Depreciation Model Case of Russia and Kazakhstan May Mavzuna Turaeva, Kwang Jae Sung GAMS MODEL PROJECT SPRING 2014

1 Introduction Dependence of a smaller economy upon a bigger economy (Russia-Kazakhstan) Russia’s devaluation of currency Subsequent trade shock in Kazakhstan due to a decrease in demand for their export in Russia Monetary approach to recover the trade deficit affecting the smaller economy Objective of the project Demonstrate trade tax symmetry theorems using GAMS model Construction of a GAMS model simulating the depreciation of currency under different scenarios On February 11 th 2014 the National Bank of Kazakhstan has decided to stop maintaining the value of tenge at the previous level by reducing the volumes of trades in the foreign exchange market and interference in the process of tenge exchange rate formation. In his statement the chairman of NBK laid out several reasons why the National Bank decided to stop maintaining the value of tenge at the previous levels among which was Russian rouble remains volatile. In 2013 the Central Bank of the Russian Federation adopted a freer exchange rate and the value of rouble weakened by 7.1% against U.S. dollar.

2 Introduction - theorems Applicable trade tax theorems Theorem 2 An a percent change in the tax factor on any balance of payments item is symmetric to a - a percent change in the subsidy factor on it and. an a percent change in both the tax and subsidy factors on it is neutral. Theorem 6 The Generalized Meade-Ruffin Symmetry Theorem An a percent change in all net tax factors on non-monetary credits combined with an a percent change in all net subsidy factors on non- monetary debits is symmetric to an a percent change in the price of domestic currency. Theorem 7 The Generalized Meade-Ruffin Neutrality Theorem An a percent change in all net tax factors on non-monetary credits combined with an a percent change in all net subsidy factors on non- monetary debits and an a percent appreciation of the domestic currency is neutral.

The Balance of Payments Approach to Trade Tax Symmetry Theorems Author(s): William H. Kaempfer and Edward Tower Source: Weltwirtschaftliches Archiv, Bd. 118, H. 1 (1982), pp Published by: SpringerStable URL: Accessed: 21/02/ :40 3 Reference

4 Methodology Key Assumptions Two-country model: Russia and Kazakhstan Endowment Economy Two commodities produced (Commodity 1: Mineral / Commodity 2: Consumer products) Analysis from the smaller economy’s perspective (Kazakhstan: Country A, Russia: Country B) a. prices of Kazakhstan goods are fixed at the world prices b. Kazakhstan uses the proceeds from exports in order to pay for imports Trade balance is exogenous

5 Parameters ParameterSpecification AlphaShift parameters in Utility Beta(I)Share parameters in Utility PW(I)World Prices PD0(I)Domestic Prices U0Initial Utility level C0(I)Initial Consumption levels X0(I)Initial trade flows Q0Initial output levels GDP0Initial GDP is0Import subsidy it0Import tax es0Export subsidy et0export tax Y0Initial Money Income TB0Initial Trade Balance Si0Import subsidy factor Ti0Import tax factor Te0Export tax factor Se0Export subsidy factor A0Border tax adjustment factor RPD0Relative domestic price of import RPW0Relative world prices E0Exchange rate Tenge per Ruble CPI0Inflation Table A: Summary of parameters

6 Initial Values Table B: Summary of initial values Initial Values Assigned and Computed PW(I)=1 PD0(I)=PW(I) RPD0=1 RPW0=1 Q0=100 is0=0.2 it0=0 es0=0 et0=0 Se0=(1+es0)/(1+et0) Te0=(1+et0)/(1+es0) Ti0=(1+it0)/(1+is0) Si0=(1+is0)/(1+it0) A0=Ti0/Te0 Beta('1')=0.3 Beta('2')=0.7 E0=PW(‘2')/PD0(‘2') C0('1')=Q0*BETA('1') X0('1')=Q0-C0('1') Y0=Q0*PD0('1') C0('2')=(Y0-C0('1'))/PD0('2') X0('2')=C0('2') U0=Y0 Alpha=U0/(C0('1')**Beta('1')*C0('2')**Beta('2')) TB0=X0('1')-X0('2') CPI0=Y0/U0

7 Variables Table C: Summary of variables VariablesSpecification UUtility X(I)Trade flow C(I)Consumption GDP PD(I)Domestic prices YMoney income TBTrade balance TiImport tax factor TeExport tax factor RPDRelative domestic price of import RPWRelative world price ABorder tax adjustment factor IsImport subsidy SeExport subsidy factor SiImport subsidy factor CPIInflation EExchange rate (Tenge per Ruble)

8 Equations Table D: Summary of system equations Utility U=E=Alpha*(C('1')**Beta('1')*C('2')**Beta('2')) Domestic Price for consumer products PD('2')=E=PW('2')*Ti Domestic Price for minerals PD('1')=E=PW('1')/Te Demand for minerals C('1')*PD('1')=E=(BETA('1')/(1-BETA('1')))*C('2')*PD('2') Demand for consumer products C('2')*PD('2')=E=Y-C('1') Material Balance for minerals X('1')=E=Q0-C('1') Material Balance for consumer products X('2')=E=C('2') Total Money Income Y=E=C('1')*PD('1')+C('2')*PD('2') Trade Balance TB=E=X('1')-X('2') Trade Equilibrium TB=E=0 Relative price in terms of tenge RPD=E=PD('2')/PD('1') Relative prices in terms of dollar RPW=E=RPD/A Border tax adjustment factor A=E=Ti/Te Net import tax factor Ti=E=(1+it0)/(1+is0) Net export tax factor Te=E=(1+et0)/(1+es0) Net import subsidy factor Se=E=(1+es0)/(1+et0) Net export subsidy factor Si=E=(1+is0)/(1+it0) Inflation CPI=E=Y/U

9 Different Scenarios Summary of scenarios examined Scenario I. Demonstration of Theorem 2 Increase of import subsidy by 20% Increase of both import subsidy and tax by 20% An a percent change in the tax factor on any balance of payments item is symmetric to a - a percent change in the subsidy factor on it and. an a percent change in both the tax and subsidy factors on it is neutral Scenario II. Russian depreciation of currency by 7.1% Scenario III. Demonstration of Theorem 6 An a percent change in all net tax factors on non-monetary credits combined with an a percent change in all net subsidy factors on non- monetary debits is symmetric to an a percent change in the price of domestic currency. Scenario IV. Demonstration of Theorem 7 An a percent change in all net tax factors on non-monetary credits combined with an a percent change in all net subsidy factors on non- monetary debits and an a percent appreciation of the domestic currency is neutral. Scenario V. Kazakhstan’s depreciation of currency by 20%

10 GAMS Results Scenario 1Scenario 2Scenario 3Scenario 4Scenario 5 20% import subsidy20% import subsidy & 20% import tax Ruble depreciation by 7.1% via proportionate change in export tax and import subsidy Simultaneous appreciation of domestic currency Depreciation of tenge by 20% VariablesLevel U Import Consumption Domestic price of export Domestic price of import Money income Trade balance..... Net import tax factor Net export tax factor Rel. domestic prices Rel. foreign prices Border tax adj. factor Net export subsidy factor Net import subsidy factor CPI E