A tight spot

How effective can the National Bank be?

The central bank of Kazakhstan, which manages the supply of tenge, is trying to hold the lid on rising prices. At present, prices in general are rising at an annualized rate of 21%. (In contrast, the rate of inflation for 2010 was 7.8%.) Some price increases are due to winter, which increases transport costs; they will fade with the spring. Food prices, which are rising more steeply than others, may also moderate in the next harvest. Even so, Kazakhstan has good reason to worry about inflation.

To avert further inflation, the National Bank of Kazakhstan has raised the interest rate at which it lends money to commercial banks. The idea is that banks will respond by borrowing less from the National Bank. This will leave them with less money to lend to the public – loans that could have expanded the supply of tenge and consequently could have fueled inflation.

The increase in the Bank’s interest rate – the “refinancing” rate – looks steep: From 7% to 7.5% per year. However, note that the new rate is much smaller than that of inflation. If this inflation continues, then those borrowing from the National Bank will be able to pay it back in tenge that are weaker than those borrowed. In other words, the borrowers will be able to spend the loans now on goods while their prices are still low – and then pay the money back later, when prices are high and reduce the money’s purchasing power. The borrowers can borrow good tenge and then pay back bad ones. In that light, the Bank’s new policy is less restrictive than it may seem. The Bank may be pushing on a string: Its new interest rate may not cool off the economy by much.

Toolin’ around

Unfortunately, the National Bank doesn’t have better tools. Western central banks usually fight inflation by selling paper loans, like government bonds, in exchange for cash and checks. These “open market operations” reduce the supply of money available for spending, thus reducing the pressure on prices to rise. Their advantage is in enabling the central bank to change the money supply with some precision. Over the past few years, the National Bank has turned more and more to open market operations. But it cannot rely on them in a big way because Kazakhstan’s market for securities is thin: Few bonds and notes trade here. As Kazakhstan’s fast-growing economy continues to develop, so will its market for securities. For now the market is too small to support major operations.

The remaining possibility for the National Bank is to discourage banks from lending by requiring them to lock up a larger share of their deposits. But at the moment, commercial banks already are sitting on a lot of cash and assets that they can convert easily to cash. They aren’t lending as much as they could. To raise the share of reserves that they must set aside would simply confirm what they already are doing.

The weakness of strength

Not only is the National Bank hampered by weak tools; it also faces a paradox. Over the past year, global oil prices have risen by almost a fourth. To pay these prices, buyers of Kazakhstani oil must have more tenge. This increase in the demand for tenge raises their foreign exchange value. Two years ago, you needed 151 tenge to buy a United States dollar; today, you need only 146 tenge. (The exchange rate last December was 147.5.) This strengthening of the tenge enables Kazakhstanis to buy imports more cheaply than before, since the imports are priced in dollars (or other foreign currencies). To buy more imports, Kazakhstanis will cut back on purchases of domestic goods. Meanwhile, Kazakhstani exports will become more expensive for foreigners to buy, since these goods are priced in tenge that are more costly to buy than before. In short, a stronger tenge reduces the demand, here and abroad, for Kazakhstani goods.

To keep tenge from becoming too strong, the National Bank has been selling them in exchange for foreign currencies, to the tune of a few billion dollars’ worth per month. This may have contributed to the increase of nearly 19% in net international reserves for Kazakhstan from December to February.

The Bank chair, Gregory Marchenko, views these operations as successful. The European euro, the Russian ruble and the Chinese yuan all have been strengthening against the dollar more rapidly than the tenge has, he notes. In fact, the tenge is weakening against the ruble, from 4.85 tenge to the ruble in late December 2010 to 5.05 tenge in late February. And it is weakening against the euro, from 193.8 tenge to 199 over the same period, according to National Bank data.

“That is why we can strengthen tenge against US dollar under the control of the National Bank, which will not adversely affect the competitiveness of Kazakhstan’s economy,” Marchenko says, according to Interfax’s account of a presidential news release this week.

The Bank’s interventions in currency markets are becoming habitual. “We see no need and no sense in sharp exchange rate swings,” Marchenko said last year, according to Silk Road Intelligencer.

The sale of tenge eventually puts more of them in circulation, increasing their overall supply. This, in turn, pressures Kazakhstani prices to rise, since there are more tenge chasing domestic goods than before. The Bank could wind up feeding the very inflation that it has pledged to fight.

Marchenko denies that the operations have increased either the tenge supply or the rate of inflation, according to Interfax. Certainly, banks might have bought many of the tenge sold by the National Bank and stowed them in reserves rather than make them available for spending. But banks won't hold large excess reserves forever; once they regain their confidence, they will put the money to work, in the form of loans.

The Bank is aware of the problem. It offset many of the new tenge by selling short-term notes for tenge, according to Delovoy Kazakhstan. Such sterilization is common among central banks. But once creditors are back in a lending mood, they will sell their notes for tenge to lend –- tenge now being stashed away. Spending will rise, pressuring prices upward.

The long-run monetary trend is clear: A broad measure of the tenge supply (M2) increased 24% in January 2011 over the previous year, according to National Bank data. The supply of money is rising faster than output. Until the Bank mops up the excess tenge, the potential for inflationary spending will exist. The Bank’s dilemma is that more purchases of tenge may strengthen the currency's value in foreign exchange. In monetary policy, all blessings are mixed. – Leon Taylor, tayloralmaty@gmail.com

Good reading

Zhanbota Tolegen. Grigoriy Marchenko: “Tenge snova vstupyl v period ukrepleniya.” Delovoy Kazakhstan. March 11, 2011. Page 1.

References

Interfax-Kazakhstan. Kazakh National Bank has purchased $6 billion in year to date to stabilize tenge exchange rate. Online. March 14, 2011.

Silk Road Intelligencer. Tenge to appreciate against dollar – Marchenko. Online. January 14, 2010.

Silk Road Intelligencer. Kazakhstan raises key refinancing rate. Online. March 10, 2011.