Marking a year of the Local Currency Initiative

By Mike McDonough

It’s a year since the EBRD launched its initiative to develop local currency and capital markets in the region and the Annual Meeting in Astana provided a valuable opportunity to hear what progress has been made over the last 12 months.


At a panel discussion on Friday 20 May, EBRD Vice President for Finance Manfred Schepers invited central bankers from Kazakhstan, Georgia and Hungary to report on developments in their respective countries. He also asked partner institutions the International Monetary Fund and the World Bank and commercial banking heavyweight HSBC to give their views on the challenges that still lie ahead.

“Working with countries in region, we have been looking at macroeconomic policy, the overall financial system and the infrastructure to support currency markets, equity markets and derivative markets, as well as the legal framework,” Mr Schepers said, referring to the multi-pronged approach of the EBRD’s Local Currency and Local Capital Markets Initiative, launched in May 2010.

“The reality is that there is a very fundamental building-block process which is needed and is difficult in this region. It is not only the end result but the pieces of the puzzle that are needed.”

Grigory Marchenko, Governor of the National Bank of Kazakhstan, welcomed the recent signing of an agreement with the EBRD allowing the Bank to obtain tenge and on-lend it to domestic banks. He said short-term saving in tenge had grown but long-term deposits remained highly dollarised. On the credit side, the share of tenge-denominated loans was increasing but credit growth in general was nearly flat as banks used deposits to repay external debts. “We definitely support the EBRD Initiative,” Mr Marchenko said. 

Georgia has one of the highest rates of dollarisation in the world and this remains steep, said Otar Nadaraia, Vice-President of the National Bank of Georgia. Work to reduce it principally involves building local trust in the lari and providing cost incentives: people’s willingness to switch from foreign currency to domestic currency savings rises sharply after interest rates go beyond 4 per cent, according to data.

“The most important thing is inflation stability. If the inflation target is low enough, one should expect nominal appreciation,” Mr Nadaraia said, before adding: “De-dollarisation is very important but should be seen together with other priorities, such as long-term development goals.”

Julia Kiraly, Deputy Governor of the National Bank of Hungary, praised the work of the European Bank Coordination Initiative – widely known as the Vienna Initiative – in tackling the vulnerabilities associated with excessive reliance on foreign currency financing.

“It’s very important from our point of view that this forum reached the conclusion that a country-specific approach was required. There is no universal solution and the Vienna Initiative helped us to understand that,” Ms Kiraly said.

Over the last year Hungary has taken “small steps, but they will help to achieve a macro-prudential framework. As far as foreign currency loan stock is concerned, there is no one-step solution. The consequence of converting the total foreign currency loan stock to domestic currency would be a huge cost.”

Ms Kiraly added that the sovereign debt crisis in the eurozone had underlined the importance of establishing local capital markets. She suggested that only the latter can offer the long-term capital needed to avoid liquidity and funding problems.

The IMF and World Bank have collaborated closely with the EBRD on the Local Currency Initiative over the last year. Mark Allen, who is the IMF’s Senior Regional Representative for central and eastern Europe, noted that smaller countries faced intrinsic obstacles to establishing local capital markets, such as the high cost of setting these markets up.

He agreed with Mr Nadaraia that building trust in local currencies was an essential step. “There are some elementary things that have to be done such as the development of benchmark overnight interest rates that are reliable and which people believe in. Consumer price indexes are crucial to making informed judgements on interest rates. As for the government bond market, there is a clear role for government to develop yield curves by having regular auctions.”

Meanwhile Gerardo Corrochano, Sector Director for Europe and Central Asia at the World Bank, cautioned against expecting too much, too soon from the Local Currency Initiative.

“We have to be realistic as to the potential for implementation and the chances of success,” he said. “These are long-term reforms and it’s likely that little visible progress will be seen in the short term. It will depend on investors and the local population’s confidence in the local currency.”

The prevalence of foreign currency lending and borrowing in the EBRD region has been much criticised since the onset of the financial crisis. But Simen Munter, CEO of HSBC Kazakhstan, said banks were constrained by the volatility of working in local currency.

“If you don’t have local currency deposits you can’t lend them. If you do have them but are not sure if you are going to have them in the future you can’t lend them,” he said. “We can only lend what we have and we price for risk.”

Mr Munter suggested central banks could play a role in mitigating credit risk so that commercial banks could do more local lending and make it more attractive to customers. But he warned that over-regulating as a way of encouraging local currency financing ran the risk of deterring commercial banks from operating in certain countries.