One year after Kazakhstan switched to free floating exchange rate of tenge - National Bank

/IRBIS, Apr.7, 00/ - The National Bank of Kazakhstan has published a special press-release devoted to one year results after the country switched to free floating exchange rate of tenge against the dollar (FFER). Considering the importance of the topic, following is the publication of the press-release by the agency IRBIS in its original form without any changes and corrections. From April 5, 1999 the Government and the National Bank undertook a switch to free floating exchange rate. It was a forced measure caused by external economic situation that was settled at that time, first of all, by a sharp devaluation of Russian rouble in 1998. The switch to FFER was not spontaneous. Prior to that, possible scenarios of further developments were analyzed, especially those in Russia, as well as possible ways the exchange rate of tenge could behave under different currency regimes. Pros and cons of each way were assessed: from the point of view of expected balance levels of tenge exchange rate, payment balance, gold and currency reserves, budget deficit, each segment of financial market, social indicators. Final decision was the necessity of FFER for open economy of Kazakhstan and unstable international financial and commodity markets. Of course, fears regarding negative consequences remained. Therefore, the ways of reducing them, that were widely commented in the mass media, were thoroughly worked out. The first results of the introduction of FFER was expected not earlier than half year later. And now a year has passed. Now we can answer the questions: what are real consequences of FFER, could any other economic condition be formed, what kind of consequences were prevailing: positive or negative? The main positive trends: economic growth of the country in 1999 equaled 1.7%, payment balance of the country has significantly improved, gold and currency reserves of the country has grown, banking sector kept strengthening. The main negative consequences: inflation - 17.8% in 1999 (against 1.9 in 1998), growth in proportion of dollars in monetary turnover up to 51% (from 42.1%), appearance of direct dependence of the state internal borrowing on the changes in exchange rate, worsening of the loan portfolios of the banks. Now, let's consider degree of influence of the introduction of FFER on each of these factors. 1. Inflation and production. Growth in the world prices for oil and significant devaluation of tenge affected the growth in general price level in the country. At the same time, in February of current year inflation equaled 0.1%, and in March - 0%, i.e. wave of the inflation, caused by the events of 1998-1999, has finally vanished. The growth in the economy of Kazakhstan was mainly determined by price conjuncture of the world commodity and raw material markets and favorable weather conditions (in 1999 growth in agriculture reached 28.9% as a result of the highest harvest during the last few years). Devaluation of tenge had an impact on the growth in some import substitute industries (textile, sewing and a few food industries). If GDP of 9 months of 1999 is examined, its growth reached 5.3%, of which 3.6%, by our calculations, is net effect of the devaluation. 2. Payment balance. In 1999 following remarkable events took place. For the first time in last four years the trade balance equaled positive 344 mln U.S. dollars (in 1998 the deficit was 801 mln U.S. dollars). Deficit of operations of current accounts decreased 171 mln U.S. dollars (1.1% of GDP), which is 7 times less than that of 1998 (1,224.6 mln U.S. dollars, or 5.5% of GDP). Such results were achieved only due to the second half of 1999, i.e. when the effect of the devaluation was obvious and the world prices for oil and other commodities were growing. Deficit of current account changed into an active balance (in the II quarter exports grew 38% compared to similar period of last year, and imports fell almost 14%). As a whole, imports (FOB) fell to 5,644.8 mln U.S. dollars (15.4%), and exports (FOB) grew some to 5,988.5 mln U.S. dollars (2%). Trade with CIS countries is more dependent on the real exchange rate of tenge, whereas exports to other foreign countries are more dependent on the dynamics of the world prices. Reduction in the volume of attracted foreign capitals, which followed the Russian financial crisis, became more important immediately after the devaluation of tenge. And only by the end of the year resumption of economic growth and improvement in the conjuncture of the world commodity markets were affecting the inflow of external financing significantly. As a result, in 1999 net inflow from the operations with capitals and finances decreased to $1,065 mln (1.7 times less than in 1998). Under the condition of limited access to private markets of capitals and significant reduction of inflow of official loans external financing was sustained mainly by direct investments of strategic investors into oil and gas and energy industries. Sharp growth in external borrowing took place in IV quarter of 1999, when sovereign bonds of Kazakhstan for $300 mln were launched on international capital markets, and after signing an agreement with IMF under EEF program the World Bank has granted a total of $175 mln loan to conduct pension and structural reforms. Net inflow of direct foreign investments in Kazakhstan was registered at $1,583.0 mln (in 1998 - $1,143.3 mln). By the estimates of the National Bank, gross external debt as of December 31, 99 fell $330 mln to $7,893.0 mln. State loans and the loans granted under the state guarantee reached $4,055.6 mln, almost unchanged since the beginning of the year. External debt, not guaranteed by the government, grew slightly during that period - from $2,737.1 mln to $2,837.4 mln. Accounts receivable of the enterprises was accepted as of Sep.30, 99 - $1,000 mln, was at $1,485.3 mln at the beginning of the year. External debt servicing norm (proportion of repayments and servicing of external debt to exports of goods and services) equaled 27.3% in 1999. Proportion of gross external debt to GDP and to exports of goods and services were 49.9% and 114%, respectively. 3. International reserves. Introduction of new exchange rate of tenge began to positively influence the dynamics of international reserves from the second half of 2000. Despite significant expenses related to servicing state external debts and the loans granted under the state guarantee and the obligation of the National Bank to convert the deposits of the population and legal entities that were voluntarily left for 6 and 9 months, the National Bank increased gross reserves to $2,002.7 mln (25.3%) from April through December, 1999, and from April, 1999 through March, 2000 - to $1,872.7 mln (17.2%). 4. Monetary aggregates. From April, 1999 through March, 2000 (by preliminary estimates) monetary base expanded 55.8%, to KZT101.6 bln. growth in international reserves of the National Bank and repayment of pensions, allowances by the Ministry of finance in December were the major factors of the expansion. During that period monetary mass grew more than twice (104.3%) to KZT272.4 bln. Positive trend of increasing deposits in the banking system in the structure of monetary mass was continuing (from 56.7% to 66.7%). 5. Financial market and banking system. Currency market. More stable dynamics in the exchange rate of tenge fluctuation and the decline in currency risks after eliminating overvalued exchange rate of tenge were the positive moments of the introduction of FFER. If devaluation was 4.9% in the first quarter, in the 2nd - 50.2% (introduction of FFER), in the 3rd - 5.9% (adaptation period), then in the 4th quarter revaluation was observed - (-)1.3%. Average monthly devaluation in the 1st quarter of 2000 fell from 1.6% to 0.9% compared to similar quarter of 1999. Overhead expenses of switching to FFER were significantly reduced by using the complex of "prophylactic" measures. However, some overhead expenses of currency market participants remained. Payments of loans in foreign currencies have increased for the lenders who have only inflows in tenge. Presently, most of currency deals are made on interbank currency market again. Volume of currency transactions at the Exchange equaled $2.2 bln from April 5, 1999 through March, 2000. Weighted average rate of tenge at the Exchange was at KZT141.95 per U.S. dollar in late March of this year, 2.7% increase from the beginning of the year. Since the inflation was also 2.7% in the first quarter, then real rate of tenge towards the dollar was stable. Monthly growth rates of the deals between the banks-residents reached 14 - 31% on average. Total amount of deals made by the banks-residents from April, 1999 through February, 2000 equaled $1.9 bln. At the same time volume of net sales of cash hard currencies to the population decreased 11.4% relative to January-February of 1999. Market for state securities. In general, introduction of FFER caused the market for state securities of the Ministry of finance denominated in tenge to shrink - from April, 1999 through March, 2000 in circulation volume of the securities of the Ministry of finance denominated in tenge fell to KZT47.2 bln (23.9%). However, due to the introduction of currency instruments circulation volume of state securities increased to KZT11.8 bln (68.6%) in terms of tenge. Negative consequences were as follows: cost of state borrowing became dependent on the change in the exchange rate of the U.S. dollar, increase in the National Bank's expenses were based on the regulation of the liquidity of the banks. During April, 1999 through April, 2000 volume of tenge notes of the National Bank rose to KZT5.0 bln (41.9%), expenses related to servicing currency notes equaled $0.14 mln. Depository market. Under the condition where external borrowing was getting expensive commercial banks were getting more active in increasing their resources: the competition between the banks for attracting free funds of the population and that of the enterprises has become strong, the number of depository services has increased, as well as the quality of services has improved. Increase in total amount of deposits in banking system means that the trust of the population in banking system has increased, which can be attributed to conversion of deposits of private persons and legal entities by the National Bank and the government in the first place. Of course, creation of an insurance system for time deposits of private persons, and adoption of the law on bank secrecy played an important role. From April, 1999 through February, 2000 deposits grew more than 2.4 times (excluding exchange rate difference the growth was 94.2%), at KZT174.5 bln. Deposits of the population increased by 94.0% (excluding exchange rate difference the growth was 48.7%). However, significant devaluation of tenge caused the process of increasing the proportion of dollars in the country to intensify. Proportion of currency deposits within total amount of deposits rose from 42.1% to 51%. Loan market. Growth in bank liabilities, especially in their basic component - deposits, allowed the banks to maintain their previous loan activities at the same level. From March, 1999 through February, 2000 volume of bank loans in the economy grew by 60.7% (excluding exchange rate difference the growth was 28.8%) and equaled KZT154.1 bln. With that, weighted average interest rate on tenge loans fell from 22.2% to 21.5%. The policy of the National Bank to decrease official refinancing rate has made a downward impact on general level of market rates of the loans in the economy of the country. Thus, from the time FFER was introduced official refinancing rate fell from 25% to 16%, official refinancing rate for REPO operations - from 23% to 19% and official refinancing rate for "overnight" loans - from 27% to 21%. Proportion of mid- and long-term loans has increased (from 38.9% to 50.1%) in the structure of all loans, caused mainly by an increase in the number of time deposits attracted and prolongation of their terms. However, the banks had inadequate impact on the growth of resources, they still prefer to invest their free funds into SS, or into currency. It becomes clear from the fact that volume of bank loans in the economy grew only KZT58.2 bln, while deposits grew KZT101.9 bln in bank liabilities. Proportion of currency loans grew significantly (from 47.4% to 52.9%) in the structure of all loans. First of all, it was caused by the measures taken by the banks to minimize the risk associated with the change in the exchange rate of tenge. Practice of granting loans in foreign currency, or in national currency, but tied to its currency equivalent were wide spread among the banks. Moreover, worsening of financial situation of many borrowers after the devaluation of tenge caused the volumes of overdue loans to increase. Loans, not paid back on time by the companies and the population, rose by 37.3%. The banking system. There is no doubt that during the first months of transformation to new currency policy there were cases where the banks were violating prudential norms. Devaluation of tenge made some banks, that were conducting currency operations actively, to break the limits of open currency position and to violate the norms of maximum risk per borrower. Later, the situation improved somewhat - the number of banks violating the prudential norms has decreased. In general, switch to a new currency policy took place without essential hurts and the banking system was stable. It can be inferred from positive dynamics of indicators that characterize the development of the banking system of the country. From March, 1999 through February, 2000 total assets of the banks rose to KZT340.7 bln (75.4%). Total equity of the banks increased to KZT71.5 bln (43.9%). However, if total equity of the banks is measured in terms of foreign currency, then it fell from $568.4 mln to $526 mln during that time (as of March 24, 2000). Introduction of FFER did not have a negative impact on the liquidity of the banks, i.e. they did not have difficulties related to the deficit of short term liquidity or shrinkage of their resources. The banks kept working on interbank market. Temporary reduction of the minimum reserve requirements (from 10% to 5%) by the National Bank allowed the banks to maintain their normal liquidity. Presently, the liquidity of the banking system is characterized as excessive. Due to an increase in credit and currency risks of the banks when national currency was devaluing loan portfolios of the banks worsened. Proportion of standard loans fell from 60.8% to 56.8%, and the proportion of doubtful and bad loans increased from 34.7% to 38.3%, and from 4.5% to 4.9%, respectively. Moreover, proportion of bank requirements to their clients fell from 51.8% to 45.3% in total volume of their assets. Currently, many banks are working to improve their loan portfolios. 6. Finally, the conclusions. What kind of consequences were prevailing: positive or negative? Could any other economic situation be formed? In general, introduction of FFER can be considered expedient and justified. However, the success was to the most part due to certain circumstances: favorable prices on the world raw material market, favorable weather conditions, improvement of the situation on the world financial market. In addition, there could be more negative consequences if the situation in Russia did not improve. Otherwise, the period of reaching balanced rate could be extended, which could have caused destabilization of the economy and the balance itself could be achieved at much lower exchange rate. Moreover, inflation could have reached higher levels unless the state regulation of the prices of natural monopolists increased, in particular, freezing the prices on railroad transportation and public utility tariffs. The most important is that the 4th quarter of 1999 and the 1st quarter of 2000 clearly showed that the banking system had not only survived, but it had also got stronger, the market for state securities had been restored completely, inflation had decreased significantly and the real exchange rate of tenge had been relatively stable.