The August 2015 Devaluation: Who Will Lose, and Why Reforms Are Needed

Note: This text was written on August 20, 2015, the day the tenge moved to a free float. The author later concluded that the weakening of the tenge is structural in nature and is linked to lagging labor productivity growth, not merely to individual devaluation decisions.

We do love to surprise people. Today, certain sectors of the economy got what they wanted to maintain their competitiveness.

However, one-day devaluations do not always have a positive effect.

Some sectors will get a boost, while others will slump.

Devaluation should be a supporting instrument alongside structural economic reforms, not the other way around.

Here, devaluation is a cure-all for every economic ailment, while reforms are a perpetual backdrop that never quite becomes the main action.

But that is all rhetoric.

In practice, there are now problems that have to be solved. Many people think they are easier to solve than helping the enterprises that suffered from a strong tenge. I am not so sure.

The first and main problem we will face is inflation. Kazakhstan has not resolved the problems of dollarization and import substitution at all. In practice, we will now see higher prices for appliances, real estate, cars, clothing, and most food and household chemicals. Prices will rise by 30 percent or more. Yes, the government will hold down prices for buckwheat, sugar, milk and another ten or so goods. But for the middle class, that is of little consequence. Restaurants, hotels, services and so on will follow. All of this will weigh on consumer demand, which will contract. To suppress inflation, tenge liquidity will have to be squeezed, so lending to households will be limited, which will further depress purchasing demand.

To contain inflation, the authorities will also hold down fuel prices and the prices of natural monopolies. Energy companies, Kazakhstan Temir Zholy (KTZ) and oil traders will suffer. We will again face fuel shortages, because exporting oil will once again be more profitable, and the Ministry of Energy will once again start its tug-of-war with subsoil users.

The topic of refining at domestic refineries will resurface, since Russian gasoline is now uncompetitive. And given the duties on fuel oil and higher refining prices (to compensate for the cost of upgrades), holding down fuel prices will again be a very big problem.

So keeping inflation even within 10 percent, with no localization of production, will be virtually impossible, unless the statisticians resort to sleight of hand.

Another problem is that all our investment projects will simply become 30 percent or more expensive, and nobody knows what to do about it. Given the bureaucratic mechanisms at Samruk-Kazyna, where decisions take years, I expect projects will simply freeze and wait for their time to come again.

The oil producers' problems will not be solved at all. The point is that savings on wages will quickly be wiped out by more expensive drilling, components, pipes, cement and so on, and given the mentality of Western oil workers, wages will be indexed. KazMunayGas Exploration Production (KMG EP) may even slip into a loss, given that most of its output is supplied to the domestic market, which will be frozen to contain inflation. I would not be too happy right now if I were buying KMG EP shares.

Housing construction can also be written off for now (although this was supposed to be one of the ways to prop up Nurly Zhol). Housing prices here are set in US dollars. Everyone will now be inclined to save and wait for housing prices to fall. With no tenge liquidity, high interest rates, expectations of falling prices and a general decline in household incomes, nobody will buy housing. The construction sector will head into the red.

Natural monopolies such as Samruk-Energy, KEGOC, KTZ and a number of other companies will be under heavy pressure as tariffs are held down, and if preferential tariffs for big business are introduced on top of that, one can only pity them.

The winners from the devaluation will be agriculture, food production, a few smaller metallurgical producers and part of machine building (although with demand shrinking, I am not sure it will help them). But their share of total GDP is very small, and the effect of the new exchange rate will last only a year, because after that inflation will simply eat up all the competitive advantages and the question of further weakening the tenge will arise again. And if oil prices rise and the exchange rate strengthens, our enterprises' competitiveness will simply evaporate.

In fact, instead of tackling bureaucracy (especially in the ministries tied to our main export product), expanding production of hydrocarbons and other minerals, resolving tax issues for subsoil users (especially uranium companies), increasing the depth of hydrocarbon processing, dealing with red tape in the akimats (local administrations) and improving the investment climate, and so on, we worry about enterprises that, doped up on devaluation, are merely prolonging their old age.

In the short term, devaluation can of course provide significant help to the national budget and some sectors of the economy. But without structural reforms and a change in the economic paradigm, we will keep devaluing every few years to support domestic producers.