. Such sudden inflation catches buyers and sellers unawares, causing them to err.

The demerit of a devaluation depends on how quickly and sharply prices will subsequently rise. In principle, a 25% devaluation should lead to a 25% increase in prices. Otherwise, Kazakhstan’s exports will remain cheap compared to those of other nations. This will stimulate demand for our exports, and thus bid up their prices, until our price advantage disappears.

But in fact, prices throughout Kazakhstan have risen only 15% (as an annualized rate) since February 2009 -- despite price spikes, immediately after the devaluation, of 9% throughout the nation and up to 15% in Almaty. Even given last year’s standstill economy, that pace of inflation is surprisingly sedate. What happened?

Rate expectations

Kazakhstanis are not alone in wondering. Around the world, evidence amasses that devaluations often stimulate small, slow adjustments in price. Under what conditions does this occur? Would this be the usual case for Kazakhstan? If it would, then we may think twice about turning over monetary autonomy to the Bank of Russia.

In 2000, John Taylor offered an intriguing explanation for an incomplete “pass-through” of inflation via the exchange rate. Price increases depend on what people think will happen in the economy. If they believe that the central bank will prevent severe, sustained inflation, then they will be less inclined to raise their own prices to ward off such consequences. The owner of a pizzeria in Almaty will shrug off the tenge devaluation, since he is not worried that his workers will demand a sudden pay raise in order to pay higher prices for nan and fermented mare’s milk. In turn, this reluctance to raise prices will help restrain inflation. The prophecy of low inflation happily fulfills itself.

A bit of evidence suggests that this prophecy may hold for Kazakhstan. Since 1994, soon after the tenge was introduced, the pass-through stemming from changes in its exchange rate have seemed modest, concludes a student in the economics graduate program at KIMEP, Meruyert Beisenbayeva. A 1% weakening of the tenge, with respect to either the ruble or the Chinese yuan, leads to an increase in consumer prices in Kazakhstan of a sixth of 1% or less. Perhaps the National Bank of Kazakhstan has convinced people that it won’t tolerate the episodes of rampant inflation that have ravaged other economies in Central Asia.

Perhaps. Another possibility is that producers in Kazakhstan are loathe to raise prices for fear of losing market share to importers. The Chinese, world champs in cutthroat pricing, are rapidly gaining ground in Kazakhstan. They sell us a seventh of our imports -- outstripped only by Russia, which accounts for just under a third of imports. Kazakhstani firms would be prudent to match Chinese pricing -– cutting prices when the Chinese do, and raising them only after the Chinese raise theirs.

Ms. Beisenbayeva finds evidence consistent with such strategizing. A 1% increase in Chinese consumer prices seems to induce a quick rise in ours of more than half of a percent. In contrast, the impact of Russian prices on ours is muted and quite possibly zero. Perhaps Russian exporters to Kazakhstan have become so familiar that our firms no longer worry about losing customers to them.

Ms. Beisenbayeva’s work raises several possibilities. First, the National Bank of Kazakhstan may already have done about all that it can to contain short-term inflation. Any future gains would have to come from an antitrust policy that keeps big Kazakhstani firms from charging the highest prices that the market will bear.

Long-run inflation, of course, remains the responsibility of the central bank. Prices can rise for years only if fueled by new money. The National Bank manages the tenge supply.

Second, adopting the ruble could endow Kazakhstan with unexpected inflation, since Russia’s central bank has trouble keeping the lid on the price level. Inflation rates in Russia double those of Kazakhstan’s (for Russia, 14% in 2008, 12% in 2009). If firms don’t trust the National Bank of Russia, then they may quickly counter ruble devaluations by raising their own prices before their suppliers can. The pass-through value will close in on that predicted by theory, 1. Economic theorists will chortle; Kazakhstani consumers and lenders won’t. – Leon Taylor, tayloralmaty@gmail.com

Full disclosure: I advised the thesis -- along with Aleksandr Vashchilko, Altay Mussurov, and Eldar Madumarov, all economics professors at KIMEP.

References

Beisenbayeva, Meruyert. 2010. The exchange rate pass-through to the CPI in Kazakhstan. Thesis for the master’s of arts in economics. Almaty, Kazakhstan: KIMEP, Department of Economics.

Organisation for Economic Co-Operation and Development. 2010. Source of data on Russian inflation. stats.oecd.org

Mishkin, Frederic S. 2008. Exchange rate pass-through and monetary policy. Speech to the Norges Bank Conference on Monetary Policy in Oslo, Norway. March 7. A readable survey.

National Bank of Kazakhstan. 2010. Source of data for consumer price inflation. www.nationalbank.kz

Taylor, John B. 2000. Low inflation, pass-through, and the pricing power of firms. Working paper. Stanford University. Influential.