Russian Roulette by the National Bank

Almaty. September 28. KazTAG - Sergey Zelepukhin. Pessimistic forecasts on the development of the financial market situation following the abandonment of the exchange rate corridor and transfer to a policy of inflation targeting seems to be coming true. Increased liquidity in the monetary market after the introduction of the base rate by the National Bank  and the corridor for it has not resulted in growth of the economy crediting but led to a new rapid decline of tenge.

Secret becomes clear

Wednesday, 16 September 2015, with no exaggeration can be called as  another black day for the currency. On this day, US dollar exchange rate tested the new psychological milestone reaching T300, in fact, it showed unlimited potential for the devaluation of the national currency in case of non-intervention of the National Bank in the situation.
The rapid dive of tenge  called immediate reaction of the regulator. To stabilize the situation, the National Bank went to foreign exchange intervention. According to the country's central bank, in order to maintain the national currency only for three days, from Wednesday to Friday (September 16-September 18) it  sold $ 481.6 million - $ 144 million, $ 270.4 million and $ 67.2 million respectively.
In fact, for the first time the regulator issued a separate press release, explaining the reasons for the intervention of the National Bank on the currency market.
"Due to the increased volatility of the exchange rate of tenge, which is due to speculation of the market players, in the absence of objective and significant changes in the fundamental macroeconomic factors, the National Bank of the Republic of Kazakhstan decided to hold foreign exchange intervention to stabilize the situation on the domestic currency market on September 16, 2015" ,  stated the National Bank.
In fact, the statement of the press service about foreign exchange intervention on September 16 does not mean that it was not carried out before that date. Moreover, the regulator has gone even further, and first began publishing a list of the banks involved in currency trading and the volume of their transactions. Relevant information can be found on the website of the National Bank.
These steps of the regulator can be welcomed, because they increase the transparency of the foreign exchange market, allowing the public to have access to previously unavailable information and to have a general idea of what forces determine the exchange rate in a free floating national currency.

Two steps forward - one step back

At the same time we can not agree with the criticism of JSC "Halyk Bank", which followed the publication of the National Bank of the information about the participants and the volume of currency trading. "Halyk Bank" said it was considered incomplete, misleading and leads to  misinterpretation, the bank called the information on the currency trades in a more correct way. And all because the regulator  made public only the general data on the volume of trade with no breakdown of the amounts of purchases and total sales of dollars for each individual bank.
"We call the National Bank of Kazakhstan to be consistent and to disclose such data of exchange trading by the banks since August 17, 2015. Moreover, the technical capabilities of the Kazakhstan Stock Exchange allow you to publish not only the volume, but also the exchange rates of buying and selling of the US dollar ", said the bank.
But according to the National Bank the call of "Halyk Bank" concerning the currency trading on KASE, on September 17 and 18, " was ignored by the controller. But the question is the fact that by the end of Friday's trading, the main bank in the country was limited to only information on  
the volume of its foreign exchange interventions without providing the data on foreign exchange transactions of banks.

Wherever you throw - everywhere is a wedge

It is disturbing also that intervention alone can not stabilize the situation on the currency market. Proof to this is that after the currency interventions, tenge weakening resumed. Moreover, if on 16 and 17 September the National Bank for its counterattacks against currency speculation made an effort to strengthen tenge, on September 18, on the background of the regulator's interference, the rate soared to 289.48 tenge.
Moreover, the concern is that extensive use of foreign exchange intervention to maintain the tenge leads to a rapid depletion of the reserves of the National Bank ( On 1 September they accounted for slightly more than $ 29 billion - KazTAG), that will ultimately force the  regulator to step back and give fate of the exchange rate of the national currency in the hands of market participants.
However, although these measures are taken, they are ineffective. Judging from the development of the situation in the money market, the regulator is struggling to protect the tenge active open market operations, interest rates holding it closer to the upper boundary of the corridor of  7-17% of their base rate.
We will not be unfounded, but give specific figures. In early September, the  level of profitability of short liquidity in the money market on such  indicators of KASE as TONIA, TWINA and SWAP-1D (USD) was below 10% for the first two  and the third one was below 15%. But by September 14 the first two indicators' yields soared to more than 15% and 14% respectively, and the third - to almost 25%. The average value of these indicators on Friday of September 18 reached 15.66%, 17% and 30.09%, respectively.

The vicious circle of speculation

However, as shown by the results of currency trading on the Kazakhstan Stock Exchange a week before, even maintaining the high yield market, the short-term tenge liquidity, coupled with currency interventions do not allow the National Bank to effectively counter the general trend of the national currency devaluation. And even in the absence of objective reasons for this in the form of a significant reduction in oil prices, a sharp weakening of the ruble and the increase of the US Federal Reserve base rate.
The question arises - why? That's because even a relatively high yield tenge  that prevailed in the money market, is nothing compared with the yield from speculative attacks, which was formed in the currency market.  And it looks as the money market and short-term liquidity are the source for currency speculation. As they say, nothing personal - just business.
To put it simply, the scheme of speculative attacks looks like this: the players take tenge or currency on the money market for the government securities  and then buy dollars on the borrowed amount, which is why the demand is growing, and after that grows the US dollar exchange rate against the tenge. After this, market participants are selling dollars and return the tenge debt on the money market getting the profit from the rates difference. And so the circle works. The more players appear, the higher the demand for dollars is, tenge rate is dropping and profit is getting higher.
In this situation, the National Bank with its interventions can only temporarily stop the high rates of the national currency devaluation by selling dollars from time to time, but it is not able to break the vicious  circle of speculation. At the same time not high volumes of US dollars purchases are needed on the market to boost the dollar rate, while the National bank needs to conduct sale of big volumes of dollars to support the tenge rate.

But the reserves are limited as sooner or later the bank will run out of them, of course, in case the speculative attacks continue. That is why the counterattacks conducted by the National Bank without taking new measures reminded of the Russian roulette.

Time is running out

What conclusions can be drawn from the current situation in the foreign exchange and money market, and the policy pursued by the National Bank?
Firstly, foreign exchange intervention and prevailing interest rates do not only make it possible for the regulator to avoid speculations , but also to reduce them.
Secondly, powerful attacks on the national currency and the counter attacks of the central bank make it impossible to implement the policy of inflation targeting as a fundamental failure to prevent the devaluation of the tenge under the current policy of the National Bank creates conditions for the strengthening of inflationary pressures.
Third, currency interventions, rather stimulate than weaken speculative attacks, leading to waste of foreign exchange reserves of the regulator.
Fourth, high interest rates and volatility in the currency market are not conducive to lending capacity of the economy, and hence economic growth, because even with the current rate the national currency liquidity flows not into the economy, but floats from the money market in the currency one and back.
It's needless saying that the National Bank is again in a difficult situation  which needs to take decisions on the nature of the situation itself. In other words, the regulator has no choice but to choose the lesser of two evils: either to limit the provision of tenge liquidity by tightening the conditions for its provision and a sharp increase in the base rate (now 12%) and its corridor (now it is 7-17%), bringing to sacrifice the currency stability, the ability to increase lending and economic growth; or leave it as it is, which increases the risks of financial instability and waste of gold reserves.
However, there is another way -  administrative one, but it is beyond the competence of the economy and the National Bank and is, rather, the policy which remains in the prerogative of Akorda. But we have no chance to predict which way the authorities will choose. We can confidently assert only that the time has come to make critical decisions in a low efficiency of foreign exchange intervention and the current interest rates in order to stabilize the situation on the foreign exchange market and prevent the depletion of gold reserves . Tomorrow it may be too late. Time does not wait.