Devaluation of the tenge: Impacts for EDB member economies
Arman Akhunbayev
Deputy Head of the Department for Strategic and Sector Research at EDB
1. The causes of devaluation
In 2014-2015 Kazakhstan’s economy was impacted by several negative shocks, which worsened its current account, reduced international reserves (by US $8.2 billion, from US $105 billion in November 2014 to US $97.2 billion in July 2015) and forced the National Bank to speed up transition to the flexible exchange rate of the tenge, which finally caused its sharp devaluation on 20 August 2015 (by almost 30% in one day, from KZT 198 to KZT 257 per US dollar, or 37% if to count with respect to KZT 188 per US dollar).
First, because of the growing competition in the oil market, the slowdown in developing countries, and the weak recovery in Europe, energy prices fell significantly (down 48.6% on average over the first seven months year-on-year), as did the prices of other raw materials, including metals, which are Kazakhstan’s main exports (down 45.6% on average for iron ore, 15% for copper, etc; in July-August 2015 metal prices reached their lowest for the last five to ten years, depending on the metal). As a result, Kazakhstan’s exports shrank by 43.4% in the first six months of the year while imports reduced by 17.5%,
Second, the toughening of sanctions against Russia (which is Kazakhstan’s main trade partner accounting for 33% of all its imports, 9% of exports, or 19% of overall trade in the first six months of 2015) related to the crisis around Ukraine has aggravated crisis in Russia and caused massive devaluation of the ruble, high inflation, and the increase in the “key rate.” Given the importance of Kazakhstan’s trade with Russia, Russia’s macroeconomic policy and the drastic improvement in its competitive ability with respect to the Kazakh economy complicated foreign trade and influenced the real sector, in particular the processing sector, which is of strategic importance to Kazakhstan’s industrial policy.
The third set of reasons was the appreciation of the dollar against all other currencies of developing countries while the U.S. maintained relatively high growth, the more significant slowdown of economic growth in developing countries, and the differences between monetary policies of the Federal Reserve System and other central banks in countries, which have become increasingly exposed to deflationary processes.
The fourth reason is the excessive debt load in the economy. In 2014 the ratio of the gross foreign debt (GFD) to GDP worsened, having increased from 68% of GDP in 2013 to approximately 76.2%. The reduced exports worsened the servicing of foreign debt with respect to exports, from 24.4% to 38% as at the end of 2014. In the first six months of 2015, the situation with GFD and its servicing deteriorated significantly because of further reductions in exports and active foreign borrowings (the issue of corporate and government Eurobonds). The worsened situation with GFD manifests itself in the regular pressure on international liquidity and, consequently, the exchange rate and is complicated by the continuing deficit of foreign direct investment.
2. Consequences for the EDB member states
It is expected that Kazakhstan’s transition to a flexible exchange rate will help to adjust its balance of payments and current account, in particular. After a new, balanced level of the exchange rate is achieved, external indicators will be adjusted, in the first place, through the improvement of the competitive ability of Kazakhstan’s economy, accelerated reductions in imports, and the improvement of certain exports. Favourable effects for exports will be restrained by the deteriorating external context and the low share of the processing sector in Kazakhstan’s exports. The possible improvements in foreign trade surpluses will have a favourable effect on the overall external stability of the balance of payments in the context of the continuing negative impacts produced by external factors. The fiscal sector is also expected to benefit: devaluation will significantly support revenues and compensate the loss of income because of falling oil prices and economic slowdown.
The slowdown in the real sector will probably be very noticeable and transition into the negative zone becomes probable. The services sector, including trade, will be affected by decreasing domestic demand. It will be hard to compensate the negative effects of devaluation on consumption by positive effects in export-orientated sectors, anti-crisis measures, the effect of which has begun to weaken, or good agricultural indicators. Given the high share of imports in consumption, we should expect accelerated inflation and the possible return to a tougher monetary policy, with all accompanying negative effects (high interest rates, limited liquidity in the tenge, etc.). Despite the high reliance of the banking system on the US dollar, it should withstand the devaluation shock.
The direct effect of devaluation in Kazakhstan on the Russian economy will be limited. According to Rosstat, in the first six months Russian exports to Kazakhstan made up slightly less than 3% of its total exports. Therefore, a decrease in the competitive ability of Russian products in Kazakhstan and the lower demand for imports at large on the part of Kazakh consumers because of devaluation will have a statistically important, but not critical effect on Russia’s foreign trade conditions. The share of Kazakhstan in Russian capital exports is also insignificant. In 2014, for example, Kazakhstan accounted for approximately 1% all foreign direct investment made by Russia abroad (according to the Bank of Russia). Therefore, the risks associated with the potential deterioration - because of devaluation - of the financial position of certain Kazakh companies or banks, which have liabilities before Russian economic agents, are also moderate.
In the meantime, the influence, which devaluation in Kazakhstan will have on the Russian financial markets, may turn to be significant in terms of consequences. Many market participants will perceive the sharp depreciation of the national currency of the large neighbouring country, which has many things in common with Russia in terms of economic structure, as a negative sign, which arose when situation in the markets was already very unstable. Due to more stringent risk assessment practices, this may exert additional pressure on the volatility of the Russian currency, worsen lending conditions in the economy, and reduce investment activity. This may have a significant negative influence on economic dynamics, in the real sector in particular.
The influence of devaluation in Kazakhstan on other EDB member countries, which have already experienced - before Kazakhstan - the negative effects of the worsening external environment and the Russian crisis, will also be limited because of limited trade and financial relationships.
In particular, the influence of devaluation in Kazakhstan on foreign trade conditions for Belarus will be insignificant. In 2014, Kazakhstan accounted for 2.4% of Belarusian exports, according to Belstat. The National Bank of Belarus informed that in 2013 (more recent data have not been published yet) Kazakhstan accounted for less than 1% of foreign direct investment, both from and to Belarus. Therefore, the influence of devaluation on net capital inflows to Belarus is not expected to be considerable. As with Russia, the devaluation of the tenge can produce a negative psychological effect on Belarus’ financial markets, especially given the fact that they are in the process of adaptation after the National Bank made transition, in the beginning of the year, to “monetary targeting,” which envisions a rather flexible exchange rate policy.
The devaluation of the tenge influences the Kyrgyz som, although to a lesser extent than fluctuations of the Russian ruble. Kazakhstan is Kyrgyzstan’s third most important partner in foreign trade. In addition, migrant workers receive a certain portion of their earnings in the tenge. Kazakhstan’s share in Kyrgyz exports approximates 40% (if to exclude gold), with a significant portion of these comprised by agricultural produce and food products. Kyrgyz domestic producers have significant expectations in terms of sales associated with Kyrgyzstan’s joining the EEU. The devaluation of the tenge has already caused emotional reaction in Kyrgyzstan’s internal foreign exchange market: over one day the som in the domestic cash market depreciated by about 3-5% with respect to the US dollar and the tenge exchange rate fell by 50%. However, the National Bank of the Kyrgyz Republic refused to make currency interventions. It is probable that this emotional situation will stabilise in several days. If the National Bank of the Kyrgyz Republic decides to make massive currency interventions in the next few days to maintain the exchange rate of the som, fluctuations in the tenge rate can cause significant appreciation of Kyrgyz exports and a decline in demand for it. If the floating exchange rate is maintained, the exchange rate of the som can be expected to adjust (depreciate) in the short term and the real sector (agriculture and the food sector) can experience some negative influence. On the whole, the further economic development will be dependent on the tenge fluctuations to a lesser extent and will depend, in many respects, on the chosen policies and the reaction to other challenges, in particular the forthcoming parliamentary election, the expected increases in budget expenses, and reductions in gold production.
The influence on Armenia, which does not border Kazakhstan, will also be limited, but negative. In 2014, Kazakhstan accounted for a mere 0.1% of Armenia’s foreign trade. However, the devaluation of the tenge will restrain the advancement of trade with Armenia and restrict opportunities for Armenian exporters. Other transmission channels also remain very limited.
The situation in Tajikistan’s internal foreign exchange market depends, to a greater degree, on the ruble-dollar dynamics, while the tenge-dollar pair has limited influence on this market. In this context, Kazakhstan’s transition to a flexible exchange rate will not have significant influence on the rate of the Tajik somoni to the US dollar. In 2013-2014 Kazakhstan’s share in Tajikistan’s foreign trade averaged 14.5%. The supplies of Kazakh oil, gas and grain to Tajikistan accounted for a considerable portion in bilateral trade. For this reason no significant changes are expected in bilateral trade and devaluation should not have substantial impact on Tajikistan’s economy.