Wednesday, March 04, 2009

Pressure on the Dram

For much of the past two years, deposits in Armenia's banks grew an average of 30 percent per annum. From November 2008 onward, however, the growth shrunk to about 8 percent. This is still a healthy growth but quite telling of the flow of capital into the country.

Bank Deposits, annual percent change

What is equally interesting is that depositors seem to have developed a preference for foreign exchange and shifted away from the Dram. In January, demand deposits denominated in Drams fell by 26 percent. In contrast, foreign exchange (FX) denominated deposits grew by 34 percent.

Demand Deposits, annual percent change

Similar to demand deposits, Dram denominated time deposits fell by one percent while FX denominated deposits grew by 64 percent in January.

Time Deposits, annual percent change

The move away from the Dram seems to have elicited a response from the Central Bank (CBA). For much of 2007, CBA has pursued foreign exchange intervention policies that could be interpreted as aimed at weakening the Dram. The most dramatic of these is the acquisition of some $173 million in November of that year. But the intervention in the past few months, particularly in light of the above shift in deposits, moved CBA in the opposite direction with the sale of $185 in December 2008 and $149 million last January.

Foreign Exchange Intervention

Of course there is a limit to how much CBA can intervene. Dipping into foreign exchange reserves may not be sustainable if cash inflows continue to decline and the flight to stronger currencies expands. It is a matter of supply and demand, and there is little that the CBA can do about it. The CBA announcement yesterday that it would not a pursue a "managed float" exchange rate policy was unavoidable. The backing of the IMF and the WorldBank is critical at this stage, but the question remains whether the public will stomach the inevitable short run inflation.

Foreign Exchange Reserves

Good sources of data on exchange rates and financial indicators include CBA and IMF (above) and both provide a statement on the shift in the Dram policy. Vahe Heboyan has a very nice paper on the value of the Dram, and a recent IMF study (page 20) extends the analysis to foreign exchange intervention.

Added March 10: Reserves dropped to $1141 million in February from 1585.3 at the end of September, and from 1259.5 in January. Source: CBA

April 28: February intervention was $251.5 million. Total intervention Oct-Feb of $691 million, and Dec-Feb of $586 million. Source: IMF


Ara said...

The CBA started selling US dollar reserves during October. They continued to sell US dollar during November and then the sale of U.S. dollar increased significantly during December and January and most probably during February. The timing corresponds to the intensification of the world financial and economic crisis during last fall. It is not clear to me why the CBA continued to support the Dram during November, December, January and February and decreased its foreign reserves and then was obliged to depreciate Dram drastically in one day generating economic crisis and hardship for the middle class and low income families.

During November most economists in the world were expecting that the economic crisis in the U.S and Russia will continue for some time. If the CBA knew that the relative demand for Dram with respect to the U.S. dollar will continue to decrease, then why did they continue to support the Dram causing the shock of March 2? Why the CBA didn’t start floating the Dram starting November, when they knew that they couldn’t continue to support the Dram? If they did float the Dram then, the shock wouldn’t have occurred and the depreciation would have been gradual.

One argument given by the Armenian authorities in defense of sudden depreciation of Dram, instead of gradual, is that gradual depreciation could increase negative expectations. The public might expect further devaluation of Dram, which could cause instability. Another argument that they are providing is that gradual depreciation starting last year’s November, could have cause speculators to become active, generating instability in the foreign exchange markets.

It is not clear to me that why after March 2, speculators wouldn’t speculate that the Dram would continue to lose its value, because the underlying causes still are there such as the reduction in remittances and the decrease in exports. Currently the authorities are promising to maintain the value of Dram in the range of 360-380. During the next few months the pressure on Dram would again increase and now everyone would speculate that in few months another major devaluation would occur and Dram would once again lose its value drastically. In general authorities could surprise the public only once! The alternative is for the CBA to allow managed gradual depreciation, which could implies that in few month the acceptable range for Dram could increase to 370-390 or to 380-400. If this is the official policy, then why they didn’t start implementing this policy in November and avoid the shock of March 2?


David said...

It looks like another $118 million was spent in February. Amazing!

CBA's policy strikes me as more of an attempt of trying to catch falling knives. They can see what was happening with deposits! This is gamble that CBA could not (did not) win and certainly ill afford. Currency interventions seldom pay off!

One interesting observation is that this episode took place at a time when the dollar has been strengthening. The Euro is worth today the same it did a year ago!