TOPIC OF THE WEEK: Iran shock reshapes CCA macro dynamics
The Iran crisis has brought to the fore two relevant cross-cutting themes in the CCA related to inflation (monetary policy) and exchange rates.
Regarding inflation and monetary policy, early in the crisis I constructed a simple comparative framework (vulnerability index) that aimed to capture the exposure of the CCA economies to the oil price shocks. Two months into these developments, I review how individual economies are faring in terms of fuel price increases, inflation dynamics and monetary policy.
Relative to my initial assessment, there is but one country, Kyrgyzstan, that has behaved differently than I anticipated back in Mar in terms of expected effect on fuel prices. I had then characterized fuel prices there as unregulated, which, strictly speaking, is correct as there are no formal retail fuel price caps. In practice, Kyrgyzstan, being a member of the Eurasian Economic Union, enjoys some direct benefits from its almost full fuel import dependency on Russia. This has resulted in smaller fuel price increases relative to the other fully liberalized markets of Armenia, Georgia and Tajikistan. It is indeed the first two that have seen the largest increase in the headline CPI as of Apr (Tajikistan Apr CPI is not yet available). Moreover, none of the CCA economies, with the possible exception of Tajikistan, will meet its CPI target this year.
The re-pricing of rate expectations that I anticipated already in Mar has now fully materialized. The National Bank of Georgia was the first to pull the trigger and hike on May 5th. Policymakers in Armenia and Azerbaijan have recently kept rates unchanged, but ramped up anti-inflation rhetoric, suggesting that hikes there may also be in order. The more muted nature of fuel price increases in Uzbekistan may still be consistent with some easing into year-end, but by much less than the 200bpts I foresaw at the start of the year. Kyrgyzstan has been hiking in any case and independently from the Iran events as the economy has been showing tell-tale signs of overheating. Finally, I see Tajikistan also looking into tighter policy on very strong growth and, now, higher fuel prices.
As for the second theme, exchange rates, higher oil prices have also provided a fillip to the Russian RUB. My readers are well aware that, over the last year I have consistently argued that the strong links between Russia and the CCA have translated into significant weakening of domestic (CCA) currencies vis-a-vis the RUB, which has in turn resulted in compensating strengthening of CCA currencies vs the US$. This process has traditionally run in the other direction, with headwinds to RUB (vs the US$) transmitting into weaker CCA currencies vs the US$. I think there is now a non-trivial chance of an even stronger RUB in the next couple of months, reflecting the time lag between higher oil prices (in Apr) and incoming oil-related revenues (May/Jun/Jul). This should then reflect constructively on CCA currencies in the short term as a strictly tactical consideration.
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