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Between elections and pandemic. Why is dollar appreciating?

Situation on the currency market of Kyrgyzstan has been unstable for the 3rd month in a row. The U.S. dollar hits all possible and impossible records. But not only the authorities are to blame for what is happening. A similar situation is observed not only in our country, but also in the neighboring states.

The National Bank of Kyrgyzstan sees a large share of psychological factors in the current situation.

«The National Bank is closely monitoring the situation on the foreign exchange market. Moreover, the National Bank actively participates in the market, offering foreign currency both in non-cash and cash form in order to maintain financial stability. All applications received from commercial banks for the purchase of foreign currency are fully covered by the National Bank. There is no foreign currency deficit,» the National Bank of the Kyrgyz Republic notes.

But we must understand that the exchange rate changes both upwards and downwards. Remember the first half of this year, when the exchange rate, having reached 85 soms for one U.S. dollar, dropped to 74-75 soms by June.

Pressure on currencies is growing

Over the past three months, exchange rate of the U.S. dollar in Kyrgyzstan has grown by 6.5 soms. If at the beginning of September it could be bought for 78.4 soms, then in the last two weeks it costs 84.9 soms. Moreover, the same situation is developing in the neighboring and other developing countries. For example, since the beginning of the year, the Russian ruble has depreciated by 22 percent, the Belarusian one — by 23 percent, the Ukrainian hryvnia — by 20 percent, the Turkish lira and the Argentine peso — by more than 30 percent.

«The pressure on the exchange rates of the member countries of the bank intensified in late October — early November 2020. The growth of cases of COVID-19 infection in the world and the tightening of restrictive measures in European countries have increased the uncertainty about the prospects for recovery of global economic activity, which has resulted in a decrease in demand for assets in emerging markets,» specialists of the Eurasian Development Bank said.

According to the estimates of the Eurasian Development Bank (EDB), as of today, most of the national currencies of the bank’s member states are undervalued against the U.S. dollar and the euro.

Moreover, the space for strengthening currencies this year is limited due to increased risks, including geopolitical ones. The Russian ruble and Kazakhstani tenge still have potential.

Import, coronavirus and riots

A floating exchange rate regime has been in effect in Kyrgyzstan since 1993. This means that the value of a foreign currency is determined by the market based on the balance of supply and demand.

Moreover, such a regime means that the National Bank does not give forecasts for the exchange rate.

Experts explain the current appreciation of the American currency by the fact that in November 2020, there was an imbalance between the supply and demand for foreign currency in the domestic foreign exchange market. It had its effect on the exchange rate. The problems arose against the background of volatility in international financial markets, introduction of repeated restrictions due to the COVID-19 pandemic in a number of countries. The strengthening of the American currency against the som is also associated with traditionally increased demand for it at the end of the year. Right now, entrepreneurs pay under export-import contracts.

As a result, a panic demand for the U.S. dollar is created in the domestic market, which, according to the laws of the market, leads to growth of the exchange rate.

The National Bank also notes that high dependence on imports and deep integration of the Kyrgyz economy into regional trade and economic relations makes its domestic foreign exchange market quite vulnerable to external shocks. The spread of the coronavirus pandemic in the world and a sharp decline in world oil prices, fluctuations in the global financial markets, led to a deterioration in the economic situation. In particular, these events caused pressure on the domestic foreign exchange market and acceleration of inflationary processes in 2020.

The currency surges were stopped thanks to the constant interventions of the National Bank. In November, the National Bank carried out 11 interventions, selling $ 84,750 million. As a result, the exchange rate of som to the dollar stopped growing so sharply. The situation in the foreign exchange market has stabilized.

«We use the available tools and make every effort to keep the som from falling. The mechanisms for setting the exchange rate are very complex, they are related to the internal state of the economy, the situation on world markets is also relevant. There is also a psychological factor in the current situation. In order to reduce it in the foreign exchange market and prevent the som from falling, we conduct interventions,» Tolkunbek Abdygulov, Chairman of the National Bank of the Kyrgyz Republic, said.

The National Bank has made adjustments to its monetary policy.

On February 24, 2020, the National Bank raised its discount rate from 4.25 to 5 percent. After that, due to the quarantine, taking into account also inflation forecasts, it was decided to keep the discount rate at the same level. This was done to support measures to stimulate the real sector of the economy.

«The National Bank regularly analyzes liquidity situation in the banking sector. To regulate it, we carry out both sterilization operations and operations to provide commercial banks with funds in national and foreign currencies.

We closely monitor the situation in the foreign exchange market. The situation is now relatively stable. The public is also concerned about international reserves in connection with our interventions. Here I would like to note that the volume of gross international reserves now amounts to $ 2.8 billion, which covers approximately 5-6 months of imports, and this is a fairly high level according to international standards,» the National Bank of Kyrgyzstan concluded.

Risks of weakening currencies persist

The Eurasian Development Bank notes that the growth of oil prices and recovery of investor’s interest in risky assets as the pandemic weakens will support national currencies in 2021. According to the baseline scenario, the average exchange rate of the Russian ruble against the US dollar is forecasted to be about 74.5, and the tenge — 423.8.

The average annual rates of the Armenian dram, Belarusian ruble and Kyrgyz som against the US dollar next year are forecast close to their current levels — 492, 2.61 and 83.2, respectively.

 «Risks for the forecast are still biased towards worsening. The key uncertainty is the development of the COVID-19 pandemic. Recent reports of progress in the development of effective vaccines have raised optimism in the financial and commodity markets. At the same time, the tests continue, and the conditions for transporting the vaccine are difficult,» the EDB reminds.

If the meteoric infection is not quickly curbed, and rollout of the vaccines is delayed, the loss to economic growth will be much more severe. Currencies may find themselves under pressure again due to the growing global uncertainty and the departure of investors to «protective» assets.

According to EDB estimates, the som is currently undervalued to the US dollar and the currencies of the main trading partners. The EDB also expects that the exchange rate will be corrected to the equilibrium level amid the normalization of the epidemiological and geopolitical situation in the world until mid-2022.

There is only one conclusion: it is necessary to diversify savings. And if we live in Kyrgyzstan, then our savings should also be in Kyrgyz soms.

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