Why Higher Oil Prices Have Little Effect on the Tenge Exchange Rate

Everyone, it seems, is talking and asking about the tenge's appreciation against the dollar. Many readers write to me that the tenge has strengthened because of rising oil prices, and that this is one of the main reasons. I will probably disappoint you: that is not the case, and I will try to explain why.

First, one must understand that Kazakhstan's foreign exchange market is highly restricted and cannot respond to market signals. For market signals to influence the exchange rate, there must be complete freedom to buy and sell currency. In our country only individuals can do this, but individuals are not financially savvy economic agents and do not drive market signals. Legal entities, meanwhile, cannot buy foreign currency for speculative purposes or to hedge their currency risks. In such a paradigm, it is financial institutions that can earn more on the currency swings, rather than companies, which, for example, could have bought currency for their future contracts when the tenge strengthened sharply.

If signals worked here as they do in large markets, then after yesterday's inflation statistics, which showed monthly inflation falling to 0.6%, and after the leak of information that in the summer the country may return to the maximum rates on mortgages (which is in essence a signal that the base rate will be cut in the summer), the currency should have weakened. Instead, it strengthened.

Now to the oil market: how it works and how it can affect the currency market. Foreign currency revenue can affect a restricted currency market only when it physically reaches that market, and that will certainly not happen in April or May. First, production fell sharply in the first quarter because of a steep cut in output at Tengiz, so the country will already receive less foreign currency revenue, including KazMunayGas as a participant in the production sharing agreement (PSA). Second, oil companies will see the additional revenue from March prices in May at best, because there is a lag between the signing of a contract and the receipt of proceeds. Third, for the additional revenue to reach the currency market, the holders of that currency must start spending it, and they will not spend more than they are supposed to. They will spend only within approved budgets and contracts, where prices are fixed and not tied in any way to oil prices. So we are unlikely to see oil companies, other than KMG, selling currency in excess of their usual volumes. Fourth, the only place where oil producers will really pay more is taxes, which in Kazakhstan are linked to oil prices. Of these taxes, only the export rent tax (ERT) goes directly to the budget; the rest goes to the National Fund, where it is sterilized and has no effect on the currency market in the short term. It could have an effect only if the government decided to increase transfers to the budget, and that is not a quick process. Therefore, higher oil prices have an extremely limited effect on the tenge exchange rate in Kazakhstan.

I think entirely different factors have been moving the tenge. In my opinion, the main influence comes from the currency market itself. More and more economic agents, including the state and quasi-state companies, prefer to borrow on external markets, and when that money comes into the market, it is converted into tenge. That is what is strengthening the tenge.

The only asset that could have increased the pressure on the currency market is gold. Here the effect is direct and immediate, because the National Bank is doing the mirroring, which was absolutely the right decision once this flaw was discovered, a flaw that also contributed to higher inflation. Let me explain the essence. All gold in Kazakhstan can be bought only by the National Bank, which can then sell it on external markets. Previously, when the National Bank bought gold, which it does for tenge, gold producers would take that tenge and buy up dollars in various ways: paying dividends, meeting their foreign currency obligations, and so on. This showed up immediately in the tenge exchange rate, which rose, and through it in inflation. Then this was understood, and the National Bank began selling currency on the market in the amount of its gold purchases, which neutralized the effect on the tenge exchange rate. Given that the price of gold has risen by more than 50% over the year, when buying gold the National Bank has had to sell more dollars under this rule, and the effect on the tenge exchange rate is now much greater.

What next, and what should we expect from the tenge? This question concerns everyone. First, I would say that, fundamentally, the tenge will always depreciate against the dollar as long as inflation here is higher than in the US or in neighboring countries such as Russia and China. The current appreciation is therefore a short-term effect, and a rebound could come at any time. Second, as a rule, the main import payments begin precisely in the second quarter and then keep growing. Third, as soon as the rate is cut, or a signal of a cut appears, non-residents will start to lock in profits and gradually reduce their positions. These are the factors that will work against the tenge. On the other hand, high energy prices will begin to reach the market, to a limited extent and directly, in the summer, as will gold prices. These are factors that will support the tenge. Also, if external borrowing grows, that too will contribute to the tenge's appreciation.