Making sense of Kazakhstan's decision to float tenge

On August 20, the day known as Black Thursday, the Kazakh tenge plunged to its record low losing 23 percent against the US dollar after the country floated its currency renouncing the previously set corridor and pursuing inflation targeting monetary policies, writes Tengrinews.kz.

According to the Kazakh central bank Governor Kairat Kelimbetov, the exchange rate will be driven by supply and demand at the FX market, yet, the National Bank retains the right to intervene if the country's financial stability is in danger.

In this case, the free floating exchange rate that Kazakhstan has introduced is not truly free, because the free one allows for no intervention. The way Kazakhstan is going to manage its exchange rate is usually called a managed float regime or, in other words, a dirty float.

Kazakhstan's policy in this case goes similar to that of Russia, which also relinquished control of its ruble last November and had occasionally intervened in the market when the ruble came down under the biggest pressure.

After Kazakhstan let its tenge float freely, the tenge per dollar rate rose to 255.26 tenge per $1 from previous 188 tenge overnight.

Hydrocarbons account for nearly half of the Central Asian country's GDP and the move is expected to help Kazakhstan, the second largest crude oil producer in the region after Russia, maintain its competitiveness amidst the falling demand for its exports, economic slowdown of its largest trade partners Russia and China, and falling global prices for oil and metals.

In particular, the price for Brent crude has recently dropped to $46.91 and analysts forecast it will continue falling.

The sharp drop in global oil and commodity prices had a big negative effect on Kazakhstan's exports that fell by 40 percent between January and July compared to the same period of last year, the country's National Economy Minister Yerbolat Dossayev said.

Kazakhstan's President Nursultan Nazarbayev told top government officials during a government session on Wednesday August 19 that the country had to learn to live with crude prices of $40 and even $30 per barrel and with the changes the decline of oil priced had brought to the country's economy. And the transition to the floating exchange rate is one of such ways.

The Central Asian economy had also been under pressure because of the continuous economic slowdown of its largest trade partners – China and Russia.

A few days ago, China devalued its yuan by almost 4 percent amid decreasing exports and overall economic downturn. The International Monetary Fund called the move “a welcome step" hoping that China would move to floating exchange rate in two or three years.

At the same time, Russian economy, which was also suffering from declining prices for oil and metals and the impact of Western sanctions imposed on it due to its role in the Ukrainian conflict, saw its ruble loosing 46 percent of its value in the past 12 months.

After Russia decided to devalue its currency, Kazakhstan has suffered a lot. In particular, by loosening the ruble, Russia made its goods much cheaper than their Kazakh alternatives. This virtually pushed Kazakh enterprises out of business and forced them to seek ways to maintain a competitive edge, cut costs and layoff workers.

To this date, Kazakh producers have been unable to sell much of their products both in Kazakhstan or in neighboring countries because of lack of demand. And since Kazakhstan's economy relies heavily on its main export goods, that are oil and metals, with companies in this sector making little or no revenues at all, the tax revenues have significantly dwindled leaving Central Asia's largest economy with a budget shortfall.

Karim Massimov, Kazakhstan's Prime Minister, explained that it was virtually impossible to continue propping up the tenge because of the escalating external factors. The country has already spent $28 billion defending the tenge in 2014 and 2015. "The global economic situation continues to deteriorate. Prices for the country's main exports - oil and metals - are falling. This has had a negative impact on the GDP growth and increases the vulnerability of the domestic economy to external shocks," Massimov said.

According to Kairat Kelimbetov, Governor of the National Bank of Kazakhstan, the tenge is expected to reach its balanced rate in the next five to seven days. But he gave no hint as to what the balanced rate was going to be.

When commenting on the new policy on Thursday, Karim Massimov said: “We are introducing a floating exchange rate for the first time. We have not had such experience before. But we have studied it thoroughly, we have long been preparing to this. We have been studying the practices of other countries and looked at the countries that we believe have the economic structures similar to ours," Massimov said.

He added that Kazakhstan would follow the lead of Canada and Australia in forming its own economic policy, as their economic structures were similar to that of Kazakhstan.

If Kazakhstan had continued tightening its currency, then the country would have defaulted, Massimov added. “If the Government and the National Bank hadn't been taking any measures and had merely been passive observers relying on the National Oil Fund (accumulating windfall oil revenues), Kazakhstan would end up with a huge default. However, the measures being currently taken, including the recent shift to inflation targeting, measures to keep the national reserves intact, austerity measures will enable Kazakhstan to ensure a greater economic stability. I am confident the nation has all the prerequisites to handle the hardships and come out of the crisis with renewed strengths," the PM said when addressing the journalists at yesterday's briefing.

By letting the tenge float freely, Kazakhstan made its goods cheaper and consequently, more attractive for foreign countries, which is likely to boost exports.

In fact, despite all the negative implications that this unexpected hike in the exchange rate created, this step is expected to have positive effects in the long run, because now Kazakhstan's enterprises are restoring their competitiveness. Moreover, a lot of jobs have been preserved thanks to the new policy.

Furthermore, with the fixed exchange rate the pressure on the tenge was constantly growing and in any case, it would have eventually led to a devaluation of the national currency.

According to PM Massimov, among the benefits that the new policy would bring are “facilitation of economic growth, stimulation of lending and investment activity, creation of new jobs and lowering of the inflation rate to 3-4 percent in the midterm".

Since the tremendous 19 percent devaluation that hit the country in last year's February because of the weakening ruble and falling oil prices, people have been living with devaluation fears all the time. “ (..) We have to decide whether we will always live with the fears and rush to exchange offices at night or we will shift to a regime where the exchange rate is determined by market forces, by more unbiased circumstances and people will sleep peacefully and small and medium-sized businesses will have the funding they need. We are ready to answer all the questions regarding today's decision," Governor Kairat Kelimbetov declared.

Massimov assured that every Kazakhstan's citizen would be protected. “The Government will be rendering support to socially vulnerable groups of population. In the long run (…) it's impossible to support all the troubled industries out of taxpayers' money (…) one of the directions of the Government's policy will be to enhance people's working skills in industries that have not been hit by the crisis. The Government will do its best to make sure every Kazakhstani is protected," the Kazakh PM said.

Besides, Karim Massimov added that Kazakhstan would not tap into the National Fund, which collects the country's windfall oil export revenues, because "the worst times may yet come".

Some analysts believe that a number of emerging countries will also opt for devaluing their currency following China in the attempt to boost exports and avoid volatility in the market especially in anticipation of US Fed hiking interest rates, which will further strengthen the dollar and cut demand for riskier assets.

Indeed, Brazil, Indonesia, Malaysia, Vietnam have all recently resorted to a more flexible exchange rates.

Source/picture: Tengrinews.kz