Friday, August 21, 2015

Does devaluation/depreciation of Kazakh Tenge bring inflation/increase of price of goods?

Does devaluation/depreciation of Kazakh Tenge bring inflation/increase of price of goods?

I think this question should be the most important one for the people residing in Kazakhstan at the moment. Will the fall of #tenge cause the price rise of the goods?

Before answering this question based on economic principles, let us see what the authorities are saying on the subject.

Tengrinews reported the Prime Minister Karim Massimov as saying “From August 20 the National Bank and the Government have decided to implement a new monetary policy based on inflation targeting and to renounce the earlier practiced currency corridor”, the country’s PM Karim Massimov said in the government sitting today.

The PM further said “The new exchange rate dependent on supply and demand will put in place conditions for the economy to recover, galvanizing lending and investment operations and enabling to create jobs and reduce the inflation rate down to 3-4%”.

So, PM seems to suggest that the new monetary policy (free floating exchange rate) will have a positive effect on the market when it comes to inflation by keeping the inflation low to the range of 3-5%. This shows that government believes there will not be increase in price of goods and that will not be allowed after the introduction of new monetary policy.

Another report here says that the PM has instructed to the country’s regional governors to prevent price hikes for basic necessities in the nearest time. PM is quoted as saying, “We will make sure there will be no sharp price hikes for essentials. In the longer run, I believe prices should be set by the market forces”.

As per this press briefing, PM thinks inflation will be caused due to new monetary policy but government is committed to make necessary intervention to keep prices low. So, what PM says is that there will not be sudden and sharp rise of prices in Kazakhstan in the short run as government is committed to control inflation but slow price rise in the long run may be possible due to market factors.

Now, let us analyse the situation from economic perspective.

If you read my first post on Kazakh #tenge HERE, you will see that I have attempted to say how devaluation and inflation are not directly related to each other. I know in my previous post, I could not make the point very clear as issue required a separate comment. Hence, I am going to repeat the basic economics before we move forward.

Inflation is caused by excessive money in the market, i.e. due to high liquidity. Because everyone has enough or too much money, the value of extra unit of currency goes down due to "Principle of diminishing marginal utility" and its purchasing power goes down. So, goods are going to become stronger. Here, the national currency of a country is compared with its purchasing power in the same economy. In contrast to that, devaluation or depreciation is a term where one currency of a country is compared with another different currency. It takes into consideration the purchasing power of one currency with respect to purchasing power of another currency. The ability of one currency to buy goods is secondary when we talk of devaluation/depreciation of a currency. However, having said so, any depreciation/devaluation of currency in practice leads to reduction of its purchasing power even within domestic markets. So, Inflation is a likely outcome when rest of the parameters are constant.

Kazakh PM has stated that he would take the measures of inflation control. That essentially means inflation is a likely scenario when devaluation happens. That is where Kazakh Government wants to intervene.

One way to control inflation is to reduce the money in the markets. So, if you are expecting your salary to rise or readjustment to happen, that is where I have a doubt. It is unlikely to happen any time soon. Logic is simple: if you have too much money on your hand, there is a high chance of your spending it. The more money you earn and spend, the more inflation it can cause and can depreciate #tenge further. So, any adjustment or hike of salary is unlikely in the next 4-6 months in my opinion.

What other measures governments can take to control inflation?

  • Increase the interest rates on the loans,
  • Increase the deposit rates (interest rates on fixed deposits) so that you are encouraged to save more and spend less
  • By offering attractive investment plans, like issuance of government bonds, selling share of government companies to public, by increasing interest rate of pension funds but also by increasing its lock-up period
  • National Bank of Kazakhstan may direct Banks to maintain certain amount as reserves/increasing the reserve ratios - so that less money is available for distribution as loans to publics/companies
  • by slashing public spending/unnecessary spending etc.

By employing the above measures, Kazakh Government can contain the inflation for some time and thereafter market forces will determine if costs of goods should go up.

If you see the last point on the measures to be taken for inflation, i.e. by slashing public spending/unnecessary spending etc., this is where there will be a great challenge to balance economic growth vs. inflation. When government reduces its spending, that means there will be low job creation, less hike in salary, less employment and slow down of the economy. Balancing "inflation" and "economic growth" will be the challenge for the Kazakh Government.

Before concluding on this post, I am again asking the same question, "Will not price rise at all? Will government be able to contain inflation?"

To be honest, government can hardly do anything to control prices when it comes to imported goods. For example, it will be expensive to buy imported branded apparels, imported jewellery, electronic items like TV, Phone, Refrigerator, Cars etc. The dealers may reduce their profit margins and may pass the import costs slowly to the buyer but these goods will be gradually expensive.

If you see statement of Kazakhstan PM, he is interested to contain prices of essential commodities. So, when it comes to prices of domestically produced items from the raw materials procured domestically, for example, bread, butter, milk, egg, the inflation caused by the devaluation of #tenge can be avoided. 

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