The devaluation of the tenge makes sense economically, but could pose short-term political challenges for the Eurasian project.
August 24, 2015
By Sergey Aleksashenko
The devaluation of Kazakhstan’s tenge came somewhat as a surprise, as is always the case in countries with a managed exchange rate. On the other hand, it was an expected and absolutely logical move. What’s most important for Kazakhstan is its transition to a free-floating currency, which could have both positive and negative consequences.
As we know from geography, Kazakhstan is located between Russia and China. Therefore it’s no surprise that these two countries are its main trading partners. If you add to that the deep historical ties that Kazakhstan has developed with Russia, and China’s leading role in the production of an enormous list of goods, then it should be no surprise that Russia and China together account for 50% of Kazakhstan’s imports (33% and 17%, respectively).
We should also keep in mind that Kazakhstan’s economy relies on the production and export of natural resources, which make up 90% of its exports (of which 75% are hydrocarbons). This means that the value of Kazakhstan’s exports is heavily influenced by world commodity prices, particularly that of oil. It follows, then, that if Kazakhstan wants to maintain its current account in periods of falling commodity prices, then it has to decrease its imports.
From the beginning of 1997, Kazakhstan pursued a managed currency regime, keeping the tenge under tight control as the country’s leadership believed that a stable exchange rate symbolized economic stability. Fluctuations were allowed within a narrow band on several separate occasions, but were so minor that what existed was essentially a fixed-rate system. This system was aided by Kazakhstan’s restrained government spending policies and its relatively successful structural reforms in the financial sector. Kazakhstan could have probably transferred to the fixed-rate system as its official policy if it wasn’t for its neighboring with Russia—which found itself unable to maintain the ruble’s value during periods of falling oil prices—and the low level of interchangeability between Kazakh and Russian goods in both countries’ markets.
Graph 1: Course of the USD against the Russian ruble and the Kazakh tenge (1997-2015)
As a result, even though Kazakhstan had emerged from the 1998 economic crisis relatively unscathed, it was forced to sharply devaluate the tenge due to the rise of Russian imports into the country and the fall of Kazakh exports into Russia following the devaluation of the Russian ruble in autumn of that year. This situation was repeated during the 2008-09 financial crisis. In the latter instance, the main hit for Kazakhstan came even earlier, when its banking system plunged into a severe crisis in 2007. But the sharp devaluation of the ruble at the end of 2008-beginning of 2009 forced Kazakhstan to enact a one-time devaluation of the tenge in February of 2009 to the tune of 25 percent.
After the 2008-09 crisis, Kazakhstan’s economy quickly recovered, and a new rise in global oil prices resulted in a sharp rise in imports, especially from Russia. The creation of the Customs Union (and its later transformation into the Eurasian Economic Union) significantly expanded the opportunities for Russian and Kazakh businessmen to carry out trade and business in their neighboring country by giving them a single system on the entire territory of the Union. The trade balance between Russia and Kazakhstan had traditionally been in Russia’s favor, but something happened in 2013 (the first year of the EEU’s existence) that nobody expected—Russian exports to Kazakhstan rose by a “normal” 11%, while Kazakh exports into Russia fell by more than 40%. As it turned out, under the new conditions the prices of Kazakh goods couldn’t compete on the Russian market, and in February of 2014 Kazakhstan carried out its first preventative devaluation of the tenge (by 20%), which led to more than a 20%-drop in Russian exports to Kazakhstan that year.
The latest sharp devaluation of the Russian ruble at the end of 2014/beginning of 2015 ate up the remaining competitive advantages that Kazakhstan had in bilateral trade with Russia. Meanwhile, the ruble’s renewed devaluation in mid-2015 once again shifted the mutual conditions of trade in Russia’s favor. Given the circumstances, the decision to devaluate the tenge became only a matter of time—this was understood even by the average citizens of Kazakhstan, who began to curb their current spending and build up their foreign-currency deposits at the bank. The Kazakh leadership thus faced a choice. They could either devalue the tenge for the second time in 1.5 years in the hopes of leveling the trade playing field with Russia, but this would require a nearly 50%-devaluation of the tenge (in order to return the ruble-tenge exchange rate to its past 10-year average), while at the same time having no guarantees that the ruble wouldn’t continue to fall. Or, they could abandon the quasi fixed-rate policy with periodic one-time devaluations in favor of a free-floating currency. The Kazakh leadership chose the second option.
Graph 2: The tenge-ruble exchange rate (2005-2015)
From a long-term perspective, this move makes perfect sense: the global experience over the last few decades has shown that fixed-rate policies are highly unstable, especially in countries that export raw materials. On top of that, Kazakhstan is counting on actively attracting foreign investment into non-raw-goods sectors, and it knows that sudden fluctuations in the exchange rate are one of the most disruptive elements to the investment climate. Since Kazakhstan’s financial system is already sufficiently developed, we can expect it to be able to handle the hedging of currency risks.
In the short-term, however, such a radical change to the rules of the game might lead to some negative consequences: it may speed up the rate of price increases, encourage the population to make foreign-currency deposits, and lower the rate of investment by the Kazakh businesses (since their savings will drop in value).
From a political perspective, the devaluation of the tenge and the move to a floating exchange rate will increase competition on the EEU internal market and will inevitably build up the mutual resentment between Russia and Kazakhstan. This will only add to the uncertainty of what is already a not so auspicious future for the Eurasian project.
Sergey Aleksashenko is the former Deputy Finance Minister of Russia and former Deputy Chairman of the Russian Central Bank. He is a Non-Resident Senior Fellow at the Brookings Institution.