Inflation and the Tenge Exchange Rate, Revisited
Translated from Russian with the help of AI. Original: Russian version
Inflation slowed in April 2023, but the current account deficit, surging imports and planned tariff increases threaten to weaken the tenge in the second half of the year.
The inflation data for April 2023 have been released. As I wrote earlier, March and April made the largest contribution to inflation in 2022. Those months have now dropped out of the current statistics, so annual inflation has slowed significantly. But the most important indicator at the moment is monthly inflation, which stands at 0.9%, implying an annualized run rate of roughly 11%. I think this is a decent result. What factors are driving inflation down in the country? In my view, first, there is the general decline in global inflation. Second, the high base rate has done much to curb consumption. Third, the policy of strengthening the tenge has lowered the cost of imports and thereby helped to bring down inflation. It seems to me that holding down the tenge's exchange rate by selling National Fund foreign currency on the open market is one of the tools the National Bank and the Government are using to contain inflation, given how important it is to bring it down. Moreover, the National Bank did not always sell National Fund currency on the open market, whereas now it does so regularly, which I have also written about.
Nevertheless, we must pay attention to the risks that could arise from the current situation, given the indicators cited by the National Bank and the Government.
The current account of the balance of payments is once again in negative territory, which means that more foreign currency is leaving the country than is coming in from exports and investment. This factor will put pressure on the tenge over the medium term, as soon as the sales of National Fund currency for transfers to the budget come to an end.
Against a backdrop of declining exports, imports have grown significantly, which is explained by high government spending and a strong tenge. Imports usually increase further in the second half of the year, so this will also weigh on the tenge, potentially creating a high risk of depreciation in the second half of the year.
The budget was based on an exchange rate of 470 tenge per dollar, which means that our already heavily deficit-ridden budget is receiving less in taxes in tenge terms. Once inflation reaches the target level, this too will put pressure on the tenge.
The planned increase in tariffs for the services of natural monopolies will show up in inflation in the autumn, adding to annual inflation.
As inflation falls to within the target corridor, the National Bank will be encouraged to cut the base rate. Yields on tenge instruments will then decline and dollarization will rise, putting pressure on the tenge.
Government spending has not yet peaked, so pressure on the trade balance will continue to grow, since a very large share of government spending goes on imports, as the National Bank has also noted.
All of this could lead to a fairly sharp depreciation of the currency in the second half of the year, which would then damage confidence in the national currency. A lack of confidence leads to even greater dollarization and even more pressure on the tenge. In my view, we need to take these factors into account and avoid creating conditions for an excessive strengthening of the tenge. As the saying goes, the higher you climb, the harder you fall. But these are only potential risks, and I believe the National Bank is taking all of these factors into account.