Dollar-drunk no more

Because economies in Central Asia wobble, firms and households prefer dollars to tenge and som, the currencies of Kazakhstan and Kyrgyzstan. The dollar looks more reliable, a safer way to hold wealth. But dollarization weakens local currencies.  People buy dollars by selling tenge, so the number of tenge that trade for a dollar -- the exchange rate-- rises.  If you hold tenge, their dollar value will fall, and you won't be able to afford as many goods from abroad. This expectation will lead you to sell more tenge for dollars, further weakening the tenge.  Moreover, because people demand dollars, the central bank may run out of them. At that point, anything goes.

Dollarization has unpleasant implications for Central Asia. First, prices may rise.  Suppose that an American book costs $15.  When the exchange rate is 300 tenge for a dollar, the book in Almaty will cost 4,500 tenge. When the rate rises to 500 tenge, the price will go to 7,500 tenge. Dollarization can spur inflation.

Moreover, because the tenge is undermined, the central bank may try to protect it by freezing the exchange rate.  This is a futile exercise in the long run, because people can always trade tenge for dollars on the street at illegal rates.  But even in the short run, the freezing causes conniptions, because it hampers adjustments to global events.  Suppose that world demand for oil falls (just you wait).  This would be grim news for Kazakhstan, which survives by selling oil to the world. The blow would be softened if the exchange rate of tenge for a dollar rose, because this would lower the dollar price of Kazakhstani oil. But if the National Bank fixes the exchange rate, this adjustment is not possible, and Kazakhstan will be in for a hard landing.

Dialing back the dollar

For all of these reasons and more, dollarization can plague Central Asia.  In 2010, after the global financial crisis knocked the props out from under banks in the region, more than 60% of all credit was in dollars, because no one trusted the tenge or the sonomi (the currency of Tajikistan).        

But times are changing, as the International Monetary Fund documented in an intriguing seminar today. Since 2010, central banks throughout Central Asia and the Caucasian region have de-dollarized their economies.  That is, they have substituted local currencies for dollars. In Kazakhstan, as Figure 1 shows, de-dollarization has been especially sharp, from 75% of credit in 2010 to 14% in 2021.  The dollar share of deposits has also fallen, from about 70% to below 40% now. 

Kazakhstan de-dollarized partly by discouraging dollar loans to unhedged borrowers. (“Hedging” here means that the borrower has taken measures to protect herself in case the exchange rate moves against her.)  The periodic strengthening of the tenge (yes, it happens) also limits the use of dollars, because people switch from dollars to tenge as the latter gain value. And the rise in deposit rates for tenge relative to dollars has persuaded depositors to go back to tenge. 

But de-dollarization can go only so far, for two reasons. First, migrants remit dollars, which are easier to send through the international banking system. Remittance accounts for an especially large share of bucks used in Kazakhstan. Second, people would still rather save dollars than tenge, as IMF officials note.

Figure 1

Source: IMF

Although the dollar’s share of Central Asian economies is falling, it is still high for public debt, even in relatively prudent Kazakhstan (Figure 2). This exposes regional governments to high foreign interest rates—especially in Kyrgyzstan, where more than 80% of the government debt is in foreign currencies.  The interest bill rises for Kyrgyzstan, one of the world's poorest countries.  The central bank of the United States, the Federal Reserve, is pumping up rates to curtail inflation (Americans think that 8% is a big deal) -- although it began slowing down today, raising the federal funds rate by half a point rather than three fourths.

Figure 2

In the region, the Central Bank of Georgia leads the way to de-dollarize with creative policy. The Bank sets a low reserve requirement ratio for private banks with deposits that are mainly in lari, the Georgian currency, not in dollars. (The reserve requirement ratio is the share of deposits that the private bank can’t legally lend out.)  A bank with a low such ratio can lend out more money and profit from the interest earned—surging ahead of banks that have high ratios because their deposits are in dollars. Competition among private banks helps de-dollarize what was once the region’s most dollarized economy: In 2010, more than 80% of Georgia’s credit was in those green George Washington portraits.

Putin's era

Nagging questions remain. Should Kazakhstan ban any requirement to pay off mortgages in dollars?  The value of the ban seems political. When the tenge weakens, a requirement to pay the mortgage in dollars becomes more expensive, and people complain. Also: Should Kazakhstan require prices to be expressed just in tenge?  Since everyone knows the exchange rate of tenge per dollar, such a requirement would be meaningless.

Central Asia is not alone in edging away from the dollar. Emerging economies the world over are de-dollarizing (Figure 3).  But the movement is especially sharp in this region.   

Dollarization is not a pure evil.  After all, it merely expresses the preferences of Central Asians for dollars.  And because the dollar is stable, it anchors the economy.  Moreover, corralling the dollar can impose costs. A startup in Almaty may need to borrow bucks to buy accounting software.  Limits on repatriating dollars of profit may discourage foreigners from building factories in the country in the first place.  Indeed, rates of dollarization can be too low. Witness Kazakhstan, a small economy that relies on trade, where dollars comprise only a seventh of credit. 

Even so, extreme dollarization, such as an 80% take of credit, may prevent a country from managing its economy in times of turmoil.  In that sense, the shift away from the dollar in the region, in an era of chaos-spawning “special military operations,” is a sign of hope.

 

Figure 3

Source: IMF

--Leon Taylor, Baltimore, tayloralmaty@gmail.com

     

 

Reference

Selim Cakir, Maria Atamanchuk, Mazin Al Riyami, Nia Sharashidze, and Nathalie Reyes.  Reducing dollarization in the Caucasus and Central Asia.  International Monetary Fund, Middle East and Central Asia Department.  December 14, 2022. IMF WP/22/154