TURKMENISTAN: NEW CURRENCY POSSIBLE HARBINGER OF

C O N F I D E N T I A L SECTION 01 OF 03 ASHGABAT 001124 SIPDIS SIPDIS STATE FOR SCA/CEN, EEB PLEASE PASS TO USTDA DAN STEIN COMMERCE FOR HUEPER ENERGY FOR EKIMOFF E.O. 12958: DECL: 10/16/2017 TAGS: PGOV ECON EFIN TX SUBJECT: TURKMENISTAN: NEW CURRENCY POSSIBLE HARBINGER OF EXCHANGE RATE ALIGNMENT, BUT LIKELY ONLY IN STAGES REF: ASHGABAT 1056 Classified By: CHARGE RICHARD E. HOAGLAND FOR REASONS 1.4 (B) AND (D). ¶1. (C) SUMMARY: The Government of Turkmenistan has announced the introduction of new currency in 2009. The new notes will be go from one manat to 500 manats, vice the 5,000 and 10,000 manats, which are the notes most common in circulation now. Unlike the current bills, which all carry the likeness of the late ruler Niyazov, only the largest bill will have his picture on it, further signaling a move away from his cult of personality. This currency change could mean that the government intends to align the dual (official and unofficial) exchange rates, something the IMF and other IFIs have been encouraging. Such a step, however, will be difficult. Individuals connected to the government who benefit and have access to dollars at a cheaper rate would resist the change. Various public-sector construction projects that use the official rate in their capital expenditures would also oppose echange rate alignment. Beyond those concerns, moving to a single exchange rate could have an effect on prices and general stability. Turkmenistan officials will no doubt take all these issues into consideration, and if the government decides to align the rates, it will likely take a gradual approach. END SUMMARY. ¶2. (U) On October 11, the Government of Turkmenistan announced that it will introduce new currency in 2009. The new bills will lop off three zeros, be denominated in one, five, 10, 50, 100, and 500 manat notes, and be printed by a British company, De la Rue. Currently, the largest note is 10,000 manat. There are public concerns already that the change will have a negative impact on the exchange rate with the U.S. dollar. The announcement, which appeared in the October 12 edition of the official newspaper, "Neutral Turkmenistan," raised public speculation about whether this may be a first step towards unifying the official (5,200 manat to the dollar) and the unofficial (23,500 manat to the dollar) exchange rates. ¶3. (SBU) Interestingly, only one of the five new bills carries the likeness of former President Niyazov, who died in December 2006. Currently, all manat notes have his picture on them. The other figures on the the face of new bills are historic and cultural figures Turkmen personages. This appears to be further evidence of the government moving away from Niyazov's cult of personality. LOPPING OFF ZEROS ¶4. (C) European Bank for Reconstruction and Development (EBRD) Resident Office Head Tony Myron told DCM on October 16 that previously the government had planned to introduce new notes in 2008, but has decided to delay it by one year. The 500 manat note would be worth $20 at the unofficial rate. Over time, the 5,000 and 10,000 manat notes (which are the bills in common use today) would be phased out, but for a period of time, in Myron's view, both old and new money would be in circulation. One important question, Myron said, will be the amount of each of the new notes in circulation. There will need to be lots of ones, fives, and 10s in order for people to conduct normal, everyday transactions. On the other hand, the number of large bills (500 manat notes) in circulation would have important implications. Myron pointed out that EU countries and the U.S. tend not to have many large denomination bills in circulation because they are generally used for money laundering and illegal transactions. Therefore, it is generally best not to have large numbers of ASHGABAT 00001124 002 OF 003 large bills available. SINGLE EXCHANGE RATE ON THE HORIZON? ¶5. (SBU) During the 2007 Article IV consultations with Turkmenistan, the IMF discussed a number of issues pertaining to the potential unification of Turkmenistan's dual exchange rate system and technical assistance the IMF could provide to the government. According to a report on IMF's consultations with Turkmenistan, the government recognized the existing system has several disadvantages, and it would like to develop a phased approach to unification. The European Union's TACIS Advisor for Turkmenistan Michael Wilson told Econoff October 17 Turkmenistan has been working on a question and answer basis on these issues with UNDP and in consultation with World Bank and the IMF. The Central Bank is running simulation exercises on the consequences of combining the two exchanges. ¶6. (C) Myron noted an International Monetary Fund (IMF) mission is coming the first week of November to discuss a single exchange rate and countries that have in the recent past combined official and unofficial rates (Iran, Belarus, and Uzbekistan, among them). While, in his view, there has been no serious discussion by the government to actually take that step, there have been "vague hints," Myron said. In addition, banks have told him that the government would bring the unofficial rate into the banking system. Nevertheless, nothing about a decision to align the exchange rates has been said in recent government meetings, so he does not believe a change is imminent. Myron does believe, however, the government could make this change in the two years it will take to formally introduce the new currency. THE CENTRAL BANK AND THE UNOFFICIAL RATE ¶7. (C) According to Myron, the Central Bank controls the unofficial or "street" trade in manat. The proof is that the rate has remained relatively stable. Over the past four years, the rate has remained between 26,000 manat to 23,400 manat to the dollar. Myron said the Central Bank sells dollars and buys manat to keep the rate steady. CHALLENGE TO STABILITY ¶8. (SBU) In Myron's view, a move to a single exchange rate would be a major economic reform step. It would present a major challenge to the government, because aligning the unofficial and official rates would affect every aspect of society. Principally, the oil and gas sector, tax revenues, and subsidized housing would feel the brunt. Many people would be affected, and there would be implications for stability. Myron said food prices had risen 24% in the period from September 2006-September 2007 (reftel) and that had led to grumbling in the population. He said the government would want to avoid a "shock" and approach exchange rate alignment very carefully. ¶9. (SBU) Serdar Jepbarov, a World Bank Operations officer, seconded that view separately to post. Jepbarov believes Turkmenistan has enough foreign exchange reserves to be able to curb any possible price spikes. Nevertheless, the government continues to be nervous about the impact of unifying the exchange rates. Another hurdle Jepbarov noted is the existence of various public-sector construction projects that use the official rate in their capital expenditures. He believes that 2009 is too optimistic of a target for eliminating the dual exchange rates. ASHGABAT 00001124 003 OF 003 ¶10. (C) In addition to the effect on the general populace, combining the two exchange rates would likely gore a few oxes. The presence of the two exchange rates has fostered a variety of corruption schemes where individuals with government connections have access to U.S. dollars at cheaper rates. Myron said a whole group of people currently benefit from the current situation, adding to the difficulty of making the change. ¶11. (SBU) COMMENT: The IMF recommended in May that the government depreciate the money and combine the official exchange rate. On the one hand, this would increase the state's budget revenue in manat, facilitating expenditure in the social sector. On the other hand, the government's use of dollars to pay off construction and other contracts means that a unified rate would increase the cost of those off-budgetary dollar investments. Until the government decides to transfer its off-budgetary spending into the budget, the unification of exchange rates will be difficult to undertake. END COMMENT. HOAGLAND