Wrong-Way Corrigan comes to Kazakhstan

Is the National Bank going in the wrong direction?

A steep recession has unfolded in Kazakhstan, says the latest Statistical Bulletin from the country’s central bank.  For January through July, average income fell by nine tenths of a percent in annual terms, estimated the National Bank of Kazakhstan.  Adjusted for inflation, the fall in income was roughly 6%.

The Bank’s figure may be exaggerated.  For January through June, the Bulletin reported an increase in income of seven tenths of a percent, compared to that of the same period in 2014.  This implies that monthly income in July alone fell about 14% (roughly 19% when adjusted for inflation). But July news accounts do not tell of any events that could have immediately reduced national output by a fifth. 

Moreover, while output was tanking, so was unemployment, claimed the Bank.  It reported an unemployment rate of 7.8% for January through June but 5.2% for January through July.  For this to be true, the July unemployment rate would have been -10.4%, which would be a sizzling labor market even for a boom.  (And impossible, of course.)  Yet firms were allegedly shutting down a fifth of their production.  Methinks the National Bank is selling us a pig in a poke.

Keynes in Kazakhstan

Even so, the National Bank has been reporting a fall in price-adjusted average income ever since April, and the government’s statistical committee puts the income growth rate this year at 1% or 2%.  If we don’t quibble over numbers, then we can easily accept that a slowdown is for real, since the annual price of Brent crude oil (the global benchmark) on the spot market has fallen by half since last year.  Which makes the Bank’s monetary policy all the more curious.

Usually, when national sales fall, a central bank tries to stimulate spending by “printing” money or (what amounts to the same thing) by cutting interest rates.  (Low rates induce borrowing. Commercial banks accommodate this by lending out tenge that depositors aren’t using at the moment.  This increases the supply of tenge in circulation.) These may be the right policies for today since it appears that the slowdown is due to deficient spending: Both output and inflation are falling, which indicates a drop in demand.  Indeed, in the last such recession, in 2008-9, the National Bank created money and the government stepped up spending, which may have made for a gentler recession here than in other countries stymied by a fall in export revenues.     

What has the Bank actually done?  It has reduced money supply in the past year or two, and it raised the key interest rate early this month, from 12% to 16%.

High interest rates discourage firms from borrowing money in order to expand their plants.  They also prevent youths from taking out loans in order to attend college. In short, high rates reduce spending and thus production.  They slow down a slowdown.

Expect the worst, and you’ll get it

What is the Bank up to?  Its chair, Kairat Kelimbetov, explains that its conservative policy is supposed to contain inflation, which over the past 15 years has been more of a problem for Kazakhstan than has low demand. There is something to his argument.  The figure below shows annual rates of consumer inflation for 2010 through 2014.  You can see that Kazakhstan has followed the same path as Russia, but with slightly lower inflation than its neighbor in recent years.  Although inflation has been far less volatile in Kazakhstan than in Kyrgyzstan, it is still several times higher here than in the United States.  Because inflation usually hits different industries at different times, it creates confusion about prices.  This can cause errors in buying and selling.  In short, inflation can make an economy less efficient unless it is at low rates, say, 2%.

Yes, inflation has afflicted Kazakhstan in the past, but not today.  Annual consumer inflation is somewhere below 5%; just where depends on whom you ask.  In any case, inflation is below the Bank’s own target of 6% to 8%.

Of course, the Bank shouldn’t wait until inflation goes haywire before fighting it.  By then, people will come to expect it -- and they will act accordingly, by purchasing goods while prices are still low and by demanding pay hikes. These measures will make inflation permanent.  Even so, the Bank should recognize that its tough policies may reduce output as well as inflationary expectations.

And it wouldn’t hurt the Bank to double-check its math, as well as to explain it.  -- Leon Taylor tayloralmaty@gmail.com

    Data source: The World Bank

Notes

Wrong-Way Corrigan was an American football player who ran toward the wrong goalposts, scoring a touchdown for the rival team.

 To estimate the Bank’s estimate of the July unemployment rate, I solved for x in (7.8*6 + x) / 7 = 5.2.  My calculation for the Bank’s estimate of July average income was similar. 
      
These calculations assume an equal weight for every month, which is reasonable for a comparison of the January-through-June average to the January-through-July one.  (The Bulletin does not discuss its methods of calculation.) But even if the Bank gave every month a different weight, a drop from a six-month average of 7.8% to a seven-month average of 5.2% in the unemployment rate is improbably large – particularly when output is supposedly falling off a cliff.  

For example, suppose that the unemployment rate was at its logical minimum of zero in July.  Then the implied weight on the July rate would be 22%.  (This is (1 – k) in the equation (k*6*7.8 + (1 – k)*0) / 7 = 5.2.)  If the July unemployment rate is positive, then the July weight will lie within (14%, 22%), which is a narrow range.  The point is that the improbability of the six- and seven-month estimates does not result from the assumption of uniform weights; the non-uniform weights are close to the uniform ones.  The improbability results instead from the fact that the National Bank estimated an incredibly low unemployment rate for July.

References

National Bank of Kazakhstan.  Statistical Bulletin, August 2015.  www.nationalbank.kz

Николай Дрозд, Кайрат Келимбетов, Нацбанк: “Мы присутствуем на рынке ровно настолько, насколько это необходимо.”  Панорама.  October 9, 2015. (“Kairat Kelimbetov, National Bank: ‘We are in the market only when necessary.’”)

Николай Дрозд.  “Кайрат Келимбетов, Нацбанк: ‘Переход к инфляционному таргетированию стал стартовым моментом программы струтурных экономических реформ.’” Панорама.  September 18, 2015.  (“Karat Kelimbetov, National Bank: ‘The transition to inflation targeting was the starting point of the economic structural reform.’”)

Statistical committee of the government of Kazakhstan.  Various statistics.  www.stat.gov.kz

Paging Professor Slutsky

Will a weaker tenge weaken the colleges?

In August, the National Bank of Kazakhstan decided to let the market set the tenge’s exchange rate.  English speakers call this a “float”; Russian speakers, a “swim.” In any case, it was a deep dive. In a few weeks, the currency fell from just under 200 tenge per US dollar to nearly 300, until the National Bank waded into the forex market to haul the tenge back to about 270 to 275.

  

What does this mean for you?  Well, each tenge has less foreign purchasing power than before, so import prices – which are expressed in tenge -- should rise.  A $1 pencil that had cost 200 tenge will now cost 275.  The price hike will tempt domestic producers, who compete with importers, to add a few zeroes to their pricetags, too.  The given income of a typical Kazakhstani -- the monthly wage averages 125,000 tenge -- will buy fewer CDs, steaks, and college courses than before.  Are the universities headed for trouble?  

The usual answer is yes.  People buy less education when they are poor rather than rich. But this is only half of the argument: Although the tenge depreciation will eventually reduce income for a while, it may lower the price of an education.  Folks may sign up for more courses.  I’ll explain.

Buyers choose between apples and oranges, Beatles and Bach, good A and good B.  Their decision depends on the price of A relative to the price of B.  If an apple costs as much as an orange, then we may divide our spending equally between them.  But if an apple costs as much as two oranges, then we may buy more oranges than apples.

A college education is like that orange.  Many sellers – like hotels and grocers – can raise their prices whenever they want, but colleges are not so privileged.  They set their tuition rates before the fall semester, since a student who enrolls in the autumn is pretty likely to stick around for the spring semester, too.  As it happens, the National Bank put the tenge on a float after the usual time when universities announce their new rates.  Depreciation may not affect tuition rates much until next fall.  Meanwhile, since tuition rates hold constant and hotel rates rise, the price of a course may fall relative to the price of a holiday.  Youths may study more and surf less.  And they may study in Kazakhstan rather than abroad, because the tenge buys less of foreign education than it had before.  Foreign education is an import. 

All in the family

So are the pessimists wrong to foretell trouble for campuses?  Not necessarily.  The depreciation does lower real income in Kazakhstan, and poorer people do cut back on classes.  But this “income effect” is offset by the “substitution effect.” The net effect is not clear.

Early in the 20^th century, the Russian economist and mathematician Eugen Slutsky thought about the general problem.  He pointed out that the size of the income effect depends on the commodity’s importance to the household budget.  If you spend half of your income on food, then a rise in food prices may squash your purchasing power.  But a price hike of a commodity that you never buy (used toothbrushes?) may have no income effect for you.

So, whether depreciation of the tenge is bad news for campuses depends on the share of the household budget dedicated to education.  For the average Kazakhstani family, the share is small; spending on all education amounted to 3.4% of gross domestic product in the first half of 2015.  But for a family with potential college students, the expected share may be distressingly large. In the latter case, yes, depreciation may induce families to cut back on a lot of purchases, including higher education.  Cap-and-gown manufacturers, take note.  – Leon Taylor tayloralmaty@gmail.com

Good reading

Mark Blaug.  Great economists before Keynes: An introduction to the lives & works of one hundred great economists of the past.  Cambridge University Press.  1986.  Includes a brief article about Slutsky.

References

Kazakhstan Committee on Statistics.  This government agency provided the estimate of the share of education in income.  www.stat.gov.kz

Back to the future, round two

The central bank of the United States, the Federal Reserve, stood pat on interest rates last week.  How might this affect the tenge?

The answer depends on how speculators view the foreign-exchange market.  Suppose that they think that the market responds mainly to supply and demand.  Then the tenge should soon stabilize, because nothing has really changed since last week.  Folks still expect the Fed to raise interest rates soon, perhaps when its open markets committee meets October 26-7.  The vice chair of the Fed, Stanley Fischer, a revered macroeconomist, has indicated that the Fed shouldn’t wait until the inflation rate equals its target of 2% before raising interest rates, since the economy needs months or years to adjust to a new policy.  Speculators have already acted on their expectations, driving the exchange rate at some kiosks in Kazakhstan as high as 300 tenge per dollar last week.  (Why?  Because higher US interest rates induce investors to sell assets that pay off in tenge and to buy assets that pay off in dollars.  The fall in demand for tenge-denominated assets reduces demand for the tenge itself, since the assets are priced in tenge.  Thus the tenge weakens relative to the dollar.)  Little remains for speculators to do.

Now suppose that speculators believe that the forex market responds mainly to psychological factors; in particular, that it is prone to fads.  Then a slight depreciation of the tenge may lead to wholesale selling, since every speculator believes that the others will respond to the initial depreciation by dumping their own tenge, regardless of whether these are actually overvalued.  In this case, the tenge may collapse around the time of the next Fed meeting, in response to even trivial statements or events.

Unbelievable

If the National Bank of Kazakhstan was credible, then it could calm the waters by announcing that it would bolster the tenge should it begin to plunge around October 26.  Unfortunately, the operative word in that last sentence is “if.” In less than two years, the National Bank has reneged on its pledges thrice:  In February 2014, when it devalued the tenge 19% after saying it would not; last month, when it put the tenge on a float after saying it would not let it depreciate sharply; and last week, when it intervened in the forex market after saying it would let the market set the exchange rate.  The National Bank now has subzero credibility.  If anything, a vow to intervene may have perverse consequences since speculators may suspect the Bank of a double-cross.

Here’s an example of the Bank’s lack of objectivity.  Last week, it effectively accused the commercial banks in Kazakhstan of currency speculation that had weakened the tenge relative to the dollar.  Leading the list was Halyk Bank, which was said to have sold $58 million worth of tenge on a recent day. 

But as Halyk quickly pointed out, the relevant figure is the sale of tenge net of the sale of dollars.  Even if Halyk sells $1 billion worth of tenge, the currency may strengthen relative to the dollar if the bank also sells $2 billions’ worth of bucks.  As it happens, Halyk’s net sale of tenge was just $12 million. In any event, the bank often buys and sells currency on behalf of its clients rather than for itself.  – Leon Taylor tayloralmaty@gmail.com

Notes

The literal translation of the Russian phrase «Народный банк» is «The People’s Bank,” but the bank is better known by its Kazakh name, Halyk.

References

Панорама.  Нацбанк принимает экстренные меры для стабилизации валютного рынка [Panorama. The National Bank takes urgent steps to stabilize the exchange rate.]  September 18, 2015.  www.panoramakz.com

Панорама.  Народный банк:  «В среду мы продавали доллары наряду с Нацбанком». [Halyk Bank: “On Wednesday we sold dollars along with the National Bank.”]  September 18, 2015.  www.panoramakz.com

Michelle Witte.  Tenge rallies against dollar following National Bank intervention.  Astana Times.  September 21, 2015. www.astanatimes.com

    

Berating interest rates

The leaders of the US central bank, the Federal Reserve, may decide today to raise interest rates.  If not today, someday. They worry that the economy may overheat, raising prices; so they want to throw cold water on it, in the form of high interest rates that discourage borrowing.   

How might this affect Kazakhstan?

Well, financial investors want profitable assets.  If a US bond pays a higher interest rate than a Kazakhstani bond (adjusted for risk), then investors will sell the latter and buy the former.  To do this, they must sell tenge and buy dollars, since the prices of American securities are expressed in bucks.   Because the demand for tenge will fall, so will its price.  This is the amount of a dollar that a tenge can buy – the exchange rate.  At the moment, one tenge trades for about 1/284 of a dollar.  This could fall to, say, 1/300 of a dollar.  In short, the tenge would depreciate.

Depreciation makes Kazakhstani goods cheaper for Americans to buy; a buck would now purchase 300 tenge’s worth of our goods, not just 270 tenge’s worth.  So, demand would rise for our exports.  Similarly, since the tenge would buy less of a dollar now than before, US goods would become more costly for us.  So, our demand for them would fall.  We’d sell more exports and buy fewer imports.  Our balance of trade would rise.

But this could take a while.  A lot of international trade is governed by contracts, which take time to rewrite in order to reflect the new exchange rate.  Meanwhile, anyone whose wealth is in tenge – say, the holder of an Almaty bank account expressed in tenge – would lose purchasing power over foreign goods that have prices expressed in bucks.  She would be worse off than before.  Holders of dollar accounts would gain.

Unpegged

Until a few weeks ago, we would have told a different story.  At that time, the National Bank of Kazakhstan tried to hold the exchange rate below 200 tenge per dollar.  Had tenge sales began increasing the exchange rate, the NBK would have countered by buying tenge.  The exchange rate would not have changed. Instead, the interest rate would have risen in Kazakhstan, since otherwise everyone would have sold tenge assets in order to buy the now-more-profitable dollar assets. Even now, the local interest rate could rise somewhat if the foreign-exchange market does not react immediately to the Fed’s move.

When making policy, the Fed usually targets the interest rate on overnight loans involving commercial banks, called the federal funds rate.  It picks this target because the funds market is so fluid that it will quickly reflect any change in the buying patterns of a customer as large as the Fed.  If the Fed sells loans in this market, then the price of a loan will fall, pushing up its rate of return to anyone buying it.  That rate of return is the federal funds rate. 

In contrast, the National Bank historically has targeted the interest rate that it charges on its own loans to commercial banks, called the refinancing rate.  This could cause confusion, because one could interpret a rise in the refinancing rate as either a signal that the NBK wanted to cool off the economy or as an attempt to deny reckless banks easy money.  Side-stepping this problem, the NBK has now adopted, as the benchmark rate, a target that looks like the Americans’ federal funds rate.  This “repo” rate is 12%, more than double the refinancing rate of 5.5%. –Leon Taylor tayloralmaty@gmail.com

Notes

My thanks to Murat Alikhanov for comments.

Call for papers

Central Asia Business Journal (CABJ)

ISSN 2073-5901 (Print)      

The Central Asia Business Journal, published by KIMEP University twice each year, promotes understanding of business issues (broadly defined) in the region.  As we see it, the region includes the post-Soviet “stans” (Kazakhstan, Kyrgyzstan, Tajikistan, Uzbekistan and Turkmenistan) as well as the post-Soviet states of the trans-Caucasus area (including Armenia, Azerbaijan and Georgia).

Central Asia is a fertile area for research.  It prospers from rich natural resources and high commodity prices as well as from its location at the crossroads of East and West.  But its open economy is vulnerable to such external shocks as the global financial crisis of 2008, and its Soviet legacy complicates its transition to markets. 

Authors may submit research papers, case studies, and book reviews as either completed works or as abstracts and proposals.  We also invite students’ papers.  All submissions must be in English.  Refereeing is double-blind.

The journal is open to all methodologies, but it especially welcomes papers that are conceptually and analytically strong and that relate to the real world.  We prefer papers with new findings but also publish surveys.  All papers should discuss applications to Central Asia. 

The journal’s interests include:

International accounting standards and taxation

Corporate governance

Financial and capital markets and industries

Market structure and efficiency

Human resources management

Leadership

International business and globalization

Business law

Marketing strategies and effectiveness

Tourism and the hospitality business

Logistics and supply chain management

Management information systems

Business cycles and economic development

Market integration and segmentation

Emerging markets

Institutional economics

Microfinance and development     

Multinational enterprises and business strategy

Natural resources and their internationalization

Nongovernmental organizations and entrepreneurs

Mathematical economics

Statistical economics

Risk and uncertainty

Political economy

Behavioral economics

We also welcome contributions to three sections of the journal:

Perspectives.  This features nontechnical surveys of issues in Central Asian business that would interest scholars.  An example is a survey of theoretical and empirical papers about customs unions.  A typical length is 4,000 to 6,000 words.  You should propose your topic to the managing editor before beginning work.

Book reviews.  Reviews should summarize and evaluate books about Central Asian business or about business issues of interest to the region.  Most reviews will concern recent books, but the journal may also publish a retrospective essay about well-known titles in a particular field.  A typical length for a review is 1,500 to 2,500 words.  Please write the managing editor about the book that you propose to review.

Symposium.  This consists of several commentaries on a recent issue of interest – for example, the February 2014 devaluation of the tenge.  A typical commentary may run 1,500 to 2,500 words.  The commentaries are not refereed.  Usually, the journal commissions commentaries, but you may propose a symposium to the managing editor.

Deadline for completed work for the March 2016 issue:  November 15, 2015.  After that date, we will consider submissions for later issues.  We try to give the author a decision in six weeks.

The Journal’s website is www.kimep.kz/CABJ 

For further information and submissions, please write to the Journal at cabj@kimep.kz or to the managing editor, Leon Taylor, at ltaylor@kimep.kz.