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Dealing with pressure on Manat.

Ashgabat, 24 August 2015 (nCa) -- On 20 August 2015, Kazakhstan decided to do away with the dollar-pegged exchange rate and allow Tenge to free float as per market conditions.

The structure of free float decision

In free float scenario, the value of Tenge will be determined by supply and demand in the FX (forex) market.

The National Bank will retain the right to intervene if the financial stability of the country is in danger. This means that Tenge will not be in absolute free float mode; the ability of National Bank to intervene makes it conditional float, also called dirty float.

The immediate effects of free float decision

The exchange rate of Tenge against US Dollar plunged from 188 to 256 by the middle of Friday, marking about 23% decline in Tenge value. Some market reports suggest that Tenge had lost 29% of its power by the end of trading hours on Friday but this is mostly speculative because most of the major forex markets close after the closing hours in Kazakhstan. The Tenge will take at least a week to show some signs of stability and it might even gain some of its lost power by that time.

The credit rating agency Fitch praised the decision of Kazakh government. The current Fitch rating of Kazakhstan is BBB+/Stable which might be upgraded in October 2015 when Fitch reviews the performance of the economy of Kazakhstan and Tenge.

The Kazakh stocks trading in the London stock market (FTSE) gained by up to 20% by the end of trading hours on Friday. -- FTSE-250 listed Kaz Minerals rose more than 20pc in early trading and closed up 14 per cent to 177.4p, AIM-listed Central Asia Metals rose 5 per cent to 160p and Kazakhstan-listed KazMunaiGas Exploration Production's London-traded shares rose nearly 5 per cent.

ADB announced US Dollar One Billion loan to Kazakhstan which helped bolster confidence in the medium and long term prospects. The announcement came the same day as the decision to free float Tenge.

Lukoil PJSC has finalized a $1.09 billion deal to sell its 50% share in Caspian Investments Resources Ltd. to Sinopec. Even though the decision was cleared in July this year, the announcement coinciding with the Tenge free float contributed to a net impact of optimism.

Implications for Turkmenistan

In order to forecast the likely impact on the Turkmen Manat, it is essential to understand the factors that led to Tenge free float decision:

Russia is one of the main trading partners of Kazakhstan. Both Russia and Kazakhstan serve as reciprocal supplier and market to each other. Since November 2014, the Russian Ruble has lost more than 40% of its power. This created an asymmetrical situation -- the Russian imports into Kazakhstan increased and started usurping the space from the local products whereas the Kazakh exports to Russia found it hard to retain their share because of diluted Ruble.

China is another important partner of Kazakhstan. The Chinese Yuan (RMB) recently shed 3.5% of its value and it may still not be off the chopping block yet. The slimmer Yuan was another source of concern for Tenge.

The core reason for Tenge slash, as explained by President Nazarbayev on 19 August, is that "everyone should recognize the fact that oil is likely to remain US $ 30-40 per barrel for the foreseeable future." -- The foreseeable future here is probably mid 2016, when the Iranian oil is expected to enter the markets in quantities that can further devastate the prices. The indications are that Iran will try to flood the markets with its oil even if that means driving down the price to as low as $ 20 per barrel. -- For proper context, Brent was $ 102 in November 2013 but has sunk to $ 46 as of this week. And, a number of analysts are predicting that it could crash sink below $ 40 if the conditions remain the same.

The sharp decline in the global oil and commodity (including metal) prices has caused about 40% decrease in the Kazakh exports between January and July this year.

Kazakhstan has spent $ 28 billion in 2014 and 2015 to defend Tenge but it is a pointless endeavor. It was a heavy drain on the National Oil Fund, which is not being replenished adequately because of the low oil prices and smaller demand.

Kazakhstan depends on hydrocarbons for nearly half of its GDP. The bulk of the other half comes from non hydrocarbon exports including wheat, Uranium, metals, commodities, and a wide assortment of products and services. The free floating Tenge may help it maintain competitiveness in export markets.

With currencies eroding around the edges in a number of countries such as Russia, China, Vietnam, Malaysia, and Kazakhstan, the Turkmen Manat will definitely come under pressure.

The hydrocarbon sector in Turkmenistan contributes about 90% of GDP. Assuming that oil remains below $ 40 -- and gas prices are tied to oil prices -- the revenues in 2016, at best, may not differ greatly from this year.

Meanwhile, we are nearing the last quarter of 2015 when the state budget for 2016 must be calculated on realistic oil prices, allocations must be made for TAPI which will enter implementation phase soon, funding must continue for TAT rail and ongoing internal transport and oil and gas infrastructure development, settlement for projects that will be completed next year and a host of other significant heads.

When viewed as a single structure, this is an enormous challenge.

However, when broken down into its component parts, there are several ways to deal with it without getting hurt.

Letting the Manat free float is not an option. The Forex market in Turkmenistan is comparatively small and as such prone to manipulation. Moreover, there is no wide base of non-hydrocarbon export products to benefit from a free floating Manat.

Increasing the currency band i.e. lower floor and higher ceiling in daily trading of Manat would be risky. It will keep sending jitters without giving any significant benefits.

The best course would be to introduce a carefully calculated devaluation of Manat, possibly in two phases. For this, there is first the need to wait and see for at least another few weeks.

During this period it would be helpful to plot and analyze the performance of Ruble, Yuan, Tenge and some other currencies that matter to Turkmenistan.

Simultaneously, an eye must be kept on the Fed rates. The US Fed is likely to hike interest rates, which will make the treasury bonds somewhat more attractive and strengthen dollar. The announcement was expected to come in September but it has reportedly been delayed because of volatility in the world currency markets. The timing and extent of the hike, when it takes place, will be important. Too soon and it could hasten the domino effect; too late and it could accelerate the currency swap trend, bypassing the dollar.

The Manat should be devalued only when it becomes clear that it is not tenable anymore at its current exchange rate. The softening of Manat, if the government decides to take this step, would actually be beneficial at several levels. For one, it will allow for generation of more Manats for every dollar in foreign exchange earnings. Moreover, it will automatically discourage the import of certain items for which substitutes are available locally.

Simultaneously, loans must be negotiated quickly for the major projects such as the national hydrocarbon and transport infrastructure development, the TAPI and TAT rail and other expected commitments.

Also, efficiency and accountability must be injected quickly into the power generation and export sector. Turkmenistan has already started this process, and if done right, it will help bring additional foreign exchange revenues as early as the second half of 2016.

The idea of negotiating temporary barter deals to ease the pressure on currency should also be considered.

For the foreign partners of Turkmenistan, it is important to recognize that any liquidity crunch caused by low oil prices and pressure on Manat is a temporary state of things. The national and mineral wealth and the partnership potential of Turkmenistan remain intact.

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Publication:News Central Asia (Ashgabat, Turkmenistan)
Date:Aug 24, 2015
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