The world is entering a “new era” of low oil prices that will sweep away currency pegs in crude-producing nations, according to the prime minister of Kazakhstan, which roiled markets this week with a surprise decision to abandon control of its exchange rate.
Central Asia’s biggest energy producer cut its currency loose on Thursday, triggering a 22 percent slide in the tenge to a record low versus the dollar. The move followed China’s shock devaluation of the yuan the week before, which drove down oil prices on concern global growth will stutter and nudged nations with managed exchange rates toward competitive devaluations of their own.
“At the end of the day, most of the oil-producing countries will go into the free-floating regime,” including Saudi Arabia and the United Arab Emirates, Karim Massimov said in an interview on Saturday in the capital, Astana. “I do not think that for the next three to five, maybe seven years, the price for commodities will come back to the level that it used to be at in 2014.”
More than $3.3 trillion has been erased from the value of global equities after China’s decision spurred a wave of selling across emerging markets. Brent crude touched a six year-low of $45.07 per barrel on Friday, while the Dow Jones Industrial Average entered a correction. The sell-off continued Sunday in Middle Eastern stocks, with Saudi Arabia’s index entering a bear market as equities sank from Dubai to Israel.
“After I watched what is happening on the financial market and stock market in the U.S. on Friday night, I thought that we did it at the right time,” Massimov, 50, said in his office in the government’s headquarters. The decision avoided “big speculation and pressure this weekend in Kazakhstan,” he said.
The central bank spent $28 billion this and last year to support the tenge, including $10 billion in 2015, Kazakh President Nursultan Nazarbayev said this week. After its slump on Thursday, the currency rallied 7.4 percent to close at 234.99 against the dollar a day later. The country’s dollar bonds due July 2025 climbed after the announcement, lowering the yield nine basis points to 5.74 percent in the last two days of the week.
Before the currency shift, Kazakhstan was at a competitive disadvantage to Russia, its neighbor and top trading partner along with China. The tenge had fallen by only 7.6 percent against he dollar in the 12 months up to Aug. 20, compared with a 46 percent depreciation for the ruble, while crude had plummeted 55 percent in the period.
Commodity weakness means Kazakhstan’s record $4 billion foreign bond sale in July will be its last for the next three to five years, Massimov said. Instead the government will raise funds on the local market to cover the 2016 budget deficit, he said. Brent at about $40 to $45 a barrel next year will leave the government with a shortfall equivalent to 1.6 percent of gross domestic product, he predicted.
The fiscal pressure may hasten reforms aimed at reducing the country’s dependence on energy exports. Bringing the tenge’s free float forward from its original start date of 2020 is one step on that path, he said.
“Structural reforms, plus new economic policy will help us to change the structure of our economy, to adjust with the current situation,” he said.
Eventually, the world’s biggest oil producers will follow Kazakhstan’s example and use devaluations to support their budgets as they compete for customers by keeping output high and prices low, Massimov predicted.
“At the end of the day they will have to do that,” he said. “They are working for their market share, not for the price.”
Traders have been increasing bets that some currencies may be allowed to devalue in the six-nation Gulf Cooperation Council, which includes the United Arab Emirates and Saudi Arabia, the world’s largest oil exporter.
One-year forward contracts for the Saudi riyal jumped to the highest since 2003 last week, indicating some speculation the kingdom may adjust its peg of 3.75 riyals to the dollar. The country’s foreign reserves have dropped five months in a row and the government faces its second annual deficit amid the plunge in oil, which makes up 90 percent of Saudi Arabia’s revenue.
The reaction in the Saudi forwards market may be “overdone,” Barclays Plc economists including Alia Moubayed wrote in an Aug. 21 research note. There remains ample liquidity in the banking market and the government’s external and domestic buffers remain solid, they said. Citigroup Inc. economist Farouk Soussa called the increase “unwarranted” in an Aug. 13 note.
Similar contracts for the U.A.E.’s dirham also surged last week, to the highest since 2009. The country, whose currency is set at about 3.67 per dollar, is home to 6 percent of the world’s proven oil reserves. The central bank last year ruled out changing its peg even after oil dropped by about 50 percent from its peak.
The U.A.E. and Saudi Arabia are among five GCC countries that keep their currencies pegged to the dollar. Kuwait links its dinar to a basket.
Amid the turmoil in the global currency markets, Massimov sticks to a tried and tested strategy when it comes to his personal finances. The former head of Kazakh lender Halyk Savings Bank prefers to spread the risk by holding his cash in a variety of currencies.
“I keep my personal currency as a basket,” he said. “I used to be a banker myself and I believe in a free market.”