Turkmenistan: next in line to devalue again?

Turkmenistan: next in line to devalue again?
Turkmenistan's President Gurbanguly Berdimuhamedov, who styles himself Arkadag ("Protector"), will have to decide whether to defend the national currency.
By bne IntelliNews February 5, 2016

Gas-rich Turkmenistan, one of the world’s most economically isolated countries, is facing severe budget and currency problems because of the sharp drop in energy prices over the past 18 months. Like its other energy-rich peers in Central Asia, the authorities could be forced to turn to austerity measures and devalue the national currency.

In November the International Monetary Fund (IMF) forecast that the country’s annual economic growth was expected to decline to 7% in 2015 and 6% in 2016, down from 10% in 2014, “mostly due to flat natural gas and oil production as well as reduced budgetary investment”. Turkmenistan’s export of hydrocarbons – its major driver of economic growth and source of foreign currency – is set to decrease to $11.6bn in 2015 and $8.9bn in 2016 from $18.5bn in 2014, the IMF predicts.

“Economic growth has probably been kept going – but at a much slower rate than the 6.7% claimed by the government for 2015 – by public spending, on wages and pensions, and on energy sector infrastructure in particular,” David Dalton, a Turkmenistan analyst at the Economist Intelligence Unit (EIU), tells bne IntelliNews. “The funds for this were accumulated from gas export earnings, but with large spending programmes could soon be run down if energy prices fail to recover as expected.”

In response to the gloomy predictions, the government cut its budget revenue and spending in 2016 to TMT102.5bn ($29.3bn) and TMT104.9bn, from TMT102.8bn and TMT106.2bn in 2015. The Turkmen manat's exchange rate was set at TMM3.5 to the dollar in both 2015 and 2016, after it was devalued in January 2015 from TMM2.85 to the dollar.

A simple comparison of Turkmenistan’s energy revenues and its spending suggests that President Gurbanguly Berdimuhamedov’s government will be under enormous strain to maintain its budget without dipping into special foreign currency funds it built up when energy prices were high, or without devaluing significantly. The EIU estimates Turkmenistan’s assets in foreign banks stand at $27bn at the moment.

State secret stats

With the majority of Turkmenistan’s economic statistics “still classified as a state secret”, it is very hard to get an accurate picture of the real state of economic affairs in Turkmenistan, Kate Mallinson, a Central Asia analyst at the London-based GWP consultancy, argues. “However, the impact of sustained low energy prices on the Turkmen economy, where fuel and energy products constitute 90% of exports, will have been momentous, particularly when the country also faces weakened Chinese demand for gas imports and Russia’s gas import suspension,” Mallinson says. “In spite of positive government rhetoric, state salary arrears, plans to issue government bonds, a big push towards import substitution and reduction in subsidies all point to a much gloomier economic picture in the country.”

In December Gazprom, Russia’s state-owned gas export monopolist, officially suspended gas purchases from Turkmenistan starting from January 2016. It decreased Turkmen gas exports from 45bn cubic metres (cm) in 2008 to 11bn cm in 2010 and further to 4bn cm in 2015 as European demand for Russian gas fell. Gazprom has found itself in fierce competition with China for Central Asian gas after Beijing funded the construction of the Central Asia-China gas pipeline, with a total capacity of 55bn cm a year from Turkmenistan via Uzbekistan and Kazakhstan, and the Chinese are building another branch of the pipeline with an annual capacity of 30bn cm via Uzbekistan, Tajikistan and Kyrgyzstan.

Last year Turkmenistan embarked on ambitious investment projects such as a $10bn gas pipeline to India via Afghanistan and Pakistan (TAPI) and “a large-scale investment programme to build over 220 facilities with a total cost of $18bn”. To fund some of these ambitious projects the Turkmen government announced last October that it would issue domestic bonds, without specifying the details of the issue such as the size and interest rate.

However, in a sign of deepening economic troubles, Turkmenistan was reported to have ordered that at least 12% of employees’ wages should be paid in government securities instead of cash. This crowdfunding experiment is reminiscent of the failed attempt by Tajikistan’s Emomali Rahmon to fund the construction of what would be the world’s tallest dam, Rogun, by selling shares in the project to the population in 2010. However, “if necessary, they could probably also borrow abroad, most likely from a ‘friendly’ government such as China”, the EIU’s Dalton suggests.

Managing the manat

The low inflow of hard currency into the country has also forced the Turkmen authorities to impose a ban on official sales of dollars in the country, giving a boost to the black currency market, and place restrictions on transfers of foreign currency abroad via the Western Union money transfer system, limiting them only to Turkmen students studying abroad and to $1,000 per sender per month. As a result of these measures, the black market exchange rate of the national currency jumped to TMM4.2 to the dollar, increasing a gap with the official rate of TMM3.5 to the dollar.

Mallinson explains that despite traditionally running a budget deficit, the government will not be able to maintain previous spending levels in the current market conditions. However, she notes it is important to understand that not all of the revenue from energy exports reaches the country’s budget, as under the terms of an existing law over two‐thirds of revenue goes into “special extra-budgetary accounts” that are administered by the presidential administration. “These accounts are used to fund a variety of projects but also obfuscate the real economic picture in country,” she says.

Turkmenistan’s less opaque Central Asian peers have reacted to the low energy prices more dramatically, with Azerbaijan increasing budget expenditure and revenue by more than 10% by tapping into the reserves of its sovereign wealth fund, in order to ease social discontent caused by a nearly 50% drop in the value of the national currency in 2015. Under the weight of economic troubles, Kazakhstan was also forced to allow its currency to float freely in August, resulting in an almost 50% loss in value in 2015, but it has said it will manage to maintain its budget in 2016.

Turkmenistan's restrictions on the circulation of foreign currency point to a possible devaluation of the manat. “The government’s recent imposition of currency restrictions underscores justified fears among the Turkmen population that devaluation of the manat is imminent,” Mallinson says. “With the budget almost entirely dependent on gas export revenues, the currency has to drop much further than the 19% it has dropped to reflect the 70% drop in global oil prices over the last 18 months.”

Dalton agrees and expects the Turkmen manat to devalue by “about 30%” in the first quarter of 2016. “The reason the authorities don’t want to devalue is that in an economy with an underdeveloped financial system, a fixed exchange rate is the easiest way to control inflation, whereas a devaluation would boost inflation, by raising the local currency cost of imports,” he explains. “On the other hand, the benefit of devaluation is to preserve foreign exchange reserves without having to keep in place economically damaging currency controls, which just cut off rather than assuage demand for foreign currency in the domestic market, fuelling currency demand on the black market, disrupting imports and deterring foreign investment since foreign firms want to be able to repatriate any local currency profits.”

Turkmenistan could follow Kazakhstan’s approach and adopt a wait-and-see approach for the time being in the hope that recent signs of a rebound in the oil price will become long-lasting. “As energy prices begin to climb, the chances of the authorities being forced into a devaluation will abate,” Dalton concludes.