The exchange rate of the Macedonian Denar against the world’s major hard currencies has been stable in recent years. Due to IMF restrictions, the local Narodna (Central) Bank does not print money and there are no physical denars in the local economy and banks.
Therefore, even if people want to buy currency on the black market, or directly from banks, they don’t have the denars to do so.
The total amount of Denars (M1, in professional financial jargon) in the economy is around 200,000,000 USD, according to official figures. This translates to 100 USD per capita. Therefore, even if each and every Macedonian citizen decided to convert ALL of their denars to Deutschmarks, they would still be able to purchase only DM150 each, on average. These small amounts are not enough to increase the rate at which German marks are exchanged for denars (= the price of German marks in denars).
But will this situation last forever?
According to economic theory, scarcity raises the price of the scarce good. If denars are rare, their price will remain high in Deutsche Mark terms, ie they will not devalue against the stronger currency. The longer the Central Bank does not print Denares, the longer the exchange rate will be maintained.
But a strong currency (the Denar, in this case) is not always a positive thing.
The Denar is not strong because Macedonia is rich. The country is in a troubled economic situation. The banking system is dangerous and unstable. Foreign exchange reserves are minimal – less than 30 million dollars.
The currency is stable due to restrictions imposed from abroad and an artificial manipulation of the money supply.
In addition, a strong currency makes Macedonian-produced goods relatively expensive on external export markets. Therefore, it is difficult for Macedonian producers and manufacturers to export. When they sell their products in Germany, they get DM for it and when they convert these receipts into Denars, they get less than they should have if the Denar reflected the true relative strengths of the two economies: the German and the Macedonian.
They pay expenses (for example: wages of their workers, rent, utilities) in denars. These expenses grow all the time as true inflation grows (as opposed to the official inflation rate which is suspiciously low), but they still get the same amount of Denars for their goods and products when they convert the DM they got for them.
On the other hand, imports to Macedonia become relatively cheaper: fewer denars are needed to buy DM products in Germany, for example.
Thus, the final result is a growing preference for imports and a decrease in exports. In the long run, this increases unemployment. Export is the biggest driving force in job creation in modern economies. In their absence, economies stagnate and dwindle and people lose their jobs.
But an unrealistic exchange rate has at least two additional adverse effects:
One: As a rule, various sectors of the economy borrow money to survive and expand.
If they expect the local currency to devalue, they will refrain from taking long-term loans denominated in hard currencies. They will prefer loans in local currency or short-term loans in hard currency. They will fear a sudden and massive devaluation (like the one that happened in Mexico overnight).
Their lenders will also be afraid to lend them money, because these lenders cannot be sure that the borrowers will have the additional denars needed to repay the loans in the event of such a devaluation. Naturally, a devaluation increases the amounts of Denars needed to repay a foreign currency loan.
This is bad both from a macroeconomic point of view (that of the economy as a whole) and from a microeconomic point of view (that of the individual company).
From a microeconomic point of view, short-term loans must be repaid long before the companies that took them have matured to the point where they can be repaid. These short-term obligations weigh them down, alter their financial statements for the worse, and sometimes put their own viability at risk.
From a macroeconomic point of view, it is always better to have longer debt maturities with less to pay each year. The longer a country has to repay loans (individual companies are part of a country), the better its credit standing with the financial community.
Another aspect: credits from abroad are a competition to the credits granted by the local banking system. If companies and individuals do not take credit from abroad because they fear a devaluation, they help create a monopoly of local banks. Monopolies have a way of setting the highest possible prices (= interest rates) for their commodities (= the money they lend).
Access to foreign credit reduces domestic interest rates through competition with local credit providers (=banks).
It would be easy to conclude, therefore, that it is in a country’s important interest to open up to foreign financial markets and provide its businesses and citizens with access to sources of external credit.
An important way to encourage people (and companies are made of people) to do things is to allay their fears. If people fear devaluation, a responsible government can never promise not to devalue their currency. Devaluation is a very important political tool. But the government can INSURE itself against a devaluation.
In many Western countries, insurance contracts called forwards can be bought and sold. They promise the buyer a certain exchange rate on a certain date.
But many countries do not have access to these highly sophisticated markets.
Not all currencies can be insured in these markets. The Macedonian denar, for example, is not freely convertible because it is not liquid: there are not enough denars to meet the needs of a free market. Therefore, you cannot insure yourself using these contracts.
These less privileged countries establish special agencies that provide companies (mainly exporters) with insurance against changes in exchange rates in a prescribed period of time.
Let’s examine an example:
The MAK firm buys combine harvesters and tractors from Germany. You have to pay in DMs.
An international development bank offered MAK a loan to be repaid in 7 years in DM.
Today, MAK would be so afraid of devaluation that it would prefer to pay the equipment supplier as soon as it has cash. This creates cash flow problems at MAK: wages are not paid on time, raw materials cannot be bought, production stops, MAK loses its traditional markets, all to avoid devaluation risks.
But what if the right government agency existed?
If there were government insurance against devaluation, MAK would surely accept the 7-year loan. It would take, say, 10 million German marks.
MAK would apply to the government agency with your business.
You would pay the government agency an annual insurance fee of 2.5% of the remaining loan balances (as it is amortized and reduced with each monthly payment). This would be considered an appropriate financing expense and the company will be able to deduct it from its taxable income.
The government will provide MAK with an insurance policy. An exchange rate will be indicated on the policy (say, 30 denars per DM).
If, at the time MAK had to make a payment, the rate exceeded 30 denarii per DM, the government will pay the difference to MAK in DM. This will allow MAK to meet its obligations to its creditors.
MAK may cancel this insurance at any time. If, for example, you suddenly sign a major contract with a German buyer for your products, you will have income in German marks that you can use to repay the loan. Then government insurance will no longer be necessary.
This very simple government aid will have the following effects:
- It will encourage companies to obtain foreign credits.
- It will create competition for local banks, lower interest rates and encourage a better and wider range of services offered to the public.
- It will encourage foreign financial institutions to lend to local businesses once the risk of repayment problems due to a devaluation is minimized.
- It will put Macedonia in the ranks of the most developed and export-oriented countries in the world.
- It will facilitate activities with longer-term credits (such as the modernization of plants for which longer payment terms are required).
Over time, the private sector may step in and provide its own insurance against devaluation.
Insurance companies all over the world do it, why not in Macedonia, which needs it more than many other countries?
