On the Real Exchange Rate

The National Bank of Kazakhstan recently published a very interesting study, "The Contribution of the Balassa–Samuelson Effect to the Dynamics of the Real Exchange Rate of the Tenge". The essence of the effect is that in developing countries the real exchange rate appreciates against a backdrop of faster labor productivity growth in the tradable sectors. In general, this holds true when starting from a low base, but the study does not describe our case. The tenge is indeed appreciating in real terms against other currencies, but this is happening against a backdrop of rising prices in the mining sector (which includes oil and gas). The study describes all of this very clearly.

Here is what is happening in our economy, put in simple terms. Large companies extract oil, gas, uranium, copper and other minerals. Selling these commodities brings a very large inflow of foreign currency into the economy, most of which reaches the budget and the National Fund in the form of taxes. This money is then injected into the economy through the fiscal impulse, as spending by budgets at all levels. It is then spent through wages and profits, including in the non-tradable sectors, which creates excess demand that is balanced through prices. The result is price growth in the non-tradable sectors, which means inflation in the country even while the exchange rate is stable. These funds also go toward increased imports. As a result, the real exchange rate of the tenge appreciates, but not because labor productivity is growing across the sectors of our economy; it appreciates because of rising prices for oil and other minerals. This money artificially strengthens the tenge, making other industries unprofitable and inefficient because they are uncompetitive. For the health and resilience of an economy, it is extremely harmful to pump oil-sector revenues into consumption: the effect does not last long, the country does not develop, and that is why economies with similar models sterilize this liquidity.

In other words, we are living with a classic case of Dutch disease. We cannot overcome it; on the contrary, we keep making it worse.

We are also using this money to try to stimulate production and to develop manufacturing and SMEs, but this has little correlation with productivity gains, even though labor productivity is precisely the foundation of rising incomes and wellbeing. Subsidies and protectionism foster inefficient production, and localization in small markets is likewise harmful to labor productivity growth. Almas Chukin recently gave good examples of small countries that have become very rich and successful: Denmark and Ireland. I would add Taiwan, Australia, Canada, Lithuania, Latvia and Estonia to that list.