Floating tenge is the correct solution
Eurasian Development Bank’s Centre for Integration Studies and the Macroeconomic Policy Department of the Eurasian Economic Commission (EEC) prepared a research titled Monetary Policies in the Eurasian Economic Union Member States: Current Condition and Prospects for Coordination. Its main objective was to analyse the current monetary policies in the EAEU member states. Mikhail Demidenko, Deputy Director of the Centre for Integration Studies, told us about the study in his exclusive interview.
Mikhail, could you please put it more precisely: how does EDB assess Kazakhstan’s monetary policy and, in particular, its transition to inflation targeting with a flexible exchange rate?
I would like to emphasise that the bank assesses Kazakhstan’s transition to a floating exchange rate positively, because the current situation in the oil market could have led to a significant loss of foreign exchange reserves and competitiveness. In fact, the transition was Kazakhstan’s best option. There was a great deal of research, including ours, which showed that when prices of the main exports change a fixed exchange rate could affect the economy negatively. The foreign exchange rate was fixed before and then the new monetary policy has been introduced where Kazakhstan is trying to overcome inflation and ensure economic development to stable target indicators. These steps seem absolutely reasonable and we believe this is the correct solution.
The main purpose of monetary policies is to achieve and maintain inflation at a low and stable level. At what stage are the EAEU member states in this respect?
On the whole, the central banks of our countries have made a step towards coordination. The announced mid-term inflation targets coincide to a significant extent or are, at least, in a narrow interval. In addition, the EAEU countries have announced plans to make transition to inflation targeting with a flexible exchange rate. Their approaches, however, remain different. According to the financial regulators of the EAEU countries, in Kazakhstan, Russia and Armenia the mid-term inflation target is around 4%, Belarus 5%, and Kyrgyzstan 5-7%.
Our analysis has shown that differencies in the economic structures and policies of the EAEU member states cause dissimilarities in their monetary transmission mechanisms. These include both the time of impact the political decisions made will have on target macroeconomic variables, and their strength and effectiveness.
Why is monetary relations coordination between the EAEU countries of low effectiveness, in your opinion?
The main cause is that we have just begun to build a common financial market. In all previous years our countries had very different monetary policies. They did have some similarities. Many countries, for example, tried to fix the foreign exchange rate but they managed differently. Each country had its problems. Belarus had periods of very high inflation, while in Russia and Kazakhstan inflation patterns were better but they had their real exchange rates strengthened. The crisis of oil prices in 2014-2015 has shown, finally, that if we fail to coordinate our policies we can seriously harm our economies, by, for example, decreasing their competitiveness or impeding mutual trade and investment flows.
At present, macroeconomic policies are being agreed in the framework of the Eurasian Economic Commission. In addition, the central banks of our countries meet and develop certain common principles.
All the EAEU countries intend to pursue inflation targeting. Some of them have already begun to do so (Russia and Armenia). Some still make announcements that they will switch to it in the near future. Other countries, like Kazakhstan, are in the process of transition. We deem it as positive developments. This helps to stabilise foreign exchange rates between our countries. If all the EAEU countries adopt an approximately similar inflation target – and this is happening – in the future when the central banks try to achieve a single level, for example 4%, mutual foreign exchange rates will be less volatile. Thus, common ideas and approaches to monetary policies have shaped. All this should influence the concordance of our countries’ macroeconomic indicators: foreign exchange rates, interest rates and inflation.
How does the deepening of economic integration affect markets in the Customs Union and EAEU countries?
The deepening of economic integration has an undoubtedly positive effect on the countries’ common markets. If to consider trade between the countries, you may notice that the aggregate trade volumes have declined. This was, in the first place, due to falling prices of energy resources. At the same time, the EAEU’s trade unrelated to energy has a more positive dynamics. This is very important to Kazakhstan because it states it is pursuing industrialisation and tries to develop its industries and these include not only the fuel and power sector but other sectors as well. It would be difficult to fulfil without integration and a common protected market.
In addition, as for successful monetary coordination between the EAEU countries, we see convergence and a stronger synchronisation of business cycles. Our analysis has shown that the convergence processes observed in the EAEU countries include real, nominal and institutional convergence. However, they are uneven and do not cover all members of the economic union at the same time. Belarus, Kazakhstan and Russia, for example, converge (or catch up) in real terms in that GDP (PPP) per capita in Kazakhstan and Belarus is gradually coming closer to the Russian indicator. Armenia has also been gradually bridging the gap with Russia in terms of GDP (PPP) per capita, but very slowly. Kyrgyzstan, with its initially very low per capita incomes, demonstrates practically no convergence with the EAEU leaders.
The Russian Ministry of Finance stated recently about its intention to enter the country’s foreign exchange market. Can this decision influence markets in other countries?
Yes, we are considering this issue right at the moment and part of our future report will be about this. I need to say that the decision of the Russian Ministry of Finance will have, in the end, a positive effect on Kazakhstan, because when Russia decided to switch to a floating exchange rate it was found out that it was strongly linked to oil prices (as it is happening in Kazakhstan). In 2014, when oil prices were still high, fuel and energy accounted for almost 70% of Russia’s exports. It is understandable that the national currency’s exchange rate fluctuates very strongly when oil prices go down. You know that in 2014 Russia could not maintain a fixed rate and began to weaken it, while Kazakhstan continued to persist with the fixed rate, hoping probably that it was a temporary shock and that oil prices would restore. This is quite explicable since at that moment we had already the experience of 2009 when oil prices had fallen very strongly but then had restored rather quickly. In the meantime, in 2014-2015 it turned out that the fluctuations of the Russian rouble because of oil prices were between 33 and more than 88 roubles (on certain days). This is an impermissible range. A question arose, therefore, how to decrease its volatility because of oil prices without fixation. The answer is simple: the amount of the dollars generated from the sale of energy resources, which is sold in the domestic market, should be decreased. In general this is what the Russian Ministry of Finance intends to do. It decided that a part of currency proceeds it had kept in the roubles would be kept in the dollars. This will decrease the volatility of the Russian rouble and, accordingly, help to stabilise mutual trade, including with Kazakhstan, because when the rouble weakens strongly Russian goods get a competitive advantage.
How does EDB assess the efforts of Kazakhstan’s National Bank with respect to the country’s foreign exchange and monetary policies in this context?
I would like to point it out again that making the exchange rate float was the only possible and correct solution. There could and can be not alternatives, especially in the situation we have been for several years already. However, time should pass for us to see to what extent inflation targeting is effective, especially if to take into account that during all previous years – for a decade even – the economy relied on a fixed rate. Nevertheless, we see this effort as positive and we wrote about it in the report.
Could you list any favourable factors that could support population’s income and investment activity in Kazakhstan?
Kazakhstan, as other our countries, has liven through a turbulence with the introduction of a floating exchange rate. This affected inflation, which is now being driven by the central bank to the targets it announces today in a rather smooth fashion, however not without the influence of external factors. In my opinion, the most obvious decision here, which could help to maintain investment activity, is to stabilise inflation and reduce interest rates accordingly.
What do external factors mean?
In the first place, these are the world prices of imports. In addition, inflation stabilisation in Russia must also be taken into account. Imported inflation in Kazakhstan turned to be lower.
Does this eliminate the possibility that any expectations in local markets will emerge in view of the U.S. and Europe’s new policies?
Yes, businesses may have expectations based on the current political situation. I believe that the election of Donald Trump adds a little of uncertain optimism. For example, many expect that the issue of sanctions against Russia will be given a new, more favourable solution, and that it will be easier to borrow in international markets and attract investments, which will boost in turn the Russian and Kazakh economies.
At the same time, we observe serious turbulence in the European Union, which is associated with the unexpected outcome of the U.K.’s referendum to withdraw from the E.U. It is quite possible that the Brexit phenomenon is linked to certain systemic errors in the European Union’s evolution. The high level of political integration, the dominating Brussel’s law-making, as well as underdeveloped mechanisms for the expansion of the Eurozone, which have failed to ensure the financial and fiscal stability of some countries, have led to serious consequences, including the loss of debt and financial stability. A close study of the EU’s experience and an understanding of what is happening in the EAEU will help to make correct decisions as regards the deepening of integration processes.
What recommendations did EDB offer Kazakhstan last year? Were they fulfilled and how? If not, why?
Since we are the managers of the Eurasian Fund for Stabilisation and Development (EFSD), when we have programmes with a country, like with Belarus and Armenia, we can recommend something, for example with respect to their monetary or fiscal policies. Kazakhstan did not apply to the EFSD. It doesn’t need to because it has sufficient financial reserves, including serious monetary reserves and national funds. In addition, the country attracts foreign investments. So, the bank does not have authority to recommend anything to Kazakhstan.
What does prevent Kazakhstan from pursuing an effective monetary policy?
There are some difficulties, certainly. And we see that the central bank of Kazakhstan is facing them. First, this is a rather high level of dollarisation and, moreover, the uneven dollarisation of the banking sector’s assets and liabilities. Second, this is still high inflation. As at the end of the previous year, inflation in Kazakhstan exceeded 8%. It is clear that the National Bank tries to work within its targets, but it is still rather high. I would remind that in our report we stated that the optimum target for our countries is 4%. Third, these are rather complicated channels for monetary policy transmission, for example the interest rate channel. It is important here that in all the previous years the exchange rate was fixed, manageable and the current situation is totally different. If the central bank manages to persuade economic agents that it has a firm intention to achieve the set inflation target and, in doing so, will form expectations, we’ll be able to conclude that the new monetary policy of inflation targeting is effective and optimum. For the time being, however, we do not have the necessary actual achievements. I think that, to measure the effectiveness of this policy, we should provide the central bank of Kazakhstan with time to demonstrate its capabilities.
How long can it take?
I think that within two to three years – not a year or less than a year – it will become clear whether it works.
Kazakhstan tries to pursue a rather balanced policy. However, how do oil price fluctuations limit the ability of its fiscal policy to stimulate domestic demand?
The main principle is that oil producing countries shoud spend a part of their revenues from energy exports and save another part. In principle, both Kazakhstan and Russia used the budget rule. Another good achievement is that not all money has been spent. However, oil prices were high for a rather long time. Since oil prices are significantly lower now, there are significantly less possibilities to stimulate investments and consumption. In Russia, for example, the new rule of budget with the oil cut-off price standing at higher than US $40 per barrel is planned to be introduced in 2020. In other words, it is expected that in 2020 the primary deficit at US $40 per barrel will be zero per cent. At present, it stands at minus 3% at the same price. All incomes received over US $40 will be saved. When oil prices are lower than US $40 per barrel, the revenue will be used to cover the budget deficit. I believe Kazakhstan will do something similar. Here I need to note that the fiscal rule once used in Kazakhstan was rather effective. The current task is to adjust it to the new reality.
According to last-year Russian media publications, EDB believed that the most probable scenario for economic recovery in the CIS and Kazakhstan in particular in 2017 would be that of inertia and that inflation would go down when external conditions stabilise. Do you still stick to this opinion or has it changed under the influence of external factors?
What we meant under external factors were, in the first place, prices of main exports and the situation in the global financial markets and global economy as a whole. As for oil prices, we do not expect significant growth or falls. We also believe that there are no preconditions for very serious crises in the world, as happened in 2008-2009 when the global financial crisis outburst. For this reason we continue to stick to the above scenario.
What is the current situation in the shale oil market and is it possible that it will influence our markets?
It is perceived that at the current level of oil prices the benefits of shale oil production become minimal. Since most shale oil deposits are loss-free at higher oil prices we don’t think that the situation with shale oil will have a cardinal influence on prices. Producing big amounts of shale oil at the current prices is economically inefficient. It is therefore quite possible that it will not have strong influence.
Kazakhstan is currently witnessing consolidation in the banking sector. Does anything similar happen in Russia?
It is difficult for me to assess this situation in Kazakhstan because I don’t know it. However, this happens in Russia too because in some cases banking structures were formed for some non-transparent interests and objectives, sometimes, possibly, illegitimate. In recent time, information about the abolishment of licences issued to small banks has appeared almost weekly. I think this is reasonable because some banks were established to pursue very narrow, special interests. This is an unhealthy situation in the banking sector and I believe it could influence its stability.
What is your forecast for further developments in the monetary policy, inflation and investment attractiveness of Kazakhstan? Some serious scandals outburst recently around large players in the domestic market, including the Single Savings Pension Fund, Baiterek and Samruk Kazyna. Can these scandals influence the country’s investment attractiveness?
I believe a policy should be assessed in fundamental terms. As for the monetary policy, as I said already, the central bank of Kazakhstan should be given time to demonstrate its capability to pursue its new policy and inflation targeting. Let’s wait and in a year or two, I think, we’ll be able to assess the situation more precisely. As regards inflation, everything will depend again on the central bank’s performance. We forecast inflation to go down, at least in the coming year. As for its investment attractiveness, Kazakhstan has done a lot here and many things will depend on the effectiveness of its monetary and fiscal policies. The level of the public debt raises no concerns at the moment. We’ll see to what extent the budget deficit can be balanced and the budget consolidated at the current oil prices. In my opinion these are the first things investors pay attention to, not scandals that occupy the country’s entire information space. People talk today and forget tomorrow, while the most important things for the investment climate are, obviously, long-term issues.
Thank you for the interview.
Source:
Kursiv (newspaper, Kazakhstan)