Turkmenistan: Price and welfare considerations of exchange rate unification

1
Turkmenistan Price and welfare considerations
of exchange rate unification

• Prepared by World Bank Economic Mission
• December 2007

2
Outline

• Introduction purpose, focus on welfare effects,
  rationale for the case studies and relevance for
  TKM
  
• Belarus and Libya
• Mexico
• Iran in 1993 and 2002
• Possible relevance and implications for TKM
• Price and welfare implications
• Fiscal and welfare implications
• General discussion

3
The case of Belaruscontext and approach

• By the second half of the 1990s Belarus had
  developed a multiple (5 markets) exchange rate
  system
  
• The approach began in late 1999 with
  liberalization of the parallel markets and the
  administered exchange rates
  
• In 2000 the government tightened monetary policy
  and further depreciated the official rate, with
  unification in September 2000

4
The Case of Belarus welfare effects

• The main welfare effect was a significant
  pass-through of depreciation to inflation in the
  short term
  
• The depreciation of the parallel rate drove
  inflation (in late 1998 and late 1999 inflation
  rose to nearly 350 by late 1999, but then fell
  gradually and consistently)
• The depreciation of the official rate caused
  limited pass-through to inflation as consumer
  goods already reflected the parallel rates and
  because of price controls
• After unification, fiscal and monetary policies
  reduced inflation to single digits by 2005
  
• Negative welfare effects were mitigated by
  reflection of parallel rate already in market
  prices, price controls, subsidies (e.g.
  utilities), and tighter monetary policy, though
  spike in inflation created negative short term
  consequences

5
The case of Libyacontext and approach

• Before unification Libyas foreign exchange
  regime was subject to restrictions and rationing
  
• Unification was gradual, starting in the late
  1990s, with full unification taking place in Jan.
  2002 (convergence strategy)
  
• The official rate was devalued incrementally over
  time
  
• The parallel (special) market was legalized and
  more transactions were transferred to it, and
  monetary policy supported appreciation of the
  special rate

6
The case of Libyawelfare effects

• The negative welfare effects were limited because
  the revaluation of exchange rates was not fully
  passed-through to prices.
  
• Further measures were taken to mitigate the
  negative welfare effects of unification
  
• Public enterprises were exempted from all taxes
• Large share of the CPI basket (nearly ¼) had
  administrative prices, with subsidies to cover
  the difference between market cost and
  administrative price
• Prices of domestically produced goods and
  services, including utilities and social
  services, were given subsidies from the budget
  
• Further, inflation was kept low after
  unification, due to prior appreciation of the
  special rate, low level public sector wages (due
  to subsidies), and trade liberalization.

7
The case of Mexico, 1987

• A case of ER unification in time of a crisis
• ER unification was part of comprehensive
  stabilization plan.
  
• aimed to bring down inflation rate (150 in
  1987).
  
• Dual exchange rate was not very deep (black
  market premium at 17-30 range during the 1980s).

8
The case of Mexico Social and welfare effects

• Difficult to disentangle due to waves of crises.
• General subsidies were cut without introduction
  of effectively targeted alternatives.
  
• Support for core education and health services
  was done poorly as evidenced by the slower
  progress and education indicators.
  
• Some studies cite that infant and preschool
  mortality caused by nutritional deficiency rose
  in the 1980s.
  
• Other evidence suggests that the decline in
  incomes has been accompanied by a reduction in
  private school enrollment.

9
Iran, 1993

• 4 exchange rates, wide spread. Large private
  sector, food and commodity imports at appreciated
  rates at the beginning. ER was not truly unified
  as imports at old appreciated rate continued.
• Initial conditions for unification weak
  softening oil revenues, fiscal and monetary
  policies loose, high external debt and imports,
  unified rate too appreciated these led to
  questions about timing and sustainability.
• Welfare was influenced by strong leakages into
  still subsidized imports and special treatment
  for foundations.
  
• Politics was not supportive no consensus on
  unification, opposition from foundations,
  conflict of interest as they had strong interest
  in the status quo.
• The coupon system had inadequate coverage, had to
  be supplemented by price controls. No employment
  programs.
  
• Problems with pace of unification.
• All of this led to collapse in a few months.

10
Iran, 2002

• 3 exchange rates. Key differences were better
  preparation on the rate, monetary policy and
  liquidity control (facility at central bank) and
  external position. Imports shifted to parallel
  rate prior to unification. Rising oil revenues
  and balanced budget.
• Welfare authorities assumed entire cost of the
  subsidies on the budget on essential items using
  their local currency oil revenues.
  
• Explicit subsidies for food imports.

11
Price and welfare

• Main sectors to consider for welfare analysis
  are
  
• industrial and construction (government and
  private)
  
• agriculture
• services
• other private sector.
• Also welfare of consumers of food and public
  services.
  
• Factors affecting Turkmenistan
• most items in parallel ER already
• Turkmenistan enjoys a highly advantageous
  starting point external reserves and debt
  fiscal surplus already existing large subsidies.
  
• Need to draw a firm distinction between ER
  unification and subsidies policy in Turkmenistan
  case.

12
Main welfare effects

• Main welfare effects arise from two price
  shifts.
  
• Official ER higher input/import costs for
  government/SOE industry, construction. But
  output prices will also rise, some activities
  will become competitive, new potential imports.
  Greater efficiency and fiscal transparency.
• Parallel ER private sector imported input prices
  will fall, but output prices will also fall.
  Effect on production, profits, employment.

13
Main welfare effects (cont)

• Main welfare effects are surprisingly modest and
  largely beneficial for the consumer and for those
  with lower living standards.
  
• But effects from (temporary) reduced output in
  the private sector from appreciation needs to be
  studied when more data is made available. There
  will be additional budget manat resources for
  additional social spending if needed and spot
  interventions for strictly temporary periods in
  sub-sectors with acute adjustment pressures.

14
Other welfare effects

• The agriculture sector will have largely lower
  input costs. Special attention to cotton
  farmers, cotton exports and textile industry.
  
• Other public policy welfare issues
• Surrender requirements, taxation and debt.
• Welfare implications of the pace of ER
  unification. Hoarding and speculative imports,
  credit implications.
  
• Giving the public confidence in the new ER
  regime. Banking sector and monetary policy
  implications. Need to assure convertibility for
  the public at all times to give confidence to ER
  policy change.

15
Fiscal ConsiderationsMain Issues

• Unification will cause direct fiscal effects
  aggregate state revenue will likely increase.
  
• Given Governments policies on subsidies of basic
  goods and services, unification will require
  increased spending on subsidies to offset the
  higher cost of inputs
• Additional subsidy costs are likely to be less
  than additional revenues generated
  
• Unification may also generate higher inflation
  and some displacement of workers
  
• If fiscal remedies are considered to address
  inflation and displacement, they should be
  designed to minimize inefficiencies.

16
Effects on Aggregate State Revenue

• The net effect is likely to be positiveaggregate
  state revenue should increase by a moderate to
  significant amount

17
Subsidies, Inflation, and Employment

• Given the policy to maintain free or symbolically
  priced goods and serviceselectricity, petrol,
  bread, public transportationan increase in
  subsidies would be required to offset higher
  imported input costs.
• Unification would displace some workers while
  creating new jobs for others, but the net effect
  would likely be some displacement
  
• If the Government decided to support public
  enterprises with input subsidies, efficiency
  considerations would argue that the subsidies
  should be modest and temporary.
• Unification would generate some pass-through of
  devaluation of the official rate to higher
  inflation, but this would be limited by
  countervailing factors
• Greater spending from higher revenue would also
  create inflationary pressure, which would erode
  the real value of wages and lead to pressure for
  higher wage increases.