The market expects tenge and rouble to depreciate gradually

Eurasian Development Bank (EDB) published a report titled Exchange Rate Fluctuations in the EAEU in 2014–2015: Analysis and Recommendations. Evgeny Vinokurov, Director of the EDB Centre for Integration Studies told K in an exclusive interview what was that aggravated the economic crisis and created problems in mutual trade between the EAEU countries and what currency fluctuations should be expected.
According to the report, in 2014 the economies of all the EAEU member countries slowed and this continued into 2015 turning into recession in Belarus and Russia. What was the reason for this?

The main reason was the decreased prices of our raw material exports — oil, gas, ferrous and non-ferrous metals. The second, indirect, reason was the recession in Russia. If Russia has a flu other economies in the region cannot avoid it (this is the case, by the way, with China also — if the Chinese economy slows sharply, we all will be in trouble). The negative patterns disseminated via three main channels. First, the recession in Russia reduced the demand for imports. Second, it shrank money remittances by migrant workers that are of special importance to Kyrgyzstan and Tajikistan. Third, the worsened perception of Russia by investors increased risk premiums throughout the region as a result of the so-called financial fever.

Negative developments have affected mutual investment. However, while the overall figure declined, Russian investment in Kyrgyz companies grew by 16% in 2015. Don’t you think that this had some political background?

The EDB Centre for Integration Studies monitors mutual investment by the region’s countries and these data show that Russian FDI in Kyrgyzstan has been growing steadily both before and after it joined the EAEU. The average five-year growth of investment by Russian companies was 15–17%. Russian FDI is rather diversified and present in almost all large sectors of the Kyrgyz economy. The leading sectors are infrastructure, IT and communications, and the fuel sector. The economies have been interacting at the corporate level for years. If you hint to Kyrgyzstan’s joining the EAEU, I would only say that this promotes the country’s exports to Kazakhstan and Russia and we see this in trade statistics.

Mutual investment slid before 2015. In particular, Russian investment in Belarus went down by 2.4% and Kazakhstan 19%. How did the situation evolve in subsequent years and what is the forecast for the forthcoming year?

This is correct. We recorded decreases in investment in three years — 2013, 2014 and 2015. There was an increase in 2016. The reasons for the increase were economic recovery in Russia, the appreciated national currencies, and business as usual with respect to sanctions. The EAEU is more stable and dynamic than the CIS region as a whole. In 2016, mutual FDI by the EAEU countries grew two times faster than in the CIS. According to the most recent data collected by the EDB Centre for Integration Studies, this indicator grew by 15%, to US $26.8 billion.

An interesting fact is that Russia does not only invest but receives more investment from its neighbours. In 2016, accumulated direct investment grew by 72%, to US $5.3 billion. However, Russia goes third after Belarus (US $8.4 billion) and Kazakhstan (US $8.2 billion). Overall, the three founders of the EAEU account for 51% of all mutual FDI in the CIS and 92% of exported mutual FDI.

Our outlook is as follows. Mutual investment will grow within the EAEU. Uzbekistan will demonstrate significant dynamics. We don’t exclude that in 2017–2018 Uzbekistan, as the recipient of FDI, will outpace Ukraine that has been the unconditional leader in terms of investment attraction from the region over the recent twenty years. As concerns industries, I see three growth points: retailing (hyper- and supermarket chains), agriculture, and commercial and residential property. In retailing, Russia is the absolute leader in terms of competencies and capitalisation. In real property and agriculture there are significant chances to see large Kazakh investment abroad.

To what extent, in your opinion, were the EAEU countries’ monetary policies efficient? For it is evident that different approaches have resulted in discordant short-term dynamics of nominal and actual exchange rates.

Indeed, the different trajectories of exchange rates have resulted greater discrepancies between exchange rates. This could have led to reduced intensity of trade and aggravation of macroeconomic volatility. One of the reasons for this was that, after the currency shock in Russia, some EAEU countries tried for some time to maintain previous trajectories of their currencies. Overall, our calculations demonstrate that flexible exchange rates and inflation targeting (possibly, with a link to the Russian rouble) is an optimal strategy in current conditions.

What monetary policy and exchange rate regime will, in your opinion, help to minimise macroeconomic volatility for the EAEU countries?

In our recent report, Lessons of Currency Crises in the EAEU, we considered whether a more coordinated foreign exchange policy by the EAEU countries in the context of the shocks of 2014–2015 could minimise negative effects. The results have shown that the stabilisation of cross exchange rates, by maintaining floating rates and inflation targeting and by devising monetary policy rules that factor in reaction (in addition to standard internal objectives) to the dynamics of the Russian rouble, can be beneficial for the four EAEU economies and will help to reduce macroeconomic volatility.

It is evident that the effects of internal shocks manifested themselves, in the first place, in the foreign exchange market. What is your forecast of exchange rates for global and national currencies by the end of the current year?

The current forecasts for the EUR/USD pair and EAEU national currencies with respect to dollar until 2019 are available in The EDB Macroreview, a quarterly publication by the EDB Chief Economist Group. According to it, the forecast for 2017 (the year-average) is as follows: EUR/USD 1.1, RUR/USD 59.1, AMD/USD 484, BYR/USD 1,942, KZT/USD 315, and KGS/USD 68.8.

After the National Bank of Kazakhstan took its currency regulation measures last year, the population’s expectations of devaluation are still strong. In your opinion, should it be expected and why?

Overall, the market expects that tenge and rouble will depreciate gradually. Forward curves indicate this. This is linked to concerns that oil prices may slide. In addition, it is believed that the budgets of Kazakhstan and Russia need weaker tenge and rouble. We should not forget that rouble is also affected by sanctions that can be expanded soon by the US Congress. If this is the case, it is highly probable that the Russian currency will depreciate by 5–10%.

How does Kazakh tenge correlate with other EAEU currencies?

The depreciation of the Russian rouble has statistically important influence on nominal exchange rates in all the EAEU countries. Belarus was under the strongest influence, followed by Kazakhstan and then Kyrgyzstan and Armenia. Therefore, the shocks associated with oil price changes affect foreign exchange rates of the member states. As for Russia and Kazakhstan, the main reason that rouble and tenge correlate is that the economies of the currencies are raw-material-based. The same factors determine the trajectories of tenge and rouble.

Is low volatility of exchange rates positive if viewed in the context of maintaining concordant foreign exchange policies by the EAEU countries?

Low volatility of exchange rates is an important condition as concerns concordant foreign exchange policies. If the currencies have totally different vectors or their mutual volatility is high, administrative measures aimed at coordinating their dynamics may result in accumulated imbalances. In the Euro zone, national currency rates moved in the same direction for a long time, even before the European mechanism of exchange rates was introduced.

So, what are the main lessons the country should learn, in your opinion, from the crisis of 2014–2015?

In our opinion, the main lessons have been learnt and the EAEU countries are moving towards free exchange rates and inflation targeting. It is good that Kazakhstan and Russia made their currencies float. This will help to reduce the economies’ dependence on external shocks, decrease dollarisation, and counterbalance mutual discrepancies in exchange rates as well as negative effects for trade and investment flows.