Inflation in Kazakhstan: Hot enough for you?

Will inflation get out of hand?

The foreign exchange market in Kazakhstan is heating up like an old radiator.  The exchange rate of tenge for a US dollar is 375, a tenth higher than two weeks ago.

Yes, we’ve seen worse than this. In late August, when the National Bank of Kazakhstan said it would no longer defend the tenge rigorously, the exchange rate depreciated by more than a fourth virtually overnight.  But you still have a perfect right to feel nervous. 

First, as a matter of history, when the tenge begins to gyrate, it usually continues for a couple of months. This complicates exports and imports.

Second, fluctuations this large destabilize prices. Why?  Because producers in Kazakhstan raise their product prices in order to pay for imported inputs, which cost more in tenge than before; workers seek pay raises so that they can afford imports – pay hikes that themselves push up prices; and the rise in export demand due to cheaper tenge increases the scarcity of domestic products here at home, which raises domestic prices.

In short, you can expect more inflation, which is already in double digits.  To illustrate the danger, suppose – quite reasonably -- that the tenge goes to 400 by mid-April.  (Actually, at the current rate of depreciation, the tenge would rise above 660, which doesn’t seem possible.) According to my crude calculations, the implied annual rate of inflation here (with respect to the United States) may well exceed 200%.  This estimate is contingent on conditions that may not hold, so you should not take it to the bank. (The Notes discuss the conditions.)  The vital point is this:  As the exchange rate spins out of control, inflation may soar.   

At inflation rates above 100%, economies begin to break down. Buyers and sellers make big mistakes because they can’t anticipate the correct prices of particular products.  Workers demand pay raises that their bosses can’t afford. People who live on fixed incomes, like retirees, may not be able to afford necessities.

The good old days

Maybe this sounds like scare talk.  The National Bank has pointed out that although the tenge weakened overnight by a fourth in February 2009, annual consumer inflation actually fell, from 17.3% in 2008 to 7.3% in 2009, according to Bank data.  If inflation wasn't a problem then, why should it be one now?

Well, 2009 was a different situation. The world economy was in a severe recession due to the financial crash of 2008, so consumers weren’t bidding up prices. This year the world economy may slow down, but a recession as severe as the one in 2009 is not likely. Yes, the Chinese economy is not growing as rapidly as it had. But it’s still growing, and the US economy is picking up speed.  

Regarding inflation, the only blessing, if I can call it that, is the decline in global oil prices. The annual spot price for Brent crude, which is the price that matters to producers, dropped by 47.1%, from $98.97 in 2014 to $52.32 in 2015.  This decline will relieve the pressure on product prices to rise in Kazakhstan, since we have less income to spend than we would have had at high oil prices.

Even so, we have good reason to worry about inflation. When the Bank put the tenge on a float last August, promising to hold the annual rate of inflation below 8%, the rate actually tripled in a few months, to 13.6% in December. That may just be a taste of things to come. --Leon Taylor tayloralmaty@gmail.com                    

Notes

Oil price data are from the United States Energy Information Adminstration (eia.gov).

To estimate potential rates of inflation, I use the real exchange rate, which measures the purchasing power of the tenge over foreign products.  In principle, prices in the US and Kazakhstan should adjust over time so that a product – say, a packing of chewing gum – will cost the same in both countries in terms of dollars (or tenge).  This principle implies that the real exchange rate in equilibrium equals 100. 

In general, the real exchange rate (using the National Bank’s formula) is 100 times the inverse of the market exchange rate times the ratio of domestic prices to foreign prices.  The mathematical formula is (100/e)*(Pd/Pus), where e is the market exchange rate, Pd denotes domestic prices, and Pus denotes US prices. Usually the price level – that is, the price of a typical bundle of consumer goods – proxies for each of these price statistics.

When the real exchange rate is at its equilibrium value of 100, we have 100 = (100/e)*(Pd/Pus).  Solving for the market exchange rate, e = Pd/Pus.  Given current prices and rates of inflation, the market exchange rate at which the real exchange rate would equal 100 by April is about 330. 

Now suppose instead that the market exchange rate in April is 400.  What ratio of prices in Kazakhstan and the US would ensure that the real exchange rate is 100?  To answer this question, recall that in equilibrium, 330 = Pd/Pus.  We want the equilibrium price ratio Pd/Pus that is consistent with a market exchange rate of 400.  Without changing our condition, we can write (1+x)*330 = (1+x)*Pd/Pus.  Let’s pick x so that (1+x)*330 = 400.  Solving with these two equations, x = (400/330) – 1 = .21.  The equilibrium price ratio would rise 21% by April – that is, over the next three months.  The implied annual rate of inflation is (1.21)^(4) = 214% under discrete compounding of prices.  If we assume continuous compounding, annual inflation is e^(.21*4) = 232%.

These estimates assume that: Prices in Kazakhstan are flexible; Americans and Kazakhstanis consume comparable bundles of goods and services; and that transport costs can be neglected.