Stavros brought up an interesting topic on this blog the other day. The Tenge is becoming ever more valuable against the U.S. dollar:

In the competitive exchange offices of Almaty a US dollar sells for only 119 Tenge today. 119 is significant as only a few months ago it was hovering around 130 Tenge. The US dollar being the currency of reference in Kazakhstan.

As I dedicated much of my time thinking about the effect oil has on the Kazakh economy, I thought I throw some of these thoughts into an extended entry on this blog. It’s economics-heavy, but I am sure that some of our readers will find this stuff informative.

Kuralbayeva, Kutan and Wyzan (2001) develop a model with whose help the main indicator of the Dutch Disease, the appreciation of the national currency, can be linked to other macroeconomic indicators for the period between 1996 and 2000. Although the authors cover a peculiar period in Kazakhstan’s transition, this does not render the applicability of their computations obsolete. In fact, Kazakhstan’s oil windfalls become much larger in the new millennium, which should in turn make Kuralbayeva, Kutan and Wyzan’s (KKW) model more applicable.

Their data implies that ‘a 10% improvement in the [net barter] terms of trade had appreciated the real exchange rate by 2.34%, indicating evidence of Dutch Disease effects’ (p.16). Furthermore, ‘a 10% increase in the real wage brings about a 3.6% appreciation of the real exchange rate during the post-1996 period’ (ibid.). Intuitively, as related to both growing government revenue through improved terms of trade and real wage increases, the most pressing concern for Kazakhstan’s policymakers should be inflation. The model suggests ‘that a 10% increase in the inflation rate appreciates the real exchange rate by 8%’ (p.15).

It seems that in the new millennium, i.e. the period between 2000 and 2004, continuous real wage increases, record-high oil prices and an annual inflation rate above 6% (IMF, 2005b) have all put pressure on the exchange rate, as predicted by KKW’s model. From 2000 to 2005, the tenge-dollar real exchange rate has appreciated by some 28 percent, with most of the appreciation occurring in 2003–04, the two years of record-high oil prices (IMF, 2005a). However, with Kazakhstan’s main trading partners, Russia and the European Union, the situation is somewhat less dramatic due to persistently high euro and rouble exchange rates against the U.S. dollar. Between 2000 and 2004, the tenge even depreciated vis-à-vis the rouble (ibid.).

The Kazakh monetary authority, the National Bank of Kazakhstan (NBK), has chosen a proactive policy to keep real and nominal appreciation of the tenge in check, for example through market interventions in the fourth quarter of 2004 (USAID, 2005) or through placing the resources of the National Fund in assets abroad which are denominated in either U.S. dollars or euros, thus ‘sterilizing’ revenue by keeping it out of the domestic economy.

Despite this interventionist approach, in January 2006 alone the tenge has appreciated by 1.4% against the U.S. dollar in real terms. Both Citibank (2006) and the Economist Intelligence Unit (2006) predict the tenge to appreciate considerably against the U.S. dollar over the short and medium term. The depreciation trend of the tenge against the rouble was also reversed in 2004 (IMF, 2005a).

The story is receiving increasing attention in the international media. The Herald Tribune noted recently:

Kazakhstan, like neighboring Russia, is battling the side effects of oil windfalls on its $7.8 billion economy, including inflation and the appreciation of the nation’s currency, the tenge.

The International Monetary Fund said on May 18 that annual consumer- price growth in the country may reach 9 percent this year and urged the government to ensure that the economy remained stable.

Consistent with KKW’s model cited above, the IMF points out that the prime reason for the tenge to appreciate against major foreign currencies is the inflation rate. Thus, it becomes important for the government to carefully keep in check increases in public spending, one of the major driving forces behind inflation.

The effects of inflation are widely-known and it will also become a tremendously important task of the authorities to limit money supply. With a surging banking sector and credit growth, this will take some political dedication.

For references, check this post.