Tenge tales

Kazakhstan’s currency is back in a free fall.  How will this affect us?

The exchange rate of tenge for a dollar has risen to 365.  Two years ago, it was 155; the tenge has lost three-fourths of its power to purchase foreign goods.  Why?  Well, in 2014, the National Bank of Kazakhstan managed the exchange rate; but since last August, it has let the tenge float.  And it floats like a helium balloon; on January 4, just before China devalued the yuan, the tenge exchange rate was below 340.

In the long run, this nominal exchange rate (that is, unadjusted for prices) should tend toward the value that will hold the real exchange rate (that is, adjusted for prices) to 100. This is the equilibrium rate because it ensures that goods in Kazakhstan sell for the same dollar price as in the US (or for the same tenge price, if you prefer). Depending on the inflation rate assumed, the nominal exchange rate for a long-run equilibrium may be around 328 to 335.

But in the short run, anything goes. The tenge is overshooting. My guess is that the nominal rate is headed for 400, since that is an easier focal point for traders to anticipate than, say, 399 or 401.

Meanwhile, tenge savers – that is, poor households in Kazakhstan – are wiped out.  Rich households will convert to dollars as long as the government permits it.  But the currency exchange points in Turkmenistan reportedly are already refusing to pay out dollars.  If that report is correct, it may be just a matter of time before exchange points here refuse, too.  In that case, the tenge would depreciate even more rapidly.

Eventually, this depreciation will lower dollar prices of Kazakhstani exports, like oil and gas.  The world will buy more of our exports, and our income will rise. But most people want to know what will happen now, not next year.  Unfortunately, the news is bad.  Inflation -- the general rate of price increases -- will crank up again.  This is partly because producers in Kazakhstan must raise the prices of their products in order to pay for imported inputs, which cost more tenge than before.

The central bank says it targets inflation within a range of 6% to 8% per year. In annual terms, the inflation rate last month was 13.6%. It is even less likely now that the Bank will be able to hit its target.

Can’t it do anything to improve its aim?  Well, it could raise interest rates again; in October, it boosted the annual base rate to 16% from 12%.  Higher rates discourage borrowing and thus spending, relieving the pressure on prices.  But borrowing is already low. Adjusted for consumer inflation, loans by Kazakhstani banks in November were nearly 10% below the figure for November 2014.

Or the Bank could cut the money supply again; with fewer tenge chasing each product, prices will slow down. But this would probably take months to work.  And the Bank doesn’t have much to work with:  In November, the supply of cash and checkable accounts was only 1.1% higher than in December 2014.

The only way that the National Bank can avoid a surge in inflation in the weeks to come is to wade back into the foreign exchange market, buying tenge and selling dollars. But this is precisely what the Bank since August has repeatedly said it would not do.

So, what can we do?  Buy dollars and pray. --Leon Taylor tayloralmaty@gmail.com

Notes

All statistics in this post are from the National Bank of Kazakhstan (nationalbank.kz) except for the US inflation rate, which is from the US Bureau of Labor Statistics (bls.gov), and daily tenge exchange rates over the past month, which are from XE.com.

To calculate the nominal exchange rate in a long-run equilibrium, I note that Kazakhstan’s real exchange rate with respect to the US was 148 in the third quarter of 2015, the most recent rate reported by the National Bank.  Since the Bank defines a rise in the real rate as appreciation, the tenge was overvalued by 48%. 

The Bank formula for the real exchange rate is (100/e)*(Pk/Pus), where e is the nominal exchange rate of tenge for a US dollar, Pk is the price level in Kazakhstan, and Pus is the price level in the US.  (Yes, this formula is the inverse of the one used in many textbooks on international economics.) Solving for the relative price level, Pk/Pus = 1.48e.

I seek the equilibrium nominal exchange rate for April 1, 2016, which I will denote as e1.  This must satisfy 

100 = (100/e1)*((Pk(1+p)/Pus)).

Here, p is the rate of inflation in Kazakhstan, relative to the rate in the US.

The annual relative rate of inflation was 8% over the second half of 2015 but nearly 14% in December 2015.  Let's calculate the equilibrium exchange rate for both rates of inflation; that will give us a range of likely exchange rates.  I assume that the relative price structure, Pk/Pus, will be the same on April 1, 2016, as in the third quarter of 2015.  Thus

e1 = (1.48)*(1+p1)*e,

where p1 is the 6-month rate of inflation.  (Why six months?  Because we want the April 1 exchange rate, which occurs six  months after the end of the third quarter of 2015.) I set e = 213.1.  With these assumptions, I calculate e1 to be between 328 (which assumes 8% annual inflation) and 335 (14% inflation).

These calculations of an equilibrium rate are rough because they ignore transport costs as well as the fact that Kazakhstanis do not consume the same goods as Americans.

References

Marat Gurt.  Turkmenistan exchange bureaus stop selling foreign currency.  Reuters.  January 12, 2016.