umnik
12-20-2000, 06:12 PM
This is one part of my term paper on Uzbekistan. Please tell me what u think and if u want i can publish entire paper (24 pages) together with reference page.
Multiple Exchange Rates
Lack of foreign exchange has always been present in Uzbekistan. After sum was introduced in 1994, government has granted 1 400 companies unlimited access to the foreign exchange market. In 1996 bad weather negatively affected cotton harvest, reducing government foreign exchange earnings. Due to falling world commodities market prices government revenues have been already declining and low cotton harvest created even larger shortage, forcing government to make prompt decisions. Under freely fluctuating exchange rates a sharp decline in international reserves would cause depreciation of home currency and the establishment of a new exchange rate. Fearing that rigid Uzbek economy would not be able to adjust and trying to prevent drainage of international reserves, the government without any notice, canceled its previous currency arrangements and introduced multiple exchange rates (MER) regime 22.
Reasons for MER
MER is a complex system of different exchange rates for different transactions, where the government rations the usage of foreign currency. Historically government adopts MER regime to manage its international debt payments, to subsidize import prices, to maintain overvalued currency and to keep international reserves. While this strategy is proven to be effective in attaining these objectives in the short run, in the long run it will distort in the patterns of consumption and production. In addition to that it taxes export sectors through the overvalued exchange rate and subsidized imports. According International Monetary Fund, agriculture was the major loser (almost 6% of GDP) from MER 23.
Structure of Foreign Exchange Market in Uzbekistan
The foreign exchange market in Uzbekistan can be divided in two parts official and unofficial 24. Official market has on the supply side government organization, Republican Monetary Commission (RMC); on the demand side there are certain importers of capital goods, raw materials and companies that are servicing contracts on government guarantees. Also importers of high priority food items that are not produced in Uzbekistan are given the right to exchange currency at government exchange rate. A major source of the currency for the government is receipts from centralized exports of cotton and gold. Another portion of foreign exchange reserves comes from compulsory sale of foreign earnings by companies to the government at the official rate. Companies that export their production had to surrender 30% and later from January 1999, 50% of their foreign currency earnings to the government. Only limited number of buyers has access to this market where Uzbek currency is sold at heavily appreciated exchange rate.
A similar picture can be observed at the commercial bank foreign exchange market, the second part of the official foreign exchange market. Technically, the forces of demand and supply should determine exchange rate set at this market. However in reality the commercial bank exchange rate was calculated based on the following formula: official exchange rate + 12% margin. Even after 12% margin was abolished in 1998, difference did not widen 25. To be eligible for this rate each buyer should be approved by RMC, and given quota. Although appreciation of this rate was a little bit lower due to the 12% margin, rate was low as well. Individuals were allowed to buy limited quantity ($50-$100) of the foreign exchange at this rate and only for certain purposes such as tourism.
The third market is the unofficial exchange rate market. It is often called bazaar rate in Uzbekistan because foreign exchange can be bought and sold on the local markets (bazaars) together with fruits and vegetables. This is the most democratic, and the most liberal foreign exchange market in Uzbekistan, where everybody can buy and sell currency without any government intervention. However selling and buying currency at this market is very risky, because officially it is illegal and nobody can guarantee the authenticity of dollars. Local population is most vulnerable to the forgery because locals often do not know English, and rarely see dollars.
There are people who specialize at this illegal trading, making decent living on spreads between buy and sell prices. Spread between buy and sell prices is currently 6-8 sums for dollar and it has been increasing with appreciation of the dollar. Although trading is illegal, foreign currency can be exchanged easily and dealers are seen at the entrances of major markets in the Tashkent and other big cities of Uzbekistan. Most tradable currencies are US dollar, Russian ruble and Kazakh tenge. Although there is no communication among different markets, exchange rates are equal on all major bazaars, ruling out the possibility of arbitrage.
The Effects of MER
The spread between the official exchange rate and the unofficial rate has been widening since 1994 at very high pace, especially after summer 1998, when Russia defaulted on its international payments. Fast appreciation of the dollar makes purchases of dollars a very profitable investment for local population, a phenomenon known as “dollarization of the economy”. For example, if in September 1997 one dollar could be traded for 50 sums, in September 2000 one dollar was equal to 820 sums, an appreciation of more than 1250%, (refer to figure 5). Since inflation during these years averaged to 20-25% annually, inflation alone could not explain such fast appreciation of the dollar. A fast growth could also be an indicator of how desperate local economy is for dollars.
MER resulted in cheap food prices for certain food items that are defined as a high priority by the government. Historically developing countries adopted various currency restrictions to subsidize food prices. Since a large proportion of income in developing countries is spent on food, government tends to subsidize food prices and overvalued currency exchange is one of the simplest ways to accomplish this goal. Overvalued exchange rate also discourages exports and increases domestic supply of goods including food items.
The MER regime is also responsible, at least to a certain extent, for extreme poverty that local population has been experiencing. Since only limited number of goods can be imported at the government exchange rate, local businessmen import rest of goods that are defined as a low priority. Local businessmen so called “shuttle traders” do not have access to the official exchange rate and have to use black market rate to obtain currency for the imports. Due to the fact that Uzbekistan does not have a good industrial base, a lot of consumer items are not produced in Uzbekistan and therefore are imported. Fast appreciation of the unofficial dollar caused rapid increase in prices of imported consumer items leaving local population, whose salaries denominated in sums, in extreme poverty. Local average nominal wages denominated in dollars at the unofficial exchange rate have decreased from $100-120/month in 1997 to $20-30/month in 2000, despite government yearly wage indexation of 40-50%. One can observe almost immediate increase in prices of consumer, non-food, items in local bazaars, once an increase in the unofficial dollar rate has occurred.
MER regime has adversely affected the investment climate in Uzbekistan. Foreign investors could not repatriate their profits back to dollars and even those investors who were granted license for exchange found out that having license does not necessarily mean having conversion. MER was responsible for creating a “vicious cycle” where government, desperate for foreign exchange, introduces stricter and stricter currency restrictions that in turn keep away more and more investors, which in turn makes the problem even worse 26.
The strict political regime, a lack of free speech and a fear to lose jobs, make government officials and local media resistant to acknowledge actual economic conditions. (26). Not only government refused to recognize harmful consequences of the MER, but also it maintained that the government, not market, should be defining what is the high and low priority for the nation. Consider this quote from one government official: “There is also great demand for foreign currency from shuttle traders importing consumer goods of unknown firms, without quality certificates. This cannot be considered sound from an economic point of view. Currency regulation, including restrictions on convertibility, prevents the influx of such goods” 28. Currency regulation actually supported inflow of these goods since high
Multiple Exchange Rates
Lack of foreign exchange has always been present in Uzbekistan. After sum was introduced in 1994, government has granted 1 400 companies unlimited access to the foreign exchange market. In 1996 bad weather negatively affected cotton harvest, reducing government foreign exchange earnings. Due to falling world commodities market prices government revenues have been already declining and low cotton harvest created even larger shortage, forcing government to make prompt decisions. Under freely fluctuating exchange rates a sharp decline in international reserves would cause depreciation of home currency and the establishment of a new exchange rate. Fearing that rigid Uzbek economy would not be able to adjust and trying to prevent drainage of international reserves, the government without any notice, canceled its previous currency arrangements and introduced multiple exchange rates (MER) regime 22.
Reasons for MER
MER is a complex system of different exchange rates for different transactions, where the government rations the usage of foreign currency. Historically government adopts MER regime to manage its international debt payments, to subsidize import prices, to maintain overvalued currency and to keep international reserves. While this strategy is proven to be effective in attaining these objectives in the short run, in the long run it will distort in the patterns of consumption and production. In addition to that it taxes export sectors through the overvalued exchange rate and subsidized imports. According International Monetary Fund, agriculture was the major loser (almost 6% of GDP) from MER 23.
Structure of Foreign Exchange Market in Uzbekistan
The foreign exchange market in Uzbekistan can be divided in two parts official and unofficial 24. Official market has on the supply side government organization, Republican Monetary Commission (RMC); on the demand side there are certain importers of capital goods, raw materials and companies that are servicing contracts on government guarantees. Also importers of high priority food items that are not produced in Uzbekistan are given the right to exchange currency at government exchange rate. A major source of the currency for the government is receipts from centralized exports of cotton and gold. Another portion of foreign exchange reserves comes from compulsory sale of foreign earnings by companies to the government at the official rate. Companies that export their production had to surrender 30% and later from January 1999, 50% of their foreign currency earnings to the government. Only limited number of buyers has access to this market where Uzbek currency is sold at heavily appreciated exchange rate.
A similar picture can be observed at the commercial bank foreign exchange market, the second part of the official foreign exchange market. Technically, the forces of demand and supply should determine exchange rate set at this market. However in reality the commercial bank exchange rate was calculated based on the following formula: official exchange rate + 12% margin. Even after 12% margin was abolished in 1998, difference did not widen 25. To be eligible for this rate each buyer should be approved by RMC, and given quota. Although appreciation of this rate was a little bit lower due to the 12% margin, rate was low as well. Individuals were allowed to buy limited quantity ($50-$100) of the foreign exchange at this rate and only for certain purposes such as tourism.
The third market is the unofficial exchange rate market. It is often called bazaar rate in Uzbekistan because foreign exchange can be bought and sold on the local markets (bazaars) together with fruits and vegetables. This is the most democratic, and the most liberal foreign exchange market in Uzbekistan, where everybody can buy and sell currency without any government intervention. However selling and buying currency at this market is very risky, because officially it is illegal and nobody can guarantee the authenticity of dollars. Local population is most vulnerable to the forgery because locals often do not know English, and rarely see dollars.
There are people who specialize at this illegal trading, making decent living on spreads between buy and sell prices. Spread between buy and sell prices is currently 6-8 sums for dollar and it has been increasing with appreciation of the dollar. Although trading is illegal, foreign currency can be exchanged easily and dealers are seen at the entrances of major markets in the Tashkent and other big cities of Uzbekistan. Most tradable currencies are US dollar, Russian ruble and Kazakh tenge. Although there is no communication among different markets, exchange rates are equal on all major bazaars, ruling out the possibility of arbitrage.
The Effects of MER
The spread between the official exchange rate and the unofficial rate has been widening since 1994 at very high pace, especially after summer 1998, when Russia defaulted on its international payments. Fast appreciation of the dollar makes purchases of dollars a very profitable investment for local population, a phenomenon known as “dollarization of the economy”. For example, if in September 1997 one dollar could be traded for 50 sums, in September 2000 one dollar was equal to 820 sums, an appreciation of more than 1250%, (refer to figure 5). Since inflation during these years averaged to 20-25% annually, inflation alone could not explain such fast appreciation of the dollar. A fast growth could also be an indicator of how desperate local economy is for dollars.
MER resulted in cheap food prices for certain food items that are defined as a high priority by the government. Historically developing countries adopted various currency restrictions to subsidize food prices. Since a large proportion of income in developing countries is spent on food, government tends to subsidize food prices and overvalued currency exchange is one of the simplest ways to accomplish this goal. Overvalued exchange rate also discourages exports and increases domestic supply of goods including food items.
The MER regime is also responsible, at least to a certain extent, for extreme poverty that local population has been experiencing. Since only limited number of goods can be imported at the government exchange rate, local businessmen import rest of goods that are defined as a low priority. Local businessmen so called “shuttle traders” do not have access to the official exchange rate and have to use black market rate to obtain currency for the imports. Due to the fact that Uzbekistan does not have a good industrial base, a lot of consumer items are not produced in Uzbekistan and therefore are imported. Fast appreciation of the unofficial dollar caused rapid increase in prices of imported consumer items leaving local population, whose salaries denominated in sums, in extreme poverty. Local average nominal wages denominated in dollars at the unofficial exchange rate have decreased from $100-120/month in 1997 to $20-30/month in 2000, despite government yearly wage indexation of 40-50%. One can observe almost immediate increase in prices of consumer, non-food, items in local bazaars, once an increase in the unofficial dollar rate has occurred.
MER regime has adversely affected the investment climate in Uzbekistan. Foreign investors could not repatriate their profits back to dollars and even those investors who were granted license for exchange found out that having license does not necessarily mean having conversion. MER was responsible for creating a “vicious cycle” where government, desperate for foreign exchange, introduces stricter and stricter currency restrictions that in turn keep away more and more investors, which in turn makes the problem even worse 26.
The strict political regime, a lack of free speech and a fear to lose jobs, make government officials and local media resistant to acknowledge actual economic conditions. (26). Not only government refused to recognize harmful consequences of the MER, but also it maintained that the government, not market, should be defining what is the high and low priority for the nation. Consider this quote from one government official: “There is also great demand for foreign currency from shuttle traders importing consumer goods of unknown firms, without quality certificates. This cannot be considered sound from an economic point of view. Currency regulation, including restrictions on convertibility, prevents the influx of such goods” 28. Currency regulation actually supported inflow of these goods since high