The de-dollarization in Kazakhstan: treating the disease, or the symptoms?

Introduction


Were the de-dollarization measures useful for Kazakhstan, or as much use as a chocolate fireguard?

Many central banks of developing countries encourage saving in national currencies. To keep a tight rein on exchange rates prior to or after devaluation, they may interfere.


The policy and its effects

In December 2014, the National Bank proposed measures to encourage saving in tenge. The National Bank banned pricing in accounting units (an imaginary monetary unit, equal in value to the U.S. dollar), increased the amount insured on tenge deposits from 5 million KZT to 10 million KZT, and decreased the annual interest rate on foreign currency deposits from 4% to 3%, reports Timur Issayev, of Forbes magazine. On February 1, 2016, the National Bank further increased the maximum interest rate on tenge deposits from 10% to 14% and decreased the maximum interest rate on foreign currency deposits to 2%, reports Tengri News.

Dollarization of savings has pros and cons. Chronic inflation drives individuals to save in hard currency. Without foreign currency deposits, they would put their savings “under a mattress” or abroad. Foreign currency accounts lower international transaction costs. However, dollarization also increases foreign exchange risks. Interest revenue in national currency on long-term loans decreases, while interest expenses on short-term deposits increase, implying currency and maturity mismatches. Furthermore, transactions in foreign currency decrease the gain on printing money (seigniorage). Hence, many countries, including Kazakhstan, conduct de-dollarizations.

Increasing the insured amount had benefits and drawbacks. It encourages saving in national currency and reduces consumption. However, banks are more likely to act in ways that may hurt depositors who would not withdraw money, as more of it is insured.

Pricing in accounting units is a response to inflation. It reduces menu costs, the costs of changing prices. Under high inflation and depreciation, the ban may create a black market.
Lowering the maximum interest rate on foreign currency discourages depositing it. However, since banks spend less on servicing foreign currency deposits, they extend more loans in foreign currency, exposing themselves and their borrowers to foreign exchange risks.

Increasing the insured amount on tenge and lowering the interest rate on foreign currency deposits decelerates the increase in the volume of transactions and deposits in US Dollars, postponing another devaluation. In the long run, both should become low, in comparison with those in national currency. Yet without well-developed securities markets, investors have no substitutes for dollars, so the policy eliminates a key diversification opportunity.

The maximum interest rate on tenge deposits is a price ceiling. If the central bank sets it below the market rate, banks will face tenge shortages; if it sets the interest rate above the market rate, banks will pay less on deposits than the maximum rate. After 2016, banks needed tenge, as they expected the currency to appreciate; they would thus gain by extending tenge loans, so the National Bank allowed paying more on deposits. This was an effect of already existing market trends, not their cause.

Deposit trends

Exchange rate fluctuations have been a key determinant of depositor behavior. Graph 1 illustrates oil prices and exchange rates.

The National Bank tried to hold the tenge exchange rate on a short leash for a while, but was unable to restrain it in the long run. Oil prices decreased in the second half of 2014 and in 2015. Nevertheless, the National Bank defended the tenge until August 2015, to keep consumers and importers of Russian-made goods contented prior to and shortly after the presidential election of April 2015. Exporters faced losses from low oil prices, so this idyll for consumers could not last forever. After the National Bank floated the tenge, there was an unprecedented depreciation. National Bank interventions to prevent tenge weakening had only brief effects, so the montly rate reached 360 KZT/U.S. Dollar in January 2016. Starting February 2016, however, oil prices began to recover, and the tenge began to strengthen, with mild fluctuations of both parameters. 

Source: The National Bank of the Republic of Kazakhstan and The World Bank

Graph 1: Monthly Crude Oil Prices and the Tenge Exchange Rate (2014-2016)

Lowering the rate on dollar deposits in 2014 did not prevent tenge weakening and did not increase tenge deposits. The substitution occurred only in 2016, when not only tenge deposit interest rates increased, but oil prices increased as well. Graph 2 illustrates tenge and foreign currency deposit dynamics.

Deposits of depository organizations increased during 2015-2016, indicating that exchange rate volatility did not erode overall depositor confidence. During the second half of 2015, depositors substituted foreign currency for tenge, but this trend is being reversed. There are still more deposits in foreign currency than in tenge, though the gap is narrowing.

Source: The National Bank of the Republic of Kazakhstan
Graph 2: Dynamics of Deposits of Depository Organizations in Kazakhstan (2015-2016) 

Various domestic and foreign factors, such as the Fed voting to increase interest rates, as it did on March 15, may strengthen the dollar relative to the tenge. Though returns on dollar deposits are low, investing in them is safer than in tenge, so more dollar deposits may be expected.
Without effective anti-inflationary measures, depositors substitute dollars. The IMF forecasts inflation for 2017 at 9%, above the target of 2-3%. Altering interest rates and deposit insurance conditions is inadequate in the long run.


Conclusion

The volume of tenge deposits has been increasing since 2016, but rising oil prices, leading to tenge strengthening, was the main reason for the increase. The National Bank is focusing on the symptoms, not on the disease. New financial instruments and better anti-inflationary policies are needed for de-dollarization in the long run.

References

International Monetary Fund. October 2016 World Economic Outlook Database. https://www.imf.org/external/pubs/ft/weo/2016/02/weodata/weoselgr.aspx. 2016.

Issayev, T. Dedollarization in Kazakhstan: all the eggs into one basket. Forbes. http://forbes.kz/finances/finance/dedollarizatsiya_vse_yaytsa_v_odnu_korzinu. 2014. 

Tengri News. Interest rates on tenge deposits will increase, starting February 1 - National Bank of the RK. https://tengrinews.kz/private_finance/stavki-depozitam-tenge-povyisyatsya-1-fevralya-natsbank-rk-287637/. 2016.

Welcome to Notes from the Golden Horde!

My name is Dmitriy Belyanin. From late December 2015 till March 2017, I worked with Leon Taylor, Associate Professor of Economics at KIMEP University, on the blog “Economics on the Silk Road”, featuring analyses of Central Asian economies, located at

www.centralasianeconomy.blogspot.com. I contributed 15 posts on economics during the period. Earlier, I had written on issues in economics and finance ranging from stock markets to environmental economics. I am grateful to Leon Taylor for all his support.

This blog is similar to “Economics on the Silk Road.” However, it may also include articles, focusing on Belarus and Armenia, the non-Central Asian members of the Eurasian Economic Union, in comparative studies. It will be less technical and, in comparison with my contributions to “Economics on the Silk Road,” each of the articles will be narrower in scope.


Thanks for your attention to my blog!

Sincerely,

Dmitriy Belyanin