Vilnius University

Kaunas faculty
Business Administration
Subject: International finance
Topic: Devaluation of Macedonian denar

Aleksandar Petrushevski

Kaunas district, 2020

Abstract

Why might devaluation help the economy and why we believe it would not help
the Macedonian economy at the present moment is the question that the Public
deserves an explanation for. In theory, devaluation makes domestic products cheaper
and foreign products more expensive, so it could stimulate exports and de stimulate
imports, improving the current account. In practice, however, Macedonian exports
appear not to be dependent on the exchange rate, while imports appear to depend only
very little. Thus, devaluing the denar is likely to have no major effect on the current
account while the costs, in terms of the loss of confidence in the national currency, will
be very high.

Keywords: devaluation, exchange rate, current account, trade, exports, imports,

denar, Macedonia.
Introduction

The Macedonian Denar is the official currency of the former Yugoslav Republic of
Macedonia. The exchange rate of the Denar is based on the demand and supply of
foreign trade. Money supply and interest rates are dictated by the exchange rate, which
is 61 Denars = 1 Euro. With this exchange rate target, Macedonia’s Central Bank has
maintained a steady exchange rate for the Denar against the Euro.

Devaluation is a measure of economic policy that reduces the value of the

domestic currency against one or more foreign currencies. Devaluation is undertaken in
order to remove the external imbalance in the economy, ie. to improve the balance of
international payments.

The first, and so far only, devaluation of the domestic currency took place in July
1997, when the exchange rate changed from 27 to 31 denars for a then German mark.
Macedonia at that time had a growing trade deficit, modest level of foreign reserves,
problems with the balance of payments and restrictive monetary policy, ie high interest
rates. Since then, speculations about possible devaluation have fueled during almost
every major political, economic or "combined" crisis that occurs in the country, and so in
the midst of the current Covid - 19 crises. With Macedonia now having the highest level
of foreign exchange reserves since being an independent state, stable and well-
capitalized banking system, historically lowest level of interest rates, current account
deficit and external debt in the zone of moderate level, as well as instruments available
to the National a bank that can guarantee that the exchange rate of the denar against
the euro will remain stable.

Almost every major political, economic or "combined" crisis that has occurred in
the country in the last 20 years since the first and so far only devaluation of the Denar in
independent Macedonia took place in July 1997 (remember, then the Denar devalued
by 16% and the foreign exchange exchange rate changed from 27 denars to 31 denars
for a then German mark) was followed by speculations for re-devaluation, ie a decision
of the central bank and the government to reduce the value of the domestic currency,
the denar, in relation to foreign currencies, in this case primarily the euro, the currency
to which the fixed exchange rate of the denar is pegged.

So it was in 1999, when due to the war in Kosovo and the wave of refugees that
came to the country from there, there was panic among Macedonian citizens who
began to withdraw their foreign currency savings from banks and exchange denars for
foreign currency. The National Bank and the commercial banks somehow managed to
solve the problem at the last minute, as evidenced by the actors involved at the time.

Then, in 2001, during the military conflict in Macedonia, the shadow of

devaluation rose again, but then the monetary authorities, richer by one experience,
eased the panic by intervening in the foreign exchange market.

On this occasion I will not deal with the motives of the authors of these
speculations (which, by the way, are extremely dangerous and can cause significant
turbulence in the foreign exchange market, but I will just try to explain why a country
actually decides to devalue its currency and whether Macedonia needs such a step at
all at the moment.
Notion of devaluation
Devaluation is an official act of economic policy that reduces the external value of the
domestic currency. Devaluation is carried out by a special decision of the government or
the central bank (or a joint decision of the government and the central bank) to reduce
the value of the domestic currency relative to foreign currencies. Thus, devaluation
differs from depreciation, where the domestic currency loses its value relative to foreign
currencies in the foreign exchange market, under the influence of supply and demand.

Devaluation is a kind of expenditure-switching policy, which should cause a change in

the relative prices of foreign and domestic products in order to shift domestic
consumption from foreign to domestic products. Devaluation also occurs as an integral
element of exchange rate stabilization programs. Within that framework, before the
beginning of the stabilization program, a significant devaluation is implemented, which
should mitigate the negative consequences of the future real appreciation of the
domestic currency.

Devaluation is used very often for two reasons:

o first, it is administratively easy and simple to apply, as there is no need for a

bureaucratic apparatus for application, nor can there be corruption or evasion;
o second, it is a decentralized mechanism that leaves the economy itself to adjust,
ie. no one decides which export or import to stimulate or prevent.
The basic criteria for the need for devaluation is the current account deficit: if the current
account deficit is unsustainable, ie. can not be financed by borrowing abroad or
reducing foreign exchange reserves, it is a sign that devaluation is needed. The current
account, foreign reserves, real exchange rate, external debt, etc. can serve as
indicators for the need for devaluation.
The three most common reasons why a country decides to devalue its currency
The three most common reasons why a country decides to devalue its currency are the
following:
1. Purpose: to stimulate exports
Benefits: In the world market, goods produced in one country compete with
goods produced in other countries. US carmakers compete with manufacturers in
Germany, Japan, Korea, etc. If, for example, the value of the euro falls against the
dollar, then the price of vehicles sold by European manufacturers in the US market, in
dollars, will become lower than it was before the devaluation of the euro. On the other
hand, a stronger currency will make the export of the country in question more
expensive, ie the import of goods produced in it more expensive for the importing
countries.
In other words, exporters are becoming more competitive in the global market,
exports are stimulated, and imports are discouraged after a national currency devalues.
Dangers: first, due to the higher demand for products from the country that
devalued its currency, the price of those products will start to rise, which may eventually
lead to the annulment of the initial effect of the devaluation. Second, as soon as other
countries see that a country has devalued to stimulate its exports, they can do the
same, and this can lead to an interstate currency war that ultimately leads to increased
inflation in all countries involved.
Otherwise, the reduction of exports as an argument for devaluation has been
pointed out on several occasions by Macedonian economic entities, mainly from the
lobby of large exporters, according to which the allegedly overvalued denar exchange
rate is the main culprit for non-competitive exports of Macedonian products.
This is only partially true. Macedonian products are not competitive enough on
the world market primarily because they have a relatively low added value, low level of
innovation, research and development, and not because the denar is overvalued.
Devaluation can have a short-term effect of several months and really increase exports,
but the weaker denar can benefit only those exporters who have relatively little or no
import components in their products. (for example, the export of agricultural products,
ore minerals, metals, etc.) All others are import dependent, so the devaluation will at the
same time make their raw materials more expensive, because the import will be more
expensive. So, the confectionery, chemical, textile, automotive parts industry (which is
currently extremely important for Macedonian exports, and is concentrated in a dozen
foreign and domestic investors mostly in free economic zones) and other import-
dependent industries will logically have more expensive production, which in the end will
only cancel out the effect of the devalued currency. Without solving the structural
problems in the economy, energy, infrastructure, abolition of all unnecessary tariffs, etc.
The problems of Macedonian production will remain and the devaluation of the
exchange rate will not make exports competitive in the long run.

Some of the representatives of the scientific and monetary sphere in the country
are advocating for the introduction of the so-called Denar management fluctuating
exchange rate against foreign currencies, instead of the current fixed exchange rate, in
order to stimulate exports, but for now the National Bank remains firm on the strategy of
defending the fixed and stable exchange rate of the denar.

2. Purpose: to reduce the trade deficit

Benefits: As soon as exports increase and imports decrease as a consequence
of the devaluation, the country's balance of payments improves, ie the trade deficit
decreases. After all, a persistent trade deficit is not uncommon today, so the United
States, like other developed and less developed countries, has had a constant trade
deficit for years or even decades. Economic theory, however, says a large trade deficit
is unsustainable in the long run and could lead to dangerous levels of external debt that
threatens the economy. Devaluation of the domestic currency can help improve the
balance of payments and reduce the trade deficit.
Dangers: But this reasoning has another side to the coin: devaluation also
increases the burden of a country's debt to foreign creditors, denominated in foreign
currency and denominated in domestic currency. This is a big problem for developing
countries, which have huge amounts of debt denominated in dollars or euros. These
external debts are becoming increasingly difficult to repay, which erodes people's
confidence in their domestic currency.
Confidence in the domestic currency will actually be reduced from the first
moment after the devaluation is announced, while the citizens will become poorer by the
same percentage as the fall in the exchange rate of the domestic currency.
For example, if the Macedonian currency would devalue to 75 denars per euro as
some speculate these days, which is 22%, it means that if the average salary in the
country is around 25,000 denars or 406 euros, after the devaluation its value in euros
would be only 333.
For the same pro The import of all goods and services in the country will be more
expensive, and the value of all loans taken by citizens and companies, which are mostly
with a currency clause, ie denominated in euros, will increase. So, if your monthly loan
installment was 5,000 denars, now it will be exactly 6,100 denars.
 Given that Macedonia is a highly import-dependent country, rising prices of many
products and services could very easily open the spiral of inflation, which will have
catastrophic consequences for the operation of businesses and the living standards of
citizens.

That is why the speculations for possible devaluation are very dangerous, as
assessed by the National Bank, especially since some of them were related to alleged
assessments by European and world financial institutions about the inevitable need for
devaluation, this summer.
"Citizens need to be calm. The stability of the Denar exchange rate has been, is
and will remain our priority. We guarantee that the denar is and will remain stable! We
call for conscientious and responsible information and verification of the truth of the
sources of information. "Any arbitrary interpretation of the information, as well as the
placement of incorrect or unverified information regarding the domestic currency can
create negative effects for the Macedonian economy," the National Bank said these
days.
As arguments in line with this statement for guaranteeing the stability of the
Denar, the NBRSM said that the foreign exchange reserves are at an appropriate high
level, which is the most important guarantee for the stability of the exchange rate of the
domestic currency. At the end of April, they amounted to 3 billion and 159.6 million
euros and compared to March increased by 142.3 million euros. Their level is almost
twice as high as in the 2008 crisis.
Additionally, the National Bank has a number of instruments at its disposal which
guarantee that the Denar exchange rate against the Euro will remain stable.
Furthermore, the projections of all relevant international institutions indicate that the
level of foreign reserves is and will remain adequate and that the stability of the Denar is
not expected to be endangered in any way.
Neither the National Bank nor the relevant international institutions are expected
to increase the inflation rate, ie no increase in prices is expected. On the contrary - in
conditions of current inflation, which are below expectations, as well as during
significant downward revisions in import prices due to the shock of the pandemic of
covid-19, especially energy, the estimates point to an inflation rate of about 0% for
2020.
The current account deficit is at a moderate level and according to the
projections it will continue to be at a moderate level, while the external debt remains in
the zone at a moderate level, during its reduction last year.
The banking system is stable and according to all indicators is ready not only to
deal with the shock of covid-19, but also to continuously deliver credit support to the
Macedonian economy and to contribute to it easier and faster to deal with the
challenges of the coronary crisis. , explained the National Bank.
3. Purpose: To reduce the burden of external debt
Benefits: A country may decide to devalue its currency if it has a large external
debt to service. If debt repayments are on fixed dates, the weakened currency
effectively makes them cheaper over time.

Dangers: But, again, this tactic should be taken with caution. Most countries in
the world have some still unpaid debt in one form or another, so it can cause the so-
called. "Currency war", ie the vicious circle of constant devaluation of the national
currencies into which countries will enter, and in the end to cause more harm than good.
Devaluations generally create uncertainty in global markets, resulting in a decline in
capital markets, real estate and eventually recessions. An example of a devaluation not
always having the desired effect is Brazil, whose national currency has lost significant
value from 2011 onwards, but a series of devaluations could not offset other economic
problems such as falling oil prices and other commodities. , as well as the huge
corruption scandals in the country. As a result of all this, the Brazilian economy
recorded weak and even negative growth rates in the period from 2012 onwards,
although until the financial crisis of 2008-2009 it was among the fastest growing
economies in the world.1

Devaluation of the MKD: Yes or No?

The scenario of spending a large amount of one country’s foreign reserves for
the purpose of protection of the domestic currency was happening to the Republic of
Macedonia in 2009. Lowerexport demand drastically decreased the inflow of foreign
currency from foreign countries. In thecountry there were fewer foreign direct
investments, compared to previous years. Access to credit onforeign markets was
becoming more and more difficult quantity wise and price wise. Inflow of
foreigncurrencies as a result of foreign remittances from foreign countries that in
previous years financed thedeficit in the current account of payment was reducing. In
such conditions supply was far beyond thedemand of foreign currencies. That caused
high pressure on the exchange rate of the MKD in thedirection of devaluation of its
value.
Negative movements in the Macedonian current account and particularly in the
trade account arestill in place. Such situation regularly enforces the inquiry of the public:
Is there not a need fordevaluation of the domestic currency? The result would be
1
https://f2n2.mk/devalvacija-ne-blagodaram/
declination of the dynamics of importgrowth and rise of the dynamics of export growth,
causing the trade deficit of the country to be at asignificantly lower level than in previous
years and protecting the foreign reserves of the country.However, it appears that in this
period of time devaluation of the MKD will be counter productivewith much more
negative consequences than positive results.The positive effects of the devaluation will
be more expensive import and cheaper export(increasing its competitiveness).
However in current terms of trading surrounded by great obscurityand challenges
from the ongoing world economic crisis, it was not really likely that the positivechanges
would remain for a long time and would have significant effect on the current account of
thecountry.
On the other hand, threats of the negative consequences from devaluation in
current condition canbe easily identified and confirmed.So eventual devaluation of the
MKD happens, the purchasing power of the MKD of the firms andhouseholds will be
lower by the percentage of the devaluation while buying goods with pricesdetermined in
foreign currency (cars, houses and similar). This is an implication that their
alreadysignificantly low consumption will continue to decrease and will motivate
negative phenomena in thereal sector (decrease in the scale of production, increase in
the number of unemployed, etc.). Eventual devaluation would cause problems for the
households and firms that are in debt withcredits in banks according to the contract with
foreign currency clause. In that case, everyone shouldhave secured significantly large
amount of MKD to return the credits, which will negatively influencethe demand and the
growth of the economy. Additional problem of the firms will be securing MKDsfor buying
foreign currencies for repayment of the borrowed credits from foreign countries, which
inturn should be repaid in the course of the upcoming years.
The devaluation will jeopardize the balance of the budget of the Republic of
Macedonia. For thepurpose of repayment of the previously taken credits from foreign
countries, the budget should secureadditional MKD for buying the necessary foreign
currencies for credit repayment. Such process willsubstantially jeopardize the realization
of the planned activities of the RM government, especially thecapital investments which
are important for stimulating the economy.
The act of one way devaluation of the MKD will cause liquidity problems for the
commercialbanks. Eventually the increased demand of MKD for everyday transactions
will cause proper exchangeof the foreign deposits of the citizens in MKD. That, of
course, will have negative influence of thebank MKD liquidity and also to the scope of
credits for the economic sector. Banks previouslyindebted in foreign countries should
reserve large amount of MKD for buying foreign currencies torepay those credits, the
result of which will be worsening of their MKD liquidity. At the same time, forthe scale of
the eventual devaluation, the founders of some of the banks should provide
additionalamounts of MKD in order to reach the capital census of the capital adequacy.
That, of course, willlower the liquidity of the founders and make the capital of the banks
more expensive. That indeed willcause increase of the bank interest rates and will not
ensure realization of development activities for thefirms, and will lower consumption.
That action at this moment is the worst scenario for theMacedonian economy!
Therefore, the act of devaluation should have happened many years ago with
establishment andsustainability of flexible exchange rate. Eventual devaluation of the
MKD today will obviously be verypainful. Because of that the answer to the question
whether devaluation of the MKD should be done inthe existing economic surrounding
should be: NO!

Replacing MKD with Euro?

Recommendation from IMF for introduction of the Euro by the Eastern and Central
European countries members of the European Union caused the Macedonian public
reviewing the possible one way introduction of the Euro in Republic of Macedonia.
The idea about introduction of the Euro as an official currency in Macedonia should be
welcomed and goes in the direction of adjustment of the domestic economy with the
EMU economies. On the other hand, the implementation of that idea is difficult and it is
correlated with many restrictions and costs.
Legally Introducing the Euro by a state legislative is not possible, because the Euro is e
foreign currency. The Euro though can be introduced by the means of specific acts that
exist in EMU.
The approval from the European Central Bank (ECB) is needed in order for the Euro to
be introduced in Macedonia as an official money. In order to get that approval,
exstensive analisis of the political and economic situation should be conducted,
especially of the monetary (and payment) system of the country. ECB would not like the
reputation of the Euro to be ruined as a result of an eventual disrupture or
inconsistencies of the domestic economy in RM. ECB does not influence the domestic
monetary policy in Republic of Macedonia, nor does the National Bank of the Republic
of Macedonia have an obligation (which is the case in member-states in EMU) to run
monetary policy in accordance with ECB. In case of one way introduction of the Euro as
an official national currency, it will be necessary to insure adequate quantity of Euros in
order to replace current money in circulation (around 15 billions MKD or 250 millions
Euros). Another problem/cost would be menu costs, i.e. changing of the prices in all
menus, values in ATMs, auto machines, fiscal machines, POS terminals, documents,
laws and many other cases. In conclusion, one way introduction of the Euro would be
related to numerous restrictions as well as costs, meaning that before eventual
acceptance of the idea, cost benefit analises will be necessary.
In conditions of crisis such as the current one, the Euro will help the domestic economy
by offering protection from fluctuations as a result of its flexibility. That will affect the
interantional trade, save the deposits in banks (there will be no with drawings or low
with drawings), which is an important positive assumtion for the inflow of foreign
investments. Trust by foreigners in the Macedonian economy will be increased to a
certain level, even though that automaticlly will not mean protection of the domestic
economy, because in the future the economy will still face negative influences of
macroeconomic measures that will be individually introduced by domestic autorities.
One way introduction of the Euro cannot automaticly protect domestic economy against
inflation. Increase of the prices is determined by the quantity of money in circullation. If
(primarily through the influence of the monetary policy) the quantity of money (Euros) in
circulation is increased through financial chanels, that will affect the inflation growth,
even though at the same time inflation in the other Euro-countries is low.
That is the reason why ECB would be concerned. On the other hand, use of the Euro
might arise possibilities of its devaluation compared to otherworld currencies (dollar,
frank, yuan, pound..). However, in that case devaluation does not depend on the
domestic economy, but on other world factors (political conditions, economic conditions,
changes in economies of the Euro zone, etc.), and on the desicions and measurements
that are brought forth by ECB. The exchange rate of the Euro towards the rest of the
world currencies is determined on the world exchange markets as a result of the
mentioned factors. In any case, if the Euro is in use, the preas sure for devaluation will
not be present as it is now the situation with the MKD.
In conclusion, the Macedonian economy would most likely want to be in the Euro-zone,
but It would obviously not be that simple.
Conclusion
References: