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The Hunger Games of the foreign exchange market

The Hunger Games of the foreign exchange market

InfoMarket Agency’s comment
"Bad luck". Is it possible to characterize in such a way the general situation in the foreign exchange market of Moldova and the falling MDL against the EUR in particular? Experts know that the rate of the Moldovan currency is pegged to the USD: when the USD strengthens, for example, against the EUR, the MDL also strengthens, and vice versa. Therefore, it is important to look at the dynamics of the USD-EUR pair.
The year began with a fairly stable rate of 1.11 USD per 1 EUR. In March, against the background of quarantine, the USD abruptly, but temporarily, surrendered its positions (1.15) and, having squatted a little in the spring, already from the middle of summer started to decline confidently - at the end of July, the exchange rate ratio was 1.18 and in early December, it used to punch the mark of 1.2 during a day.
All the world media write about the grounds for the USD-EUR pair’s volatility, citing everything as reasons: from the presidential elections in the United States, the launch of printing presses during the pandemic and the rapid news around the spread of COVID-19 to the beginning of the struggle for world hegemony in the most popular world market - the market of the vaccine against the new coronavirus: the one whose vaccine takes a dominant position will "reign".
The local market is closer to us. The start of the EUR strengthening on world markets in the summer was not felt in Moldova: during this period, for some reason, the MDL strengthened "simultaneously" with the EUR. That is, against the background of the devaluation of the USD (paired with the EUR), the MDL strengthened against the USD and this is the reason we could see the exchange rate decreasing below 17 MDL per 1 USD, with the apparent stability of the MDL against the EUR (19.5-20 lei).
Let's visually compare two charts for the last 12 months.

USD vs EURO exchange rate dynamics
(December 2019-November 2020)
The MDL exchange rate dynamics vs EUR vs USD
(December 2019-November 2020)
Over the year, the EUR appreciated against the USD by almost 10%. And on the chart featuring the MDL dynamics against the USD and the EUR, the divergence of the lines is clearly visible. The MDL strengthened against the USD from mid-May until the second half of September. Just like on world markets, the EUR was strengthening against the USD. That is, the global tendencies of the EUR strengthening have not been reflected in any way in our market.
The psychology of the Moldovan market participants is not strongly influenced by the trends that take place in the international markets. Nevertheless, the National Bank of Moldova (NBM) had a direct impact on the situation in the foreign exchange market through its interventions.
Perhaps this is a coincidence, but the MDL exchange rate returned to the 17 mark only after the second round of elections on November 20. And since then, the Moldovan currency has continued to devalue. In general, the MDL exchange rate against the USD in early December corresponds to the situation at the beginning of the year.
There are, perhaps, more weighty reasons why the NBM influenced the dynamics of the MDL exchange rate - the intervention of the central bank in the foreign exchange market. In March (when the quarantine was introduced), the central bank sold $114.5 million, in April - $55.92 million. The average rate in March was 17.72 MDL per 1 USD; in April - 18.15 MDL per 1 USD. That is, in March, the National Bank gained just over 2 billion lei from the sale of foreign currency; in April - just over 1 billion; in total - over 3 billion lei.
* IMPORTANT: Accurate calculations are possible if data are available on the days of currency interventions. Since the reports are published on a monthly basis, InfoMarket used the average monthly MDL to USD exchange rate to reflect the situation in a comparable matching framework.
In the same April, the NBM acquired $1 million in the market, and later it only acquired US dollars, moreover, in July and October, the NBM acquired very large amounts of US dollars.
2020 Thous. USD Average rate
Thous. MDL
Buy rate Sell rate Buy rate Sell rate
March   114500,0 17,7209   2029043,0
April 1000,0 55920,0 18,1541 18154,1 1015177,0
May 25000,0   17,8046 445115,0  
June 22000,0   17,3265 381183,0  
July 48000,0   17,0818 819926,0  
August 28000,0   16,6511 466231,0  
September 29600,0   16,6735 493536,0  
October 68864,4   16,9836 1169565,0  
TOTAL 222464,4 170420,0   3793710,0 3044220,0
In March and April, the NBM sold $170.42 million at the average rate for two months - 17.94 MDL per 1 USD. And in July-October, the NBM bought US dollars at a lower rate - during these 4 months the USD average value was 16.848 MDL per 1 USD. Albeit, the National Bank started buying foreign currency after April, against the background of the MDL strengthening, which reached its best revaluation mark in August - 16.5477 (12.02.2020).
And if we take into consideration only the amount that the NBM sold in the spring and bought back in the summer and autumn ($170.42 million), then it becomes clear that the regulator earned at least 186 million lei or $11 million only on the account of the exchange rate difference. We will be able to see the exact figures submitted by the National Bank when the bank will publish its report on the results of its activities in 2020.
In total, over 10 months of 2020 (in fact, over 7 months, from April to October), the NBM acquired $222.5 million in the market on the wave of the MDL revaluation. So the real profit from the investment activity of the regulator by the end of the year will be higher. December has arrived, and the figures for November have not yet been published.
There are deeper reasons for the National Bank’s actions. In March, the country entered quarantine, and in order to avoid the pressure of a possible panic in the foreign exchange market, the NBM saturated it with currency, making a preemptive move. Thus, the regulator did not allow speculation on the MDL exchange rate against the background of the pandemic panic and absorbed the excess MDL mass. In the following months, the NBM gradually returned the national currency to the market. Against the background of the MDL strengthening, investors had only one way to deal with the national currency - to direct it for the purchase of government securities (GS). At the same time, the actions of the regulator were very cautious, since while returning the national currency to the market, it was necessary to ensure the demand for government securities so that the Ministry of Finance would not have to raise rates on securities.
The situation changed in October. Buying up almost $69 million in October was the NBM signal to all participants that the exchange rate would accelerate: already in the third decade of the month, the exchange rate again exceeded 17 MDL per 1 USD and continues to devalue. In order to understand what to expect in the coming month, let us recall that by the end of December the MDL exchange rate is always strengthening since people are selling currency before the holiday expenses.
In the explanatory note to the law on the 2021 budget, it is noted that at the end of 2020, the exchange rate is expected to be 17.40 MDL per 1 USD. And since in the last decade of December the exchange rate is traditionally strengthening, then, most likely, by the middle of the month it will be over-clocked above this figure in order to fit into the announced forecast by December 31. The same forecast says that the average USD exchange rate for the entire 2020 will be 17.34 MDL. And this figure has already been reached - over 10 months the average rate was 17.33 MDL per 1 USD. The forecast for December is obvious. Well, as far as for the national currency, the MDL exchange rate against the EUR will depend on world markets.
One cannot but mention inflation. Maintaining its level within the given corridor is the main goal of the NBM. Our corridor is 5% plus minus 1.5 percentage points, that is, inflation should be between 3.5% and 6.5% per annum. However, this year, against the backdrop of the pandemic, all countries are recording deflationary processes, and in August in Moldova, the annual inflation "fell out" beyond the corridor, amounting to 3.45% per annum. In October (for 12 months) the inflation was already 1.56% per annum. The National Bank forecasts the bottom point to be registered in the first quarter of 2021, and the minimum range of 3.5% per annum to be reached in a year, in the first quarter of 2022. But this does not mean that it will not pump inflation - including through the exchange rate.
We already observed a similar situation in 2012-2013, when the NBM, after an 8-month absence from the foreign exchange market, began to buy up foreign currency, thereby stimulating inflationary processes. But then the situation got somewhat out of the control of the regulator: other market participants also actively joined the currency games. The National Bank then had to threaten with administrative sanctions those who openly engage in currency speculation.
Despite the similarity with the situation 8 years ago, this year has its own specifics. In March-April 2020, the NBM abruptly withdrew more than 3 billion lei from the market (by selling currency), then gradually issued national currency (by buying up foreign currency) in the market in portions. These funds, as mentioned above, were “intended” for the Ministry of Finance, who was placing government securities to cover the budget deficit.
This year, due to the pandemic and the huge budget deficit announced at 16 billion lei, the government decided to repay 6 billion lei through the initial placement of government securities. Already as of the end of 10 months in 2020, this source brought the budget more than 5 billion lei. And there is a demand for securities, despite not very high return rates.
Deflationary processes against the backdrop of the pandemic have reduced the inflation rate to 1.56% per annum (and it will be lower). This influenced the reduction of the base rate by the National Bank - to an unprecedented 2.56% per annum. The yield on government securities depends on the base rate; thus, it is important for the state to buy at the lowest possible rate by attracting an unprecedented 6 billion lei through the sale of government securities.
In a recent interview on television, Prime Minister Ion Chicu said that out of the assumed deficit of 16 billion lei, it would actually be possible to stop at 10 billion lei. More than half will be covered by the sale of government securities, the rest - by external funding sources. By the way, the beginning of the MDL rate increase coincided with the first 50 million euros tranche received from the European Union. The Ministry of Finance seems to have “earned” almost 30 million lei for the budget on the account of the MDL rate alone. Let us recall that, the EU is providing assistance totaling 100 million euros in two equal tranches. The Ministry of Finance reported that it received 51.62 million euros. The difference of 1.62 million euros within the 50 million euros sum is only 0.3 MDL per 1 EUR in exchange rate difference. But this is just a guess.
The topic of inflation and the government securities market requires special attention, particularly on the eve of 2021. We'll get back to this topic shortly. Albeit, the analysis of the current situation is already enough to make at least a brochure. // 03.12.2020 - InfoMarket.

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