Kazakhstan
Background Paper and Statistical Appendix

This Background Paper and Statistical Appendix reviews the real economy and systemic reforms in the Republic of Kazakhstan during 1993–94. In early 1994, the Kazakh authorities launched a major stabilization program to improve the financial situation and reinforce the structural reforms. A tight budgetary stance was targeted, monetary policies were reinforced, and the liberalization of prices and the external trade regime continued. By the third quarter of 1994, inflation had been sharply reduced, the exchange rate had remained relatively stable for several months, and external reserves continued to rise.

Abstract

This Background Paper and Statistical Appendix reviews the real economy and systemic reforms in the Republic of Kazakhstan during 1993–94. In early 1994, the Kazakh authorities launched a major stabilization program to improve the financial situation and reinforce the structural reforms. A tight budgetary stance was targeted, monetary policies were reinforced, and the liberalization of prices and the external trade regime continued. By the third quarter of 1994, inflation had been sharply reduced, the exchange rate had remained relatively stable for several months, and external reserves continued to rise.

I. Introduction and Overview

Kazakhstan’s economic and financial situation has undergone a decisive change since early-1993. Following a period of turbulent membership in the ruble zone, and several months of transition marked by uncertainty after the Russian currency reform, Kazakhstan moved to monetary independence with the introduction of its own legal tender, the Tenge, on November 15, 1993. However, the freshly gained control over domestic financial policies did not translate immediately into a break from the high inflation past that had characterized the ruble zone. Although substantial efforts were made by the authorities during the second half of 1993 to move forward with financial stabilization and systemic reforms--and some significant results were achieved in several areas--progress was hampered by the depth and scope of the critical policy issues that needed to be tackled simultaneously, by weaknesses in institutional and policy implementation capacity, and by a difficult external environment. As a consequence, inflation remained high, output declined substantially, external trade was adversely affected, and financial pressures in the economy did not abate; on the other hand, an ambitious privatization program was initiated, substantial progress was made in price liberalization, state intervention in the economy was reduced, the modernization of the monetary system (notably the central bank) began, and progress was made in installing the legal and institutional framework for a market economy. Most importantly, toward the end of 1993 the national currency was successfully introduced and important steps were taken to strengthen monetary and foreign exchange policies.

In early-1994, the Kazakh authorities launched a major stabilization program to improve the financial situation and reinforce the structural reforms. A tight budgetary stance was targeted, monetary policies were reinforced, and the liberalization of prices and the external trade regime continued. However, the stabilization effort was derailed in March-May by the extension of sizable bank credit to enterprises to clear domestic arrears that had accumulated and by the inability of the authorities to impose financial discipline on the enterprise sector; thus, the fiscal position, which was already under pressure as a result of weak tax collections, worsened rapidly, inflation rose to unacceptably high levels, and the exchange rate depreciated sharply. In mid-1994, the Kazakh authorities took corrective actions to bring the stabilization program back on track, by drastically tightening the fiscal position, strictly limiting credit expansion and raising interest rates to positive levels in real terms, and further improving the management of macroeconomic policy; substantial progress was also made in reaching virtually full price liberalization, the trade regime was further liberalized, and the coverage of the privatization program was enlarged. By the third quarter of 1994, inflation had been sharply reduced, the exchange rate had remained relatively stable for several months, and external reserves continued to rise; however, progress in the area of enterprise reforms was only beginning.

Against this background, it is useful to distinguish three distinct periods during the past eighteen months under review:

(i) Full membership in the ruble zone until late July 1993. In this period, monetary policy and developments continued to be determined by the policies of the Central Bank of Russia. Thus, for Kazakhstan, inflation was mainly exogenous, reflecting the stance of monetary policy in the ruble zone as a whole; however, with relatively tight fiscal policies in place, Kazakhstan refrained from taking a “free ride” in the ruble zone. This period ended with the decision of the Central Bank of Russia to demonetize in Russia pre-1993 Russian ruble notes at the end of July 1993, effectively sealing the monetary boundaries between Russia and the rest of the former FSU countries which had not introduced their own currency by that time.

(ii) Transition period between end-July 1993 and mid-November 1993. Since Kazakhstan did not have a national currency, this period was de facto a dual currency era, in as much as “Kazakh” rubles (i.e., pre-1993 ruble notes) and Russian (post-1993) noncash ruble were used in parallel. Initially, the Kazakh Government reacted to the demonetization of the pre-1993 ruble notes by seeking to establish a new monetary union with the Russian Federation. As these attempts failed, Kazakhstan proceeded with the introduction of its national currency; in fact, preparations for monetary independence had been underway for more than a year. For those countries that were outside the ruble zone but without their own currency, this period was characterized by a “competitive” dumping of pre-1993 rubles, and Kazakhstan was among those which ended up with a large amount of pre-1993 ruble notes. These factors, along with insufficiently tight domestic financial policies, put pressure on domestic prices, and inflation accelerated from an average of 25 percent per month in January-July 1993 (the average inflation rate in Russia was 22 percent) to some 38 percent a month in August-November 1993 (compared with an average inflation rate in Russia of 21 percent). Accordingly, the exchange rate of the “Kazakh” ruble quickly deviated from par with the “Russian” ruble and depreciated sharply.

(iii) The period of full monetary independence. Following the introduction of the Tenge on November 15, 1993, this period has been characterized by a sequence of attempts to reinforce financial policies and reduce inflation. With regard to macroeconomic developments, four subperiods can be distinguished:

(a) November 15, 1993-January 1994: The subperiod immediately following the introduction of the Tenge was marked by major price increases with the monthly inflation rate averaging around 44 percent (including November). The Tenge was allowed to float on the foreign exchange rate auction market without major interventions by the National Bank of Kazakhstan. As supporting fiscal and monetary policies were not tight enough, and confidence in the new currency was weak at the beginning, the Tenge depreciated rapidly. The authorities used the introduction of the national currency to adjust upward several administrative prices. However, nominal wage increases were kept well below the actual inflation rates, and hence a 40 percent decline in real wages occurred in the period between end-November and end-January.

(b) January-February 1994: This subperiod was marked by an effort to stabilize the financial situation. A key element of policies was a relatively tight budget, which aimed at a fiscal deficit of 4 percent of GDP for the year as a whole, with domestic bank financing limited to 1 percent of GDP. This was supplemented by a tightening of monetary policy, with interest rates moving closer to positive real levels. As a result, the monthly inflation rate was reduced from 43 percent in January 1994 to 24 percent in February, and further to 17 percent in March. However, the nominal exchange rate of the Tenge vis-a-vis the U.S. dollar roughly doubled in this period.

(c) March-May 1994: A major policy decision to provide, through the budget, central bank financing for the netting of interenterprise arrears starting in March 1994 completely reversed the declining trend in inflation. Nominal wages rose sharply as a substantial injection of new credit into the economy led to a rise in monthly inflation to 32–34 percent in April and May and to 46 percent in June. The overall fiscal deficit, inclusive of the arrears netting operation, reached 18 and 15 percent of GDP in the first an second quarters, respectively. High rates of monetary expansion created severe pressures on the foreign exchange market, and the nominal value of the Tenge relative to the dollar dropped by two-thirds between February and May.

(d) July 1994-September 1994: The subperiod from July 1994 to date has been characterized by a substantial reinforcement of financial policies. Most importantly, the fiscal stance was drastically tightened despite declining revenues and a shortfall in foreign financing. As a result, the cash deficit of the first half year is estimated to have turned into a surplus of 4 percent of GDP in the third quarter, although at the expense of some accumulation in budgetary arrears. As the National Bank reduced credit emission to banks and enterprises, interest rates rose to positive real levels and foreign reserves continued to increase. Monthly inflation fell from the June peak of 46 percent to 25 percent in July, 13 percent in August, and under 10 percent in September 1994.

With regard to broader developments in the economy, the supply side remained bleak through most of 1993 and 1994, marked by a prolonged contraction of output (Chart 1). The disappearance of traditional markets and input sources in the context of the break-up of the FSU, culminating in the end of the ruble zone, played a major role in the output loss in 1993 and in the first nine months of 1994. From the demand side, the sharp drop in domestic investment played an important role; in the context of high inflation and uncertainties regarding market conditions and government policies, private investment failed to fill the investment gap that had resulted from cutbacks in public investment programs. Private consumption is likely to have declined at a much more moderate rate than investment, as declines in real household incomes were partly offset by sharp drops in the private savings rate.

Chart 1
Chart 1

KAZAKHSTAN: SELECTED ECONOMIC INDICATORS, 1993–94

Citation: IMF Staff Country Reports 1995, 999; 10.5089/9781451820751.002.A001

Source: Data provided by the authorities; and staff estimates.1/ Including grants. Does not include quasi-fiscal operations.

Despite sizable current account deficits in 1993 and in the first half of 1994, substantial capital inflows enabled the National Bank of Kazakhstan to increase its net foreign reserves from below US$100 million in 1992 (equivalent to a few days of imports) to US$541 million at end-1993 (1.3 months of imports), and further to US$652 million at end-June 1994 (almost 2 months of imports). As trade with the other countries of the former Soviet Union continued to be turbulent and volatile, and as terms of trade losses occurred vis-a-vis Russia--mainly associated with the latter’s monopolistic position--part of Kazakhstan’s external trade with the FSU has shifted toward non-FSU countries. This shift was facilitated by an increasing availability of trade financing from non-FSU countries. The structure of the increasingly important non-FSU financing also changed. While in 1993 commercial credits were dominant, in the first three quarters of 1994 official credits became more important. The Fund has supported Kazakhstan’s adjustment policies; the amount of Kazakhstan’s purchases from the Fund exceeded US$190 million as of September 30, 1994.

Since mid-1993, significant progress has been made in the areas of price and trade liberalization, in reducing direct state intervention, and in the privatization of the economy. Temporary price and profit controls that accompanied the introduction of the Tenge in November 1994 were removed within two months. Petroleum prices were liberalized in March 1994, and coal prices were liberalized in May 1994. With bread, fodder, and grain product prices liberalized in October 1994, only the tariffs for public utilities and municipal services are still subject to administrative controls. Export tariffs were lowered and the number of goods subject to export licenses and quotas or to import licenses was substantially reduced, while 30 percent of the remaining export quotas have been put up for auctions starting in 1994. A wide-ranging three-tier privatization program was adopted in April 1993, and its implementation is broadly on schedule. The first tier involves the privatization of small-scale enterprises, mainly in the services area; the second tier contains the mass privatization of medium- to large-scale enterprises, involving a combined voucher-investment fund scheme; and the third tier provides for the privatization of large enterprises on a case-by-case basis, involving international tenders.

In contrast, progress in enterprise restructuring has been much slower. The monopolistic structures that had characterized Kazakhstan’s industry and agriculture at mid-1993 remained largely in place. Similarly, little has been done in restructuring loss-making enterprises, including closure of enterprises without prospect of return to viability. In this respect, the Government’s decision to clear payment arrears of loss-making enterprises in early 1994 in the context of the general arrears netting operation, as well as the lack of implementation of the existing bankruptcy law, further delayed necessary action on the restructuring front. However, in September 1994, two decrees were issued, introducing a temporary scheme to deal with loss-making enterprises until a revised bankruptcy law is adopted.

II. The Real Economy and Systemic Reforms

1. Overview of output developments

Little progress has been made to improve the coverage and economic content of the official statistics on output during the past two years. Output data reported by the Kazakh statistical agency, Goskomstat, cover only the non-service activities of the state sector, and thus do not include: (i) the state-operated service sector (education, health care, general government management); (ii) production by newly established private enterprises or joint ventures; and (iii) private sector activity in the services sector or in agriculture. There are indications, based upon employment statistics, that the state service sector is declining at a rate far lower than that of the non-service sector, and that private business activity is actually growing. However, no data yet are available concerning output developments for these unreported activities, thus neither for the whole economy. The indicators mentioned below therefore may overstate the actual output decline.

According to such information, production continued to decline throughout 1993 and in the first nine months of 1994 (Chart 2). Real output fell by 12 percent in 1993, and further by an estimated 17–20 percent in January-September 1994, as compared with the same period of 1993. The contraction was especially pronounced in the construction and transportation sectors (Tables 2 to 4), although output decline was severe in all areas.

Chart 2
Chart 2

KAZAKHSTAN: REAL SECTOR INDICATORS, 1993–94

Citation: IMF Staff Country Reports 1995, 999; 10.5089/9781451820751.002.A001

Source: Data provided by the authorities; and staff estimates.

The main contributing factors behind the decline in 1993 were the sharp drop in interstate trade, especially following the Russian currency conversion, increasing interenterprise arrears, a lower grain harvest (a reduction of 25 percent, compared to the peak 1992 harvest), sharp increases in input prices, notably for energy products, and major cuts in capital outlays from the budget (Table 5). In 1994, two additional factors contributed to the output decline: first, a domestic payment crisis which emerged at the beginning of 1994, and second, a further drop in agricultural output in July-August, owing to poor weather and shortages of equipment and fuel. The 1994 grain harvest could be just 80 percent of its 1993 level.

2. Output developments by sectors

The extent of output decline during 1993–94 varied among sectors. Industrial production in the state sector fell by 33 percent from its end-1992 level by September 1994, while agricultural output dropped by 23 percent over the same period. Output decline was more pronounced in the construction and transportation sectors where production levels were nearly halved during this period. Construction activity fell rapidly as investment activities were virtually halted, while transportation was hampered by sharp increases in energy-related costs and by the lack of improvement and maintenance of the road and railway infrastructure.

a. Agriculture

During the course of 1993, and in contrast to other sectors, production in the agricultural sector was maintained at relatively high levels, although there was a significant decline in output relative to the record levels achieved in 1992 (Table 3). However, the financial position of the sector has deteriorated rapidly from the end of 1993, as the number of farms reporting losses increased. These losses were due to a growing discrepancy between low procurement prices and liberalized input prices, as well as to a fall in productivity. In addition, payment delays eroded the value of sales in a highly inflationary environment. Agricultural output declined substantially in the first nine months of 1994, to a level of about 70 percent of production during the same period of 1993. The production of meat, milk and eggs dropped as a result of a decline in the size of livestock herds and the smaller grain crop, which reduced the availability of feed. The area sown with grain was reduced by about 10 percent, and grain yields have fallen, due in part to the collapse of production and of the use of fertilizers (Table 2). Shortages of agricultural machinery, spare parts, and fuel hampered field work.

b. Energy

During 1993–94, the situation in the key energy subsector has become difficult, as production of primary resources--crude oil, coal and natural gas--has declined sharply, as has processing. In 1993, 23 million tons of crude oil were produced, 10.9 percent less than in 1992, while refinery operations fell by 12.4 percent. Refinery activity was hampered by the decline in crude oil deliveries from Russia, to less than three-quarters of 1992 levels. Kazakhstan’s oil refining industry is heavily dependent on Russia for crude oil, as only one of the country’s three refineries (at Atyrau) is supplied with domestically extracted crude oil; reflecting the Soviet-era production system, the other two Kazakh refineries (at Pavlodar and at Chimkent) are linked to the present Russian system and depend upon crude oil from West Siberia. 1/ Production also declined in the non-oil energy subsectors: the country produced 112 million tons of coal and 6.7 billion cubic meters of natural gas in 1993, a drop of 11.8 percent and 17.3 percent over the previous years respectively, while electricity production amounted to 76.1 billion kilowatt hours, a 6.3 percent decline relative to 1992.

The problems in the energy sector worsened during the first nine months of 1994, as domestic production of crude oil fell by a further 13.2 percent, and crude oil deliveries from Russia again fell sharply. Crude oil exports from Russia to Kazakhstan during the first nine months of 1994 were 54 percent below 1993 levels, and production of refined products again suffered severely from the reduced supply of crude oil. The output of gasoline, diesel and fuel oil declined by 23–35 percent during the first nine months of 1994. Imports of refined products from Russia virtually collapsed, with import levels below 20 percent of the 1993 volumes. Severe shortages resulted, and gasoline was rationed in Almaty in the first week of May, while sowing and planting activities were delayed. The drop in the supply of crude oil and of refined products also affected the chemical industry, where production levels fell by almost two-thirds in the first three quarters of 1994.

The opportunities for a recovery in the near future of the oil-related energy sector appear to be limited. The current Russian-Kazakh pipeline transport system leaves little scope for an immediate expansion of Kazakhstan’s crude oil production for export. The profitability of crude oil producers increased following price liberalization in April 1994; however, the financial condition of refining and petrochemical enterprises remains difficult, due to payment arrears. 1/ The longer-run prospects of the sector depend on the investment in an upgraded pipeline system to link crude producers in western Kazakhstan to refineries in the east and to individual customers in urban areas, as well as on negotiations to build an export pipeline from western Kazakhstan across the Caspian Sea to the Russian port of Novorossiisk, reducing Kazakhstan’s dependence upon the existing Russian transit system. In addition, an agreement on the legal demarcation of the Caspian Sea among the bordering countries of Russia, Kazakhstan, Azerbaijan and Turkmenistan would allow the development of various off-shore projects.

Production in the non-oil energy subsectors during the first three quarters of 1994 was also reduced, as output of coal declined by 5.2 percent, of natural gas by 35.0 percent, and of electricity by 15.5 percent.

3. Price developments

The monthly rate of inflation, as measured by the change of the consumer price index (CPI), averaged around 30 percent during January 1993-July 1994 (Tables 10 and 11). Inflation averaged about 25 percent until September 1993, but accelerated in the period before the introduction of the new currency in November. Following the adoption of tighter monetary policy in 1994, the monthly inflation rate declined to 17 percent in March; however, with the extension of credit to clear interenterprise arrears in March-May 1994, monthly inflation accelerated in April-June 1994. Credits enabled enterprises to purchase foreign currency, so that the value of the Tenge fell, and also to grant substantial wage increases, with the nominal average wage increasing by almost 70 percent in April. Adjustments of oil prices and the prices of regulated services in April further fuelled inflation, and monthly inflation peaked at 46 percent in June. Another tightening beginning in June 1994 resulted in a steady decline of monthly inflation from July 1994 onwards, reaching a level of less than 10 percent in September. The stabilization of the nominal exchange rate from the end of May, together with deceleration of nominal wage increases, has helped bring about a trend fall in inflation. Lower prices for fruit and vegetables and stability of administered and energy prices also helped.

In addition to the overall monetary stance, the main factors behind the inflationary process in Kazakhstan were nominal wage increases, adjustments in administered prices, increased prices of energy imports (Tables 8 and 9), and imported inflation from other FSU countries, Russia in particular. Until the breakup of the ruble zone in July 1993, price developments in Kazakhstan closely reflected monetary policies in the ruble zone as a whole. In the following period, and until the introduction of the Tenge in November 1993, Kazakh inflation was fuelled by the depreciation of the Kazakh ruble versus the Russian ruble, on top of high inflation rates in Russia itself. The sharp fall of the Tenge in early 1994 contributed to another round of strong price increases.

The process of generalized price increases has masked significant changes in relative price structure. During January 1993-September 1994, prices of dairy products increased almost twice as fast as the average price level, while administered prices for rent, water and power were increased by a rate seven times greater than the increase of the CPI. Prices for clothing, footwear and household goods rose substantially less than the average.

The pattern of price increases at the wholesale level was broadly in line with the one at the retail level, although wholesale prices increased less than consumer prices in the weeks preceding the introduction of the new currency, an indication that consumer goods were more affected by speculative behavior in that period. The liberalization of energy prices in April 1994 contributed to a monthly increase of the producer price index that was more than four times greater than the increase of the CPI for that month. The April 1994 price liberalization, together with substantial price adjustments in the preceding period when prices were still set administratively, resulted in strong increase of wholesale energy prices relative to the other wholesale prices.

4. Investment and consumption

Investment data show a continuous decline of investment expenditure in real terms. Real investment during 1993 amounted to just 61 percent of 1992 levels, and investment was halved again during the first six months of 1994 (Table 5). The volume of investments in 1994 was less than one-sixth of the volume in 1991. The sharpest fall of investment since 1991 has been in the agricultural and construction sectors, while investment in energy-related sectors has become relatively more important. The share of total investment by state enterprises and organizations declined from about 85 percent in 1992 to around 69 percent in the first half of 1994, while the proportion of total resources provided by centralized state funds has remained at approximately 20 percent (22 percent in 1992, 24 percent in 1993 and 19 percent in the first half of 1994). Internally generated funds of state enterprises and organizations are the most important source of investment financing, accounting for 49 percent of investment by source in the first half of 1994 (Table 6).

Information about earnings and expenditures of the population are available, based on Goskomstat’s income surveys. Monetary income of the population (nominal) rose by more than 8 times in 1993, as compared with 1992, with an increase of monetary expenditure by almost 10 times, and with a period average increase of consumer prices of about 16 times (Table 7). These data would indicate both a decrease in the savings ratio and a decline in income and expenditure in real terms in 1993. However, underreporting of income, in particular from self-employment, and of purchases from outlets outside the state retail system suggests that conclusions about personal income and consumption from available data should be made with caution. A fall in the officially recorded savings ratio therefore illustrates a decline of savings through the traditional instruments, namely Sberbank deposits. Data from the period January-June 1994 regarding the population’s monetary income and expenditures implied a further substantial decline of both in real terms, and recorded savings fell to an extremely low level. With real interest rates having become positive in the summer of 1994, financially intermediated domestic saving is expected to begin to recover.

5. Wages and employment

Periodic adjustments of the minimum wage and a steady growth of average nominal wages prevented a strong erosion of wages in real terms in the first ten months of 1993; however, in conjunction with the acceleration of inflation at the time of the monetary reforms of November 1993, real wages sharply declined. Real wages stabilized afterwards, and the real wage decline during 1993–94 as a whole has been broadly in line with the fall in output (Chart 2 and Table 14). As long-run unit labor costs did not increase, total employment in the state sector remained virtually constant until the summer of 1994 (Table 16). Growing tensions in the labor market, however, are reflected in hidden unemployment and in a slow but steady increase in the number of officially registered unemployed (Table 17).

The decline in real wages in the aftermath of the introduction of the new currency was facilitated by the adoption of a new wage policy at the beginning of 1994. 1/ A levy of four times the profit tax rate was imposed on payments for labor in excess of a productivity-based wage norm. During the first two months of operation, the wage policy had a clear impact, and the excess wage penalty led to a rate of growth in nominal wages that was substantially below the increase of the CPI. Financial and wage policy were relaxed after February, however, in the context of the arrears clearing operation, and enterprises granted substantial nominal wage increases in March and in April (see Chart 2). The minimum wage also was raised by 150 percent on April 1. After a small decline in real terms in June, the peak month for price inflation, nominal average wages increased broadly in line with the increase of the CPI in July-August. The minimum wage was adjusted again by 50 percent on July 1, and by 33 percent on October 1. As of end-September 1994, the real average and minimum wages stood at 74 percent and 21 percent of their January 1993 levels, and 77 percent and 45 percent of their November 1993 levels, respectively.

Sectoral wage differentials were fairly constant prior to the introduction of the Tenge, but increased rapidly thereafter. Differences in sectoral financial conditions, in particular in agriculture, and competitive pressures from the private sector resulted in rapidly widening wage differentials among state-employed workers (Table 15). Prior to end-October 1993, the average wage in state financial institutions was less than twice the average wage in state farms; by end-March 1994, a gap of more than four-fold had developed and has persisted.

The level of employment in the state sector and the number of officially registered unemployed remained virtually constant during the first nine months of 1993, and declined slightly in the fourth quarter. Total employment declined slowly throughout the first nine months of 1994, while the official number of unemployed increased gradually from around forty thousand at the end of December 1993 to about sixty thousand at the end of September 1994, about half of whom received benefits. The decline of real output since 1991 has clearly not been matched by a concurrent fall in total employment or by an increase in official unemployment. While the above-mentioned longer-run decline in real wages certainly played a role, this can be mainly explained by the insufficient level of and difficulty in obtaining unemployment benefits, and by the provision of social services and other non-monetary benefits by enterprises, which provides incentives to accept compulsory furloughs or other reductions in work without seeking new employment or unemployment benefits. Private sector employment is believed to be growing, but no detailed information is available.

In spite of the stability of the levels of total employment and registered unemployed, other measures reveal considerable pressures and activities in the labor market in Kazakhstan. For example, there have been sectoral shifts in employment, including a net outflow from the agricultural and construction sectors and an inflow into the state services sector, while the availability of positions, as measured by the number of reported vacancies of enterprises, was strongly impacted by the financial crisis of early 1994. The number of vacancies fell from 56 thousand in October 1993 to only 25 thousand in February 1994, although there has been a recovery since that time. Finally, the Government’s estimates of the number of hidden unemployed--including people not working but not registered as unemployed, or those working reduced schedules--rose from less than 180 thousand at end-October 1993 to almost 775 thousand at end-February 1994 (more than 10 percent of the labor force). Although the authorities’ estimate of hidden unemployment declined to approximately 500 thousand by August, this figure still represented 7 percent of the labor force.

6. Privatization and structural reform

Progress on structural reforms during 1993–94 was significant. In addition to the completion of price liberalization mentioned already, a new privatization program was introduced in 1993 and is now being implemented, while the “state needs” procurement system has been eliminated, except for grain purchases. There has been progress in initiating land reform and in introducing the necessary legal framework for private sector commercial activity. More limited progress has been made in the areas of demonopolization and state enterprise restructuring.

a. Privatization and land reform

Some initial privatization took place between 1991 and early 1993. This initial round involved approximately 10 percent of state-owned assets, and was characterized mainly by sale of enterprises to managers and workers’ collectives. The procedures for this initial round of privatization were neither orderly nor transparent, and excluded outsiders; and a broader, ambitious National Privatization Program for 1993–1995 was adopted in April 1993. Under this program, all state enterprises, except those in banking and agriculture, were divided into three categories for privatization: (i) small-scale enterprises (less than 200 employees), to be sold through auctions on a local level; (ii) medium- and large-scale enterprises (200–5,000 employees), to be privatized through a combined voucher-investment fund scheme; and (iii) special industrial facilities (more than 5,000 employees), to be sold on a case-by-case basis. The small-scale privatization program started with the sale of 67 enterprises on a number of experimental auctions held in August-September 1993. By mid-September 1994, a total of 2,166 enterprises had been sold, mainly in the retail and consumer services sectors, and from a list of over four thousand enterprises scheduled for sale during the year. Under the privatization program for medium- and large-scale enterprises, Kazakh citizens have participated in a unique system, in which they invest privatization coupons in investment funds that then bid for shares. The non-tradeable investment coupons were distributed freely to every Kazakh citizen through deposit accounts of the Savings Bank and are denominated in points. Shares of medium- and large-scale enterprises included in the mass privatization program are sold on auctions to about 180 Investment Privatization Funds (IPFs). The enterprises are first transformed into joint-stock companies, with up to 51 percent of the shares being offered for sale; 10 percent of the shares are transferred to employees, with the state, at present, retaining the remaining shares. A single IPF is not allowed to acquire more than 20 percent of the shares of an enterprise, or to concentrate more than 5 percent of its outstanding coupons in one enterprise.

In the third category of privatization under the program for 1993–95, very large enterprises belonging mainly to the raw materials and heavy industry sectors are privatized on a case-by-case basis, in view of particular needs of the firm (e.g., technology, management or investment) or conditions of the sector (e.g. natural monopoly). The sale may therefore take the form of an auction, a direct sale, a management contract, or a conditional sale to a group of investors. In designing the privatization method and linked restructuring programs, the State Property Committee has been advised by foreign consultants on a tender basis.

As with the privatization of small enterprises under the first tier, the mass privatization program for medium and large enterprises has proceeded as planned, with the distribution of coupons by end-March 1994; by that time most enterprises under this program had also been converted into joint-stock companies. The first share auction was organized in April 1994, and by early October, the State Property had held seven coupon auctions with shares in nearly 400 enterprises having been offered for sale for the first time. 1/ The enterprises offered for sale included companies in the construction, machine building, distribution, consumer goods and clothing industries.

Under the case-by-case approach, one large, specialized enterprise, an Almaty tobacco-processing factory, was sold to an international tobacco company in 1993. In February 1994, the Government announced a list of 38 major enterprises to be offered for sale on a case-by-case basis. Two international tenders, both in the agro-processing sector, were completed in the second quarter of 1994. The Government subsequently expanded the list of enterprises to be privatized under this section of the privatization program from 38 to 180 enterprises, among which are firms in the natural resources and metallurgy sectors, telecommunications, energy, and transportation sector.

The Government has pursued structural reform in the agricultural sector through privatization of agro-enterprises and farms, and through land reform measures. The privatization program started in 1993 and was accelerated in 1994. In the first nine months of 1994, 802 state farms and agricultural enterprises were privatized, compared to a total of 580 planned for the year as a whole. By end-September, nearly half of all state farms had undergone privatization procedures comprising a distribution of shares corresponding to machinery, storage facilities and other non-land assets and of land rights among farm workers and retirees. Each share-holding farm worker is granted the right to take his or her assets and land to establish a private farm. Although in many cases the farm workers have elected to maintain cooperative management the number of private individual farms is gradually increasing and now exceeds 20,000. These farms account for a substantial and rising share of the production of meat, milk, eggs and vegetables (Table 3). The privatization program for agro-enterprises has mainly been a closed process, with access to shares restricted to employees, suppliers and the state.

In a further step toward land reform, private persons and enterprises were given stronger land rights by a March 1994 Presidential Decree that provides for the sale of use rights for land belonging to enterprises, as part of the privatization of these enterprises. Life-long land ownership and use rights can be bought, sold or received as gifts by individuals and legal entities other than state farms. Also, in the course of 1993, more than 1 million apartments became private property, and an additional 85 thousand apartments were privatized in the first quarter of 1994; housing privatization is now close to completion in most regions.

b. Trade and production structures

Considerable progress has been made to reduce state control of domestic trade and procurement. The state orders system introduced in 1992 was replaced by a state needs system in 1993, intended to cover only interstate agreements and normal government procurement needs (health care, education) on the basis of voluntary participation and negotiated prices. The state needs system was seen as a transition towards a fully market-oriented government procurement scheme. The state needs system broke down in 1993, even though a substantial share of industrial, energy, and agricultural production was covered as a result of underdelivery by producers. Planned purchases under the state needs system for 1994 only involved agricultural products, but by mid-1994 it was decided to limit the system to procurement of grain, and the volume of procurement was reduced from about one-third to about one-fourth of the anticipated harvest. At the same time, procurement prices for grain were adjusted for inflation. A new procurement law along the lines of the UNCITRAL Model Law on Procurement of Goods and Construction is now under preparation.

Progress towards the introduction of an effective anti-monopoly legislation has been somewhat slow, as an anti-monopoly law that was introduced in September 1992 is being revised. The Law includes a long list of items that are produced by monopolists and sets profitability limits for monopoly producers, which are verified by an Anti-Monopoly Committee. In November 1993, the Government introduced additional profitability restrictions on production and sale of a number of basic consumer goods, including dairy products, meat, sugar, salt and soap, to accompany the introduction of the new currency; these were lifted in January 1994. Some steps towards the introduction of an effective anti-monopoly legislation were taken in mid-1994, as the State Committee for Prices was incorporated into the Anti-Monopoly Committee, and its role began to shift from ex-ante price setting for a number of commodities to ex-post monitoring of prices and profits of monopolistic enterprises. Beginning in the 1993, the Government established a network of 83 partially state-owned sectoral holding companies, comprising 1,564 major enterprises that produce more than 75 percent of industrial output. 1/ The holding company structures were created to impose a business-oriented management style and corporate governance on enterprises with continuing state participation. The holding companies were given the key responsibility for the restructuring of affiliated enterprises. In practice, however, the holding companies appeared to have taken over most of the tasks of former branch ministries, including discussions of price arrangements with governmental agencies, securing access to inputs, and transferral of profits and losses throughout the holding structure. Recently, the Government announced its intention to abolish the holding companies due to fears that the holding companies were reinforcing monopoly powers and not fulfilling the objectives cited at the time of their formation.

c. Enterprise restructuring

During the summer of 1994, and following the exercise to deal with domestic interenterprise arrears, the Government initiated new measures to restructure loss-making state-owned enterprises. Two decrees issued in September established a mechanism to deal with these enterprises, by dividing insolvent state enterprises into different categories: (i) enterprises of strategic importance to the state, which will remain in the public sector and be financed by the budget; (ii) enterprises scheduled for privatization within six months; and (iii) enterprises that offer no prospect of viability, even with restructuring, and which therefore have to be liquidated. A fourth group of insolvent state enterprises will be restructured with funds from a Rehabilitation Bank, supported by the World Bank, from a Fund for Restructuring, supported by the EBRD, from special units set up by local commercial banks, and from a government agency for financial rehabilitation.

The present Kazakh bankruptcy law dates from January 1992. The law mainly provides for liquidation of bankrupt enterprises and contains few provisions for reorganization as an alternative in appropriate cases; as a result, the law has not been applied. The authorities have recently finalized a revised bankruptcy law, which will be submitted to Parliament in early November 1994.

III. Budgetary Policies and Fiscal Developments

Fiscal policies have played a decisive role in the overall macroeconomic policy mix of the Government in 1993–94. After a major success to reduce the deficit from over 7 percent of GDP in 1992 to approximately 1 percent of GDP in 1993, these efforts went temporarily off-track in the first half of 1994, following the Government’s decision to provide, through the budget, financing for the interenterprise arrears netting operation. As a result, the overall deficit reached 16 percent of GDP in this period. However, starting in July 1994, a major fiscal effort, relying on severe sequestration, turned the fiscal position completely around, and the fiscal deficit was reduced to 3.4 percent of GDP in the period of January-September 1994.

Fiscal adjustment was accompanied by important structural actions: the main extrabudgetary funds were incorporated into the budget; the project to set up a Treasury is near completion; and substantial progress has been made to revise the old, central planning-type tax code.

1. Fiscal policies in 1993

The fiscal position improved dramatically in 1993 relative to 1992, reflecting tighter budgetary policies, but also the positive impact of the “zero option” agreement reached with Russia. The overall budget deficit, on a commitment basis and including grants, was limited to T 384 million, or 1.2 percent of GDP in 1993, as compared with a budget deficit target of 4.3 percent of GDP, and with the 7.4 percent of GDP deficit in the previous year (Table 18 and Chart 3). Expenditures were cut sharply, while revenues were broadly maintained in real terms. After some repayment of arrears that were incurred in 1992, the cash deficit was 1.3 percent of GDP in 1993. The 1993 deficit was financed in large part from domestic sources (1.1 percent of GDP), almost exclusively from credit from the National Bank of Kazakhstan; the external financing of the budget was relatively small (0.2 percent of GDP).

Chart 3
Chart 3

KAZAKHSTAN: FISCAL INDICATORS, 1993–94

Citation: IMF Staff Country Reports 1995, 999; 10.5089/9781451820751.002.A001

Source: Data provided by the authorities; and staff estimates.

The virtual stability of revenue collection--revenue declined marginally from 22.9 percent of GDP in 1992 to 22.3 percent of GDP in 1993--masked two divergent trends. There was a sizeable decline in tax revenue collection, amounting to almost 6 percentage points of GDP, which, however, was almost fully offset by an increase in non-tax and capital revenue collection (Tables 18 and 19). The decline in tax collection reflected a number of factors: (a) a reduction in the general VAT rate from 28 percent to 20 percent, as of January 1, 1993; (b) the accumulation of interenterprise arrears, which negatively affected both VAT and profit tax payments; (c) a sharper decline in the traditional tax base--industrial production--than in GDP as a whole; (d) a decline in real revenue from foreign trade activity, largely due to the sharp drop in exports and a reduction in export taxes; and (e) continued tax erosion, due in part to weaknesses in tax administration.

While the drop in VAT collection was a major contributory factor to the tax revenue decline, it was partly an exogenous development for the Kazakh authorities, in particular, a reduction in the VAT rate in line with policies adopted in other CIS countries. Initially the Kazakh authorities intended to reduce exemptions as an offsetting measure, however, no exemptions subsequently were removed. VAT collection was also adversely affected by the interenterprise arrears crisis as it created a severe liquidity squeeze on enterprises. These factors explained the loss of some VAT revenue equivalent to 2.5 percent of GDP in 1993 as compared to the previous year; the shortfall in comparison to the budget target was 1 percent of GDP.

Excise tax collection was also reduced, due to two factors. First, there was a delay in introducing envisaged excise tax measures, in particular, the extension of the excise tax base to selected imports, including automobiles, textiles, apparel, cosmetics, footwear, electrical appliances, and furniture, was delayed from the beginning of the year until September 1993. Second, there was a decline in the production of alcoholic beverages, including vodka, which comprise the base of the bulk of domestic excise collections.

Revenue from income taxes declined by a little more than 1 percent of GDP in 1993 relative to 1992, reflecting a reduction in profit tax collection; collection from personal income taxes remained broadly unchanged. Profit tax collection was positively influenced by enlarging the tax base through eliminating the tax exemption for export companies. At the same time, however, the methodology for calculating corporate profits was changed by increasing depreciation allowances and by introducing a carry-over of losses for a period of three years. Moreover, the collection of profit taxes was hampered by the accumulation of interenterprise arrears. In contrast, personal income tax collection remained strong, reflecting high nominal wage increases, as well as a relatively efficient collection of this tax.

As a major offset to the decline in the collection of taxes, collection of revenue from non-tax items improved by 3 percentage points of GDP in 1993, relative to 1992. This mainly reflected the imposition of levies by local authorities and increased profit transfers from the National Bank to the budget, the latter in turn reflecting high seigniorage. Capital revenue collection, amounting to 2.5 percent of GDP, resulted mainly from privatization proceeds.

As mentioned above, the improvement in the fiscal performance in 1993 emanated from a contraction in expenditures, with total expenditures declining from about 32 percent of GDP in 1992 to 23.5 percent of GDP. This reduction reflected a combination of adjustment efforts and favorable external developments. Most of the decline reflected a contraction in expenditures in foreign exchange, as Kazakhstan benefitted from the zero option agreement with Russia concerning repayment of former U.S.S.R. external debt, and as allocations for centralized imports were curtailed. The Government also adopted an incomes policy which resulted in the containment of wages and salaries in real terms in the budgetary sphere, in spite of increases of the minimum wage. 1/ While subsidies for bread and fodder continued to be provided by the budget, the number of subsidized agricultural products was reduced. Budgetary subsidies for transportation also were largely eliminated, as expenditures were financed from a local tax earmarked for the development of public transportation.

Public investment was also cut, to a level of just 1.4 percent of GDP in 1993. New investment projects were delayed and expenditure for ongoing projects was limited to levels significantly below the earmarked revenue of the Investment Fund and the Fund for the Replenishment of Natural Resources. A significant proportion of construction projects that were to have been initiated in 1993 were not undertaken, including those related to housing cooperatives.

2. The 1994 budget

a. The January 1994 budget

The initial 1994 budget was approved in January 1994, and a revised version was adopted in July 1994. The initial budget aimed to contain the overall fiscal budget deficit to T 7.8 billion (4 percent of GDP), and domestic bank borrowing to T 2.9 billion (1.5 percent of GDP). The remainder of the deficit was to have been financed through sales of Treasury bills of T 1.2 billion (0.7 percent of GDP) and through net foreign financing equivalent to T 3.6 billion (1.8 percent of GDP). In order to provide a consolidated picture of the Government’s operations, the budget’s coverage was widened to include five extrabudgetary funds: the Road Fund, the Employment Fund, the Pension Fund, the Social Insurance Fund, the Fund for the Protection of Natural Resources, and the Fund for Promoting Entrepreneurship. 1/

Total revenues were projected to decline from 22.3 percent of GDP in 1993 to 21.3 percent of GDP in 1994. The rate structure of the VAT was simplified, with rates of 10 and 20 percent, and a reciprocity principle was applied in regard to imposing VAT on imports from other CIS countries. Regarding excises, tax rates on alcoholic beverages and tobacco products were increased and the tax base was extended to include gasoline, fuel and other oil products, natural gas, cars, soft drinks, luxury items, and household appliances. An airport tax of T 60 for travel to non-CIS states was budgeted to be introduced. The number of products subject to export taxation was significantly reduced, the rates of taxation on petroleum products and minerals were increased, the requirement to prepay such taxes was abolished, and payment in domestic currency was allowed. Import tariff rates were scheduled to be revised, with increases for major luxury items and reductions for essential goods to result in an average duty rate of 15 percent, compared to about 3 percent in 1993. Corporate income taxes were unified at 30 percent, with the exception of banks and insurance companies, which were subject to a 45 percent tax. Finally, severance payments, bonuses paid by enterprises, and receipts from the sale of personal capital assets were made taxable. A major effort was made to reduce exemptions to all taxes.

The Government moved to strengthen tax administration by granting the Central State Tax Inspectorate (CSTI) the legal authority to improve taxpayer compliance. In addition, the Customs Committee broadened its responsibilities, introduced legislation to consolidate and update customs and excise laws, and undertook the development of a computerized customs clearance system.

On the expenditure side, the 1994 budget aimed to maintain total expenditure at the 1993 level of 25.3 percent of GDP, and emphasis was placed on improving the structure of expenditures. The Government cut generalized subsidies, both explicit and implicit, and increased targeted cash benefits to low-income pensioners, families with numerous children, and recipients of unemployment benefits. The Government also discontinued the practice of extending loans at preferential interest rates and eliminated budgetary compensation for the impact of inflation on Savings Bank deposits. State subsidies to producers for bread, fodder, and flour were halved, while housing, community, and heating subsidies were cut by more than 50 percent. Pension eligibility provisions were standardized across sectors and employer contribution rates were reduced significantly from 37 to 30 percent; employee contribution rates were eliminated.

b. The revised 1994 budget

The Parliament approved a revised budget in July 1994 aiming at an overall fiscal deficit of 4.6 percent of GDP (Tables 18 and 19). In order to relieve pressures from the extensive sequestration that had occurred in the first months of 1994 for certain outlays, the revised budget provided for some new expenditure allocations. At the same time, various new tax measures were introduced, some of which were in the original budget proposal for 1994, but which had not been implemented. On the expenditure side, bread and energy-related subsidies were reduced, and capital outlays were further curtailed. In order to contain the wage bill, the Government undertook a major effort to reduce the number of civil service employees, aiming at a reduction of 25 percent of senior level positions in the central administration and of 15 percent in other areas of the budgetary sphere. At the same time, the revised budget provided for higher interest payments, net social safety outlays, and for some increase in operations and maintenance expenditures. On the revenue side, excise taxes were raised for alcoholic beverages (in the case of vodka to 85 percent) and tobacco (to 100 percent), and excises were imposed on automobiles (25 percent), beverages, and electric household appliances. The revised budget also included stiffer penalties on tax evasion and stronger tax enforcement procedures.

3. The budget outturn through September 1994

In the first three months of 1994, the overall budgetary position deteriorated sharply, with the fiscal deficit exceeding 18 percent of GDP, as compared to expectations of a surplus, based on the experience of previous years. The deterioration was due to a sharp decline in revenues, increased outlays for regular expenditures, and payments for formerly quasi-fiscal operations that had not been envisaged in the budget. The decline in tax revenue collection continued and in contrast to 1993, non-tax revenues could no longer offset its adverse impact. In addition to reasons already listed, tax revenues declined further as certain tax measures that had been envisaged in the original budget were not implemented (e.g., the extension of VAT to non-CIS imports and the increase of the average import duty rate to 15 percent). Moreover, tax compliance and collection declined significantly, as a result of a switch to barter transactions by enterprises, following the emergence of payment arrears and delays in bank settlements. The State Tax Inspectorate estimated tax arrears in the first quarter of 1994 at about 2 percent of GDP. Finally, as problems with interenterprise arrears mounted, several large state enterprises were successful in obtaining permission from the Government to temporarily postpone tax payments.

The impact of lower revenue collection was exacerbated by an increase in real expenditures. Regular budgetary outlays rose by almost 5 percentage points of GDP in the first quarter, as compared to their 1993 level. The minimum wage was increased twice in four months, resulting in a larger-than-budgeted wage bill. Increases in petroleum prices and a particularly cold winter also increased outlays. Defense and security related expenditure also rose as Russian border troops began to withdraw, and the Kazakh troops took over their responsibilities. In addition, retail prices for bread and fodder were not fully adjusted in line with rising inflation, which resulted in larger-than-expected subsidies. These larger subsidies and net lending to enterprises more than offset savings resulting from lower levels of other transfers to state enterprises.

However, the main reason for the deterioration in the fiscal performance in the first part of 1994 was related to unforeseen budgetary outlays. Most importantly, the Government undertook an interenterprise arrears netting operation, which entailed extending credit to net debtor enterprises in March-May 1994 of T 18 billion. This credit was intended to have a term of 90 days and be repaid from the resources of the debtor enterprises or from liquidation proceeds. The Government financed this operation mainly through central bank credit, but also from the proceeds of dollar-indexed, 1-year maturity bonds, and from some foreign resources. Another major formerly unbudgeted expenditure item was payment of government guarantees on external debt of enterprises contracted in 1992–93.

The worsening of the fiscal position slowed in the second quarter, as the Government resorted to significant expenditure sequestration and cuts in order to limit the size of the deficit. All expenditure categories were affected, including subsidies, investment outlays, and allocations for operations and maintenance. Some arrears occurred in the payment of wages, pensions, unemployment benefits and external debt service. At the same time, however, outlays for formerly quasi-fiscal operations remained high, and the overall deficit in the second quarter was still 15 percent of GDP.

Fiscal policies were drastically tightened starting in July 1994. In view of a shortfall in foreign financing, regular as well as quasi-fiscal expenditures were severely limited. Expenditure cuts were made across-the-board, and the Government took an additional measure to contain the wage bill by allowing for only a partial spill-over of a series of minimum wage increases into the budgetary sphere. At the same time, revenue collection began to stabilize. As a result, according to preliminary data, the deficits of the first half of the year are estimated to have been transformed into a surplus of 4 percent of GDP in the third quarter of 1994.

4. The social protection system

Kazakhstan has faced a major challenge to provide for the social protection needs of its population during the transformation from a command to a market economy. At the beginning of the transformation process, about 17 percent of the population received retirement benefits while some 37 percent were under 18 years of age. Thus, the country’s dependent population was larger than its active work force.

In 1993, the social security and welfare system was characterized by general protection for most of the population. The system comprised of two types of arrangements: (i) subsidies and transfers, and (ii) cash benefits. Subsidies and transfers included not only those for essential goods and services, such as foodstuffs, heating, transportation, and housing, but also for cinemas, publishing, and circuses. In most cases, these subsidies were not targeted and were aimed at maintaining low prices for all consumers. Budgetary transfers were paid to producers to compensate for the difference between costs and controlled prices. Targeted subsidies, such as in-kind coal transfers, were also provided to particularly vulnerable groups. It is estimated that the budgetary cost of these subsidies and transfers amounted to 5.7 percent of GDP in 1993. In the 1994 budget, the Government shifted away from general subsidies toward targeted ones. It curtailed untargeted subsidies to producers (by 50 percent in the case of bread, fodder, and flour, and by over 50 percent in the case of heating, community services and housing) and replaced them with targeted cash benefits. Moreover, in October 1994, the Government eliminated all bread and fodder subsidies in tandem with the liberalization of bread and fodder prices, and provided for a monthly Tenge 60 cash allowance for only the most vulnerable groups of the population.

Cash benefits are targeted to certain vulnerable groups such as pensioners, children, the unemployed, and the disabled. These payments are administered by the budget (in the case of family allowances) and by three extrabudgetary funds: the Pension Fund, the Employment Fund, and the Social Insurance Fund. In 1993, these three extrabudgetary funds were financed through payroll contributions of 37 percent for the Pension and Social Insurance Funds, and an additional 1 percent payable by employees. Since these funds enjoyed a surplus equal to 19 percent of expenditures in 1993, the authorities decreased the employer contribution rates in the 1994 budget to 30 percent, while employee contributions were eliminated. The proceeds were split between the two funds, with 85 percent going to the Pension Fund and 15 percent going to the Social Insurance Fund. The Employment Fund is financed by a 2 percent payroll contribution payable by employers.

The Pension Law stipulated that old-age pensioners received benefits equal to 60 percent of earnings of the last year before retirement, with an additional 1 percent for each year of service above 25 years for men and 20 years for women. These benefits were increased annually in line with changes in the cost of living index and amounted to about 5 percent of GDP in 1993. These old-age benefits are available at the young age of 55 for women and 60 for men, in cases where special preferences did not apply. Women who raised large families, plasterers, house painters, shepherds, and members of many other occupations are able to receive old-age benefits at even younger ages.

The Social Insurance Fund provided various social insurance benefits amounting to 1.4 percent of GDP in 1993, including for sick leave, temporary disability, maternity leave (142 days at full pay), one-time child birth payments (four times the minimum wage), funeral payments, and sanatorium services. Sick leave and temporary disability benefits were determined on the basis of years of service and accounted for one quarter of spending by the fund in 1993. Nearly two-thirds of the expenditures in 1993 financed stays in sanatoriums and resorts for employees of state enterprises.

Unemployment allowances, training, public works programs, and payments to immigrants were provided by the Employment Fund, with expenditures totalling 0.2 percent of GDP in 1993. Despite an unemployment rate that is estimated to have reached 7 percent of the labor force in 1994, registration for Employment Fund benefits was limited to one-tenth of that level. This could be explained by the very low level of unemployment benefits--the replacement ratio was only 17 percent in September 1994--as well as by the fact that once unemployed, the person loses all social services which are currently financed by enterprises.

Families with children receive benefits under the family allowance program. This program, financed by the budget, provides monthly payments to families with children whose per capita income was less than twice the minimum wage. Families with a per capita income exceeding this amount receive no benefits. Additional benefits, which were not means-tested, are provided to single mothers, families with many children, and children with special needs. Overall, spending on family allowances amounted to roughly 0.6 percent of GDP in both 1993 and in the first half of 1994.

5. Structural changes in the fiscal area

Three major structural changes have occurred in the fiscal area since mid-1993. First, with the exception of the Pension Fund, all major extrabudgetary funds were incorporated into the budget, facilitating expenditure prioritization and better financial management in the government sector as a whole. Second, substantial progress has been made in setting up a Treasury. The project is near completion; once operational, the Treasury will largely improve the cash management of the budget. Third, work is well under way to modify the tax code. The aim is to revise completely the present code, which is largely based on the old central planning system, and to streamline the tax structure. In addition, it is important to note that, unlike in many other FSU countries, the financial relations between the budget and the NBK has been placed on market conditions: the Government pays a market-related interest rate on loans from the central bank (the refinance rate of the NBK), while it receives market-related interest on its deposits with the NBK. Central bank profit transfers are regularized on the basis of the law on the central bank and annual negotiations between the two government bodies.

IV. Monetary and Credit Policies and the Financial System

Domestic developments in money and credit were largely subordinated to the policies of the Central Bank of Russia until mid-1993, given Kazakhstan’s participation in the ruble area. 1/ A tumultuous period immediately followed the currency reform in Russia in July 1993, in which rubles issued prior to 1993 were no longer legal tender in Russia. Not until Kazakhstan issued its own national currency, the Tenge, in November did its National Bank gain control over domestic monetary developments. At that time, the authorities immediately embarked on policies aimed at lowering inflation and developing confidence in the new currency. The effectiveness of these policies was temporarily derailed, however, as the National Bank extended credit to clear sizeable domestic interenterprise arrears in the spring of 1994. Monetary and credit policies were tightened thereafter, helping to dampen inflation and stabilize the nominal exchange rate. Throughout most of 1993 and 1994, the National Bank implemented policies aimed at adapting the financial system to the needs of a market economy. The role of market-determined interest rates was widened, commercial bank prudential requirements were tightened, and improvements were made in the National Bank’s commercial bank supervision.

1. Monetary policy and developments during the ruble era

Monetary policy in Kazakhstan was largely subordinated to Central Bank of Russia policies until Russia’s currency reform in July 1993. As in the rest of the ruble area, monetary and credit aggregates increased rapidly in Kazakhstan in 1993. Currency in circulation increased by 3.5 times, base money by 4.5 times, and broad money by 4 times during the first half of 1993. Most of the increase in lending was in the form of directed credits to state enterprises channelled via state banks, the bulk of which was for financing the grain harvest and for replenishing the working capital of state enterprises.

The Kazakh monetary authorities were not fully prepared for the currency reform in Russia in July 1993. While recognizing the merits of using the opportunity to establish a national currency, the authorities first opted for negotiations and preparations to establish a new monetary union with Russia. They accordingly started the legal and administrative changes necessary for membership in a new ruble area. An agreement was signed with Russia on September 23, 1993, aimed at eventually reunifying the monetary systems of the two countries. The agreement called for harmonization of financial policies and institutions, coordination of price policy and the movement of trade, labor and capital, and creation of a joint fund of gold, foreign exchange and other liquid assets for the support of the Russian ruble. In the interim, Kazakhstan shared the use of pre-1993 rubles with other former ruble area countries that had not yet established national currencies; among neighboring countries, only the Kyrgyz Republic had a separate national currency at that time. Nevertheless, Kazakhstan continued to implement credit policies aimed at lowering inflation, while resorting to currency controls to stem the inflow of old ruble notes. The growth rates of monetary aggregates remained high, however, with base money rising by 40 percent and broad money by 60 percent during the third quarter as commercial banks drew down excess reserves with the NBK to expand credit to the economy. Pending clarification of the country’s position in the ruble area, the NBK built up its foreign reserves through the accumulation of domestically produced gold and the suspension of foreign currency auctions.

While pre-1993 and new Russian notes had been circulating at par until the July currency conversion, the rate between them widened to around 2:1 by September. Despite efforts to stop the inflow of old notes, the anticipation that the NBK would carry out a currency reform led to a move to hoarding, barter trade and use of foreign currencies. Together with substantial adjustments in the domestic prices of energy and bread, the monthly inflation rate accelerated (Chart 4), and the exchange rate between pre-1993 and Russian rubles widened to about 5.1. By end-October, with dimming prospects for agreement on a new ruble area, confidence in the pre-1993 ruble collapsed, with the exchange rate against the U.S. dollar dropping from Rub 2,700 in late-October to Rub 7,000–10,000 in the week of November 8.

Chart 4
Chart 4

KAZAKHSTAN: MONETARY INDICATORS, 1993–94

Citation: IMF Staff Country Reports 1995, 999; 10.5089/9781451820751.002.A001

Source: Data provided by the authorities; and staff estimates.1/ Effective Refinance rate for 1993 is based on average maturity of 12 months.

2. The introduction of the Tenge

Kazakhstan introduced its national currency, the Tenge, on November 15, 1993. The period for conversion to the Tenge took place during November 15–20, with the circulation of large denomination ruble notes suspended on November 15, and circulation of small denomination notes suspended on November 18. Individuals could exchange cash only up to 100,000 rubles per person (equivalent to the average wage in October), at a rate of 500 rubles per Tenge; 1/ amounts in excess of the limit could be deposited in special accounts, which would be frozen for 6 months, pending an examination of legitimacy. Deposits also were converted at T 500 per ruble. 2/

Legal entities could exchange cash only through deposits at commercial banks. For enterprises engaged in retail trade, the limit on amounts to be converted was set at their average daily balance for July 1993 multiplied by a factor of 1.3; for other legal entities, the limit was their average daily cash balance. Banks were prohibited from accepting deposits in excess of these limits, and enterprises were limited to a single conversion transaction (except for enterprises involved in retail trade and services). Amounts in excess of the above limits were to be placed in special accounts blocked for a period of six months, pending the results of an inspection of the sources of the funds.

The National Bank exchanged slightly less than Rub 1 trillion of pre-1993 notes during the conversion period, compared to an estimate of Rub 1.2 trillion for currency in circulation at end-October. 3/ To insure that the introduction of the new currency would not lead to price increases during the conversion period, the Government introduced penalties for (i) discrepancies between the prices of goods as expressed in Tenge and in rubles; (ii) refusal to sell goods for Tenge; (iii) the sale of goods for foreign currencies by non-licensed organizations; and (iv) deliberate closure of businesses. 1/ In order to bolster confidence in the new currency, controls on the use of cash were removed; cash controls had been used during the ruble area period, as the receipt of ruble notes from the Central Bank of Russia typically had fallen short of local needs. Price and profit controls introduced at the time of the conversion were removed shortly thereafter.

3. Monetary developments following the introduction of the Tenge

With the introduction of the Tenge, the National Bank was for the first time in a position to conduct an independent monetary and credit policy, and policies aimed at reducing inflation were put in place. The National Bank reduced the growth in credit, increased commercial bank reserve requirements from 20 to 30 percent, and increased the proportion of central bank credit allocated through credit auctions, which were held on a monthly basis. The NBK refinance rate was increased administratively from 170 percent to 240 percent on December 12, 1993, exceeding for the first time the refinance rate of the Central Bank of Russia, and further to 270 percent on January 10, 1994 (Table 21). As a result of these policies, the quarterly growth rate of NBK credit to banks fell from more than 25 percent to less than 10 percent in the fourth quarter of 1993. The quarterly growth in broad money slowed from almost 64 percent in the third quarter of 1993 to less than 25 percent in the fourth quarter. Moreover, a large portion of the increase in base money reflected a significant strengthening of the NBK’s net foreign asset position. Inflation dropped during in the early months of 1994 (Chart 4), accompanied by a rapid slowdown in the depreciation of the nominal exchange rate (Chart 5).

Chart 5
Chart 5

KAZAKHSTAN: EXCHANGE RATE DEVELOPMENTS, 1993–94

Citation: IMF Staff Country Reports 1995, 999; 10.5089/9781451820751.002.A001

Source: Data provided by the authorities; and staff estimates.1/ Kazakhstan Interbank Currency Exchange.

Progress toward price stability was derailed in March 1994 when the National Bank began providing financing to clear massive domestic interenterprise arrears. The implementation of tight credit policies following the introduction of the Tenge, combined with loose financial discipline in the enterprises sector, had contributed to the rapid development of large-scale arrears among domestic enterprises that threatened to undermine the banking and payments systems. The Government formulated a plan that included the use of credit to clear the arrears in mid-February 1994. 2/ Gross arrears covered by the operation amounted to T 38 billion, and the amounts remaining after the netting operation was T 18 billion owed by net debtor enterprises, and T 11 billion owed to net creditor enterprises. 1/ The Government lent net debtor enterprises T 18 billion at a (simple annual) interest rate of 200 percent, about half of which was due in September 1994 and the remainder of which was due by the end of 1994. As for the net creditor enterprises, some energy sector firms were immediately given T 1.1 billion as settlement of their claims, and the remaining net creditor enterprises were given one-year Treasury bonds carrying an annual interest rate of 3 percent, with the principle indexed to the Tenge/U.S. dollar exchange rate of April 22, 1994. Government resources amounting to T 2.6 billion in 1994 were earmarked for the exercise. The National Bank was called upon to finance about T 7.6 billion by mid-year, an amount equivalent to about one-half of base money at the time.

The emergence of interenterprise arrears also had an adverse effect on tax collections, helping boost the Government’s borrowing needs. Domestic credit increased rapidly, and together with a further build-up of net official international reserves, base money increased by almost 170 percent in the first quarter of 1994 (Table 20). Growth in broad money also was high, even though commercial banks held sizeable deposits with the National Bank; part of the increase in deposits was the result of raising bank reserve requirements in January.

Following the sharp increase in March-April, the National Bank severely restricted new credit to the economy; and base money expanded by just 24 percent during the second quarter of 1994. However, the momentum from the growth during March-April resulted in a still substantial increase of bank credit to the economy and of broad money, the latter expanding by 72 percent in the second quarter. Base money increased by over 60 percent during the third quarter, as the Government repaid the National Bank the principal borrowed for the arrears clearing operation. Almost all of the increase in National Bank credit during the third quarter was either auctioned or directed to the needs of the agricultural harvest. The tightening of credit policies after April led to a break in the inflation-exchange rate depreciation cycle of the first five months of 1994, when credit obtained at NBK credit auctions had been used for speculation in the foreign exchange market, which had led to a decline in the foreign exchange value of the Tenge and boosted the cost of imported commodities, thus further fueling inflationary expectations and adding to credit demand.

4. Credit auctions and interest rates

Steps toward the introduction of a market-based system of credit allocation system and interest rate determination were started while Kazakhstan was still in the ruble area. In 1993, the National Bank began to move away from extending credit at highly subsidized interest rates, and adjusted its refinance rate generally in line with that of the Central Bank of Russia. Except for a two-year Rub 400 billion loan for the replenishment of working capital of state enterprises extended at 25 percent per annum in January 1993, virtually all NBK credits were extended at the official refinance rate of 65 percent per annum (Table 21). The National Bank’s average lending rate rose from 21 percent per annum during the last quarter of 1992 to about 50 percent during the first quarter of 1993; however, real interest rates remained highly negative, as monthly inflation averaged 32 percent at that time. The first credit auction was held in September 1992, and only two auctions were held that year. The NBK started holding credit auctions on a monthly basis as of January 1993, although the amount of credit sold on the auction initially remained small (Table 22). 1/ Between the beginning of 1993 and June, immediately prior to the currency reform in Russia, auction interest rates rose from 105 percent (per annum for three-month credits) to 185 percent, an effective monthly rate of 15 percent. On July 5, 1993, the NBK’s refinance rate was raised (with retroactive effect to July 1) from 65 percent per annum to 110 percent and to 140 percent on July 23, 1993, leaving a gap of 20 percentage points in comparison with the CBR refinance rate.

The movement towards deepening the credit auction slowed in the third quarter of 1993. Adjustments in the National Bank’s official refinance rate, at which the bulk of its credits were extended, were also delayed, as the refinance rate was raised to 170 percent on September 22, about ten weeks following a similar move by the Central Bank of Russia. The refinance rate was maintained at that level until the introduction of the Tenge, even though the monthly inflation rate reached 55 percent in November. Although the share of auctioned credit in total credit extended to banks remained at a level of approximately 10 percent, the September and October auctions yielded rates of 265 percent and 263 percent for three-month maturities, respectively. Besides Kazakhstan’s uncertain position with regard to the ruble area, part of the central bank’s reluctance to raise its refinance rate and to intensify the use of credit auctions stemmed from pressures to provide loans to certain sectors of the economy, such as agriculture, which were dependent on subsidized central bank financing; credit obtained through the auctions was primarily used by trading enterprises.

Following the introduction of the Tenge, credit auctions began to acquire a more central role in the credit allocation process. The NBK’s refinance rate was more closely linked to the interest rate resulting from the auction in December 1993, 2/ and the rate applicable to rolled-over credits extended to banks was set equal to the refinance rate. The interest rate charged on new lending to the Government and the rates paid on government deposits were raised further to the level of the National Bank’s refinance rate in January 1994. Credit auctions were also held more frequently, and their share in total credit extended by the National Bank rose to 21 percent in December 1993 and to 62 percent in January 1994 (Table 22). Interest rates increased rapidly in the first quarter of 1994, with auction rates averaging over 300 percent per annum during January and February, 1/ and peaking at 426 percent for credit of three-month maturity (equivalent to an effective monthly rate of 27 percent) at the end of May. 2/

The National Bank was less successful in raising the share of auctioned credit in total credit to banks after the initial increase in December 1993-January 1994. In the period from February through August 1994, this share fluctuated at around 25 percent, as a result of demands for directed credits from the agricultural sector and from utility companies. However, the frequency of auctions was increased, with nine auctions held in August, several in regional centers outside Almaty. Almost all non-auctioned National Bank lending, including to the Government, has been extended at the official refinance rate; the only exceptions were the deferral of repayment of agricultural and coal credits due in 1994, and a credit for the payment of agricultural wages extended at 25 percent per annum. Interest changes on credits extended for the financing of the inter-enterprise arrears netting operation were calculated on the basis of the official refinance rate, even though the Government charged net debtor enterprises a lower rate. Concurrent with the decline of monthly inflation, the average credit auction rate declined gradually to 287 percent by end-September 1994, equivalent to an effective monthly rate of 20 percent. The refinance rate of the NBK, which had been increased to 300 percent in March, was correspondingly lowered to 280 percent as of September 1, and to 270 percent as of September 20. Given the more rapid decline in inflation during the period, interest rates became positive in real terms (Chart 2).

5. Structural reform of the financial system

Institutional reforms of the banking system gained momentum in the course of 1993. The legal foundations of the NBK were strengthened through adoption of new statutes, and new banking and foreign exchange laws were approved by Parliament in April. These measures were accompanied by an overhaul of the instruments of bank supervision and a tightening of commercial bank capital requirements and licensing procedures. More recent efforts focused on modernizing the accounting systems for the National Bank and commercial banks, auditing the commercial banks, and on improvements to the payments system.

The banking sector in Kazakhstan had by 1993 evolved into a system where five formerly specialized state banks (in agricultural, foreign trade, construction, savings and industrial operations) coexisted with about 200 smaller banks that were established in 1991–92. 1/ Many of the smaller banks had been set up by state-owned enterprises in order to access refinance credits from the NBK. Most banks, including Agroprombank, were dependent on refinance credit rather than deposits; banking activities in 1993 were also characterized by insider lending to shareholders of small banks and by easy roll-over of both refinance and bank credits.

The process of structural reform in the financial sector accelerated after the introduction of the new currency. As mentioned earlier, the NBK moved to reduce the role of refinance credit following the introduction of the Tenge, to increase the share of credit allocated through the auction and to align the refinancing rate with the rates determined by the auctions. To provide additional incentives for banks to meet the prudential norms set by the National Bank, only commercial banks which met these norms were allowed to participate in the credit auctions. To further reduce dependence on directed credits, the NBK reduced the maximum maturity of its credits from nine to six months in March 1994, although a limited amount of credit with maturity of nine months was provided during the summer of 1994 to meet the needs of the agricultural sector.

In 1994, progress in structural reforms included a strengthening of the banking supervision operations of the NBK and implementation of a wide range of prudential measures. Prudential measures included: (i) increasing minimum capital requirements, which were denominated in U.S. dollars; 2/ (ii) setting the minimum capital adequacy ratio on risk-weighted assets at 8 percent; (iii) raising the reserve and liquidity ratios to 30 percent on domestic deposits. In addition, as of October 1, 1994, a 15 percent reserve requirement was imposed on foreign currency deposits with commercial banks; (iv) imposing single outsider and insider borrowing exposure limits; (v) introducing ceilings on foreign exchange positions; (vi) initiating audits, in July 1994, of the ten largest banks, to be completed by January 1995; and (vii) expanding the NBK’s banking supervision department. The strengthening of the NBK’s supervisory role, together with the increase in capitalization requirements, resulted in a sharp reduction in the licensing of new banks, the closure of problem banks, and the encouragement of bank mergers. The total number of licensed banks fell from 204 on January 1, 1994 to 190 on August 1. The implementation of these regulations was expected to help address growing arrears to commercial banks. At the end of 1993, arrears of T 1.7 billion on bank loans were equivalent to 11 percent of bank credit to non-government borrowers; these arrears were not included in the February 1994 arrears clearing operation. Arrears to banks increased to T 3.7 billion by end-March 1994, and further to T 8.5 billion by end-July, equivalent to 20 percent of bank credit to the economy.

Substantial progress has been made in reducing the state’s holdings in banks and in restructuring the five large, formerly specialized banks. At the end of 1993, the state remained an important shareholder in most banks, directly or indirectly through ownership of enterprises that in turn owned bank shares. The state maintained a majority position in the agriculture and industrial banks (Agroprombank and Turanbank) and the full ownership of the Sberbank. The state’s shareholder position began to be diluted during 1992-93 through issuance of new shares to non-state entities and has been reduced further with the implementation of the privatization program, as bank shares have been privatized indirectly when the state enterprises that own bank shares were privatized. 1/

The authorities have moved more recently to reorganize four of the five formerly specialized banks: Agroprombank will be split into two banks, one taking over performing loans and onlending directed agricultural credits (only with explicit state guarantees), and one for collecting bad debts; Alembank will be broken up into a state-owned Eximbank and a private commercial bank; Sberbank was privatized in January 1994 as the “People’s Bank”, with market-determined deposit interest rates and lending resources channeled through NBK credit auctions; and in early September 1994, Turanbank was reestablished as the Reconstruction and Development Bank, following divestiture of some commercial activities. 2/ The state guarantees for deposits held at Sberbank were not extended to new People’s Bank deposits. Sberbank’s housing loans were transferred to a new Housing Construction Bank, which also obtained the state guarantee deposits formerly granted on Sberbank.

Other financial sector reforms since the beginning of 1993 include the promotion of foreign banking activity and payment system reform. A new Banking Law adopted in April 1993 eliminated may restrictions on the establishment and activities of banks with foreign participation. The legislation distinguishes three forms of foreign participation: “national” banks have foreign capital of less than 35 percent of initial capital; “joint-venture” banks have foreign participation of between 36 to 50 percent of share capital; and “foreign-owned” banks have foreign capital participation of more than 50 percent. The registration procedure of “national” banks is the same as for domestic banks with no foreign participation. Joint-venture and foreign-owned banks are required to submit a number of additional legal documents to obtain NBK approval. At the end of September 1994, 5 joint-venture and 4 foreign-owned banks were operating in Kazakhstan with aggregate initial capital of US$37.4 million. Seven representative offices of foreign banks also have been opened in Almaty, and the number of foreign shareholders in domestic bank is growing. Banks with foreign participation are almost exclusively engaged in the financing of foreign trade activities.

The payment system still suffers from a number of major weaknesses. Transactions via regional clearing centers in the nineteen oblasts require up to three weeks to process and settle, resulting in a high negative float, a net reduction in banks’ monetary assets, and reduced availability of working capital of enterprises. Measures were taken in the first half of 1994 to introduce more appropriate payment procedures. Commercial banks were instructed not to execute clients’ payments orders that are not covered by adequate funds, and the use of irrevocable letters of credit as a payment instrument is being facilitated.

Since July 1994, the National Bank has remunerated commercial bank average monthly holdings of required reserves--with the exception of required reserves on foreign deposits--at 50 percent of the official refinance rate: this has helped improve the banks’ financial position. All banks were instructed to consolidate the correspondent accounts of their branches. Required reserves have been included into the correspondent accounts, and the reserve requirement is now computed on a consolidated basis, including all branches. Reserve requirements on foreign currency deposits with commercial banks introduced in October 1994 are not remunerated.

V. External Sector Developments

1. Balance of payments developments in 1993 and early 1994

a. Overview

Over the past year, the quality of balance of payments statistics has improved, both in terms of coverage and economic content. Despite the improvement, the estimates of the balance of payments are still subject to a significant margin of error, due to less than full compliance with reporting requirements by enterprises, widespread valuation problems, the switching of trade data sources to customs statistics and continuing weakness in data for certain entries (e.g., trade in services, and foreign investment as well as capital transactions with FSU states). Significant adjustments were applied to primary data supplied by Goskomstat in consultation with the Ministry of Economy and the NBK, in order to eliminate inconsistencies and to account for counterparts of tied-import financing and outflows represented by surpluses in barter trade. 1/

The balance of payments of Kazakhstan is traditionally presented in a main, consolidated table and two other tables showing FSU and non-FSU transactions separately. In the past, this breakdown was necessary, as it closely reflected a distinction in terms of currencies (non-convertible and convertible, respectively). The two sets of transactions also exhibited fundamental differences in the average quality of commodities traded and in applicable trade and payments regulations. In addition, the discrepancy in trade prices was very large, and the comparability among FSU and non-FSU capital account items, minimal. During the period since the last Article IV consultations, these differences have been substantially reduced as a result of the emergence of realistic exchange rates and improvements in the degree of convertibility of Kazakhstan’s and other FSU countries’ currencies. Moreover, as some FSU transactions are now settled in convertible currencies, the distinction among trade transactions in terms of currencies is becoming different from the one in terms of geographical directions. 2/ Nevertheless, because significant differences between FSU and non-FSU transactions still remain--for example in their evolution over time--the analysis of the consolidated accounts still must be complemented by examining FSU and non-FSU accounts separately.

Kazakhstan’s consolidated external current account showed a deficit of US$438 million in 1993, which increased to US$532 million in the first half of 1994, equivalent to over 10 percent of GDP (Table 23). 3/ This current account outcome was largely trade-driven. In both 1993 and the first half of 1994, the bulk of the consolidated current account deficit arose from FSU trade, where Kazakhstan suffered substantial terms of trade losses. These were was accompanied by a sharp contraction in the volume of FSU trade, mainly due to settlement problems and the decline in overall economic activity. Non-FSU trade exhibited more stability, with exports actually increasing in 1993, despite a decline in non-FSU oil export volumes due to lack of access to Russian oil pipelines. Import volumes from non-FSU countries were supported by access to substantial trade financing under export credit agency cover. In the first half of 1994, non-FSU exports declined by almost 20 percent in dollar terms, driven by a sharp drop in oil exports; at the same time, imports increased by almost 66 percent. 1/

The overall balance reflected, by and large, the substantial availability of foreign financing. The structure of the consolidated balance of payments has undergone a distinct change since 1992. In that year, financing (other than the running up of arrears on Kazakhstan’s share of Soviet debt) was more readily available from Russia than from non-FSU sources. In contrast, both in 1993 and the first half of 1994, the FSU overall balance was substantially underfinanced and offset by a surplus on the non-FSU account. The composition of financing also has changed: in 1993, commercial trade credits, were predominant, with well over half of the US$710 million trade credits provided by all countries coming from Russia. In contrast, in 1994, official loans became more important, while credits from Russia were both much smaller and of a different nature. 2/ Disbursements of trade credits from countries outside the FSU reached US$379 million in 1993, and US$261 million in the first half of 1994.

b. Current account transactions

Available data indicate a sharp decline in trade with FSU countries in 1993, and a further drop in the first half of 1994. 3/ The most important factors contributing to this decline were disruptions in energy trade, difficulties with interstate payments, and the weak implementation of interstate trade agreements. A reorientation of trade from countries of the former Soviet Union to other markets also contributed to the decline in FSU trade (Tables 27 and 28). 1/

By far the most important trade partner in FSU transactions was Russia, which accounted in 1993 for two-thirds of total FSU exports and almost three-quarters of total FSU imports. Other FSU countries with significant shares in trade included Ukraine, Uzbekistan (both with 7-8 percent), Belarus and Turkmenistan (see Table 24, for example, for energy exports).

As mentioned, exports to non-FSU countries increased in 1993, but dropped in the first half of 1994, as compared to the same period of 1993. In contrast, inports from non-FSU countries exhibited an increasing trend in both 1993 and 1994. Kazakhstan’s main export items are nonferrous and ferrous metals and metal products, grain and oil; however, the commodity composition of trade with these countries underwent substantial changes in 1993–94, as exports of foodstuffs increased dramatically, while the shares of crude oil and, to a lesser extent, minerals, declined (Table 27). The composition of imports from non-FSU countries shifted away from agricultural products toward machinery and equipment. Regarding geographical composition, bilateral trade with China soared in 1992 (China accounted for almost one-half of Kazakhstan’s non-FSU imports in that year), then declined to around one-seventh of the total in 1993 (Table 26). Nevertheless, China remained the leading source of non-FSU imports in 1993, followed by Germany and the Czech Republic. On the export side, China, Germany, the United States, Switzerland and Sweden were the most important trade partners (Table 25). Much of Kazakhstan’s trade with non-FSU countries, particularly that with China, was carried out through barter arrangements.

During 1993 and the first half of 1994, trade prices in general and those for energy products in particular had not reached world market levels for trade with countries of the former Soviet Union. In this period, Kazakhstan sustained substantial losses in interstate energy trade because the average unit import price for oil exceeded the average unit export price for oil. 2/ A primary reason for this difference appears to be the effective use by Russian refineries of their monopsony position, relative to Kazakh oil exporters arising from the geographic configuration of the pipeline system constructed prior to the break-up of the Soviet Union. This system forces practically all oil trade through the Russian Federation. 1/ Since Kazakhstan cannot link its major oil fields with domestic refineries without large-scale investment in new pipelines, Kazakh oil suppliers are likely to continue to be in a weak bargaining position vis-a-vis Russian refineries in the near future.

c. Capital account transactions

During the first half of 1993, Kazakhstan received financing of around US$400 million from Russia through the central bank correspondent accounts credits. During the same period, Kazakhstan provided net credit through the same mechanism to other FSU states, including Georgia, the Kyrgyz Republic, Tajikistan, Uzbekistan and Ukraine, of around US$55 million, mainly to finance trade of goods and services.

The Central Bank of Russia (CBR) froze the correspondent accounts with Kazakhstan in mid-1993, from which time the availability of financing became a binding constraint on imports from Russia. In July 1993, Russia agreed to provide Kazakhstan with a medium-term state credit of Rub 150 billion (approximately US$146 million at the July 1993 Ruble/dollar exchange rate, at market terms. However, less than 10 percent of this credit was disbursed by end-1993, and about one-third was disbursed by mid-1994. In view of the financing constraints for trade with Russia, Kazakh enterprises increasingly built up arrears. At the same time, enterprises in other FSU countries also accumulated large payments arrears to Kazakh enterprises. Thus, the stock of outstanding gross arrears grew rapidly throughout 1993. 2/ At the time of the introduction of the Tenge, Kazakh enterprises had a net debtor position of around Rub 260 billion, in excess of US$200 million at the prevailing exchange rate. 3/ According to NBK data, the entire net amount of interstate enterprise arrears was repaid during the first four months of 1994, although large gross arrears remained on both sides.

Official foreign financing in 1993–94 consisted of relatively small amounts of official grants, bilateral government credits (from Germany and Russia), and, in the latter part of 1994, disbursements under the World Bank’s Import Rehabilitation Loan. Through the end of September 1994, Kazakhstan had made purchases amounting to the equivalent of US$193 million from the International Monetary Fund, including US$88 million in 1993 under the first drawing of the STF, and US$105 million in 1994 under the second drawing of the STF and under a purchase related to the stand-by arrangement.

d. Foreign investment activity

The authorities have worked to develop a favorable climate for foreign investment in Kazakhstan. Foreign investors can receive tax holidays, exemptions from licensing and quota restrictions, and can freely repatriate their profits. A National Agency for Foreign Investment is in charge of centralizing the dissemination of information and providing support to foreign investors.

As a result of the favorable climate, a number of significant foreign investment agreements were concluded in 1993–94, primarily in the oil sector, but also in the food processing and tobacco industries. 1/ In 1992, a major French oil company concluded an exploration agreement for the Temirmunai oil field, and work began in 1993. In April 1993, a major American oil company signed a 60-year contract with Kazakhstan to develop the Tengiz oil field, located in western Kazakhstan. Another international consortium plans to make substantial investments in the Karachaganak gas field over the next ten years. While the prospects remain excellent, there has been a sobering of expectations on the prospects for immediate expansion of oil exports, in the absence of cooperation from Russia on access to pipelines. At the same time, there is continuing interest in the non-energy sector following the purchase by a foreign company of a tobacco factory at the end of 1993.

e. Developments in the trade regime

The trade regime prevailing in 1992 and the first half of 1993 was characterized by inconsistencies related to ad hoc abolition of a number of earlier restrictions while other regulations became ineffective due to widespread exemptions or evasion. At the same time, several exchange rates coexisted at any moment in time during that period, and domestic prices for Kazakhstan’s main export commodities were set administratively at levels below world market prices, resulting in highly distorted relative prices. As discussed elsewhere in the report, inflation was high despite remaining price controls. In these circumstances, the share of barter trade increased, capital flight was substantial and foreign exchange was in short supply. Moreover, some Kazakh exporters sold commodities at prices below those on the world market simply to earn foreign exchange, resulting in accusations of dumping by trade partners. Finally, in the absence of a working system of natural resource taxation, economic rents were not adequately captured by the budget, despite efforts to use state orders and quantitative trade restrictions to that end. In order to ensure more favorable export prices, increased repatriation of export proceeds, adequate budget revenues, and to lower the share of barter trade, 13 sectoral state trading monopolies were formed in mid-1993 to control Kazakhstan’s trade in strategic commodities, which account for the bulk of non-FSU exports.

Throughout 1993, export licenses continued to be required for an extensive range of products, including most raw materials, processed industrial goods, and a number of priority consumer goods. The granting of export licenses for strategic commodities was restricted by the Ministry of Foreign Economic Relations (merged with other Ministries and reorganized as the Ministry of Industry and Trade in 1994) to state trading companies and large state-owned companies.

Since mid-1993, and in conjunction with economic reform programs agreed with the Fund, considerable progress has been made (i) in lowering barriers to trade, (ii) in creating economic incentives for voluntary repatriation of export proceeds, (iii) in preparing the ground for elimination of the monopoly position of state trading organizations and (iv) in further liberalization of the trade system. The number of goods subject to export quotas in Kazakhstan was reduced from 34 in December 1993, to 25 in February 1994 to 7 in early May. By the end of 1993, there were no import quotas. The number of commodity groups subject to export licenses was reduced from 55 at end-93, to 50 by late January 1994 and to 30 by early May. The number of commodity groups subject to import licenses was reduced to 8 as of early May 1994; this number remained unchanged through September 1994. Monetary and exchange rate stability, the most important precondition for voluntary repatriation of export proceeds, began to be achieved during the summer and fall of 1994. The level of export taxes was reduced, and export taxes became payable in Tenge from January 1994 rather than in foreign currencies.

Other reforms to the trade regime during 1993–94 targeted the further dismantling of the Soviet-era system, and putting in place temporary trade arrangements to deal with the abrupt decline of trade with other countries of the former Soviet Union. As such, there has been a substantial reduction in the coverage of interstate trade agreements, and use of state orders to facilitate foreign trade was fully eliminated at the end of 1993. While the trade system lacked transparency in 1993, due to frequent revisions of regulations and widespread exemptions from trade taxes, tariffs and the surrender requirement, most exemptions have now been eliminated.

The surrender requirement was increased in mid-1993 from 10 percent to 30 percent, and extended to cover export proceeds in domestic currency. Surrender of foreign exchange was effected at the official exchange rate. 1/ On January 1, 1994 the surrender requirement was raised to 50 percent and applied to all export transactions, with surrender made directly to the auction at the KICE exchange rate. All previous exemptions from the surrender requirement were withdrawn, with the exception of those for joint ventures. Revised trade regulations were adopted in February 1993, resulting in similar treatment of FSU and non-FSU trade in practically all aspects, with the exception of treatment of trade by joint ventures in non-FSU trade and trade under existing intergovernmental agreements in FSU trade.

Auctions for the right to export under existing quotas were introduced in March 1994. However, effective demand for several quotas fell short of the amounts allowed under the quotas, even in the case of commodities whose domestic prices had not yet fully reached world market levels. This was partly due to the fact that high transportation and other transactions costs, as well as declining volumes of production, have led to oversized quotas, which were set using optimistic output assumptions.

A free trade agreement between Kazakhstan, Uzbekistan and the Kyrgyz Republic came into force in February 1994, which resulted in trade free of customs and trade tariffs; quotas and licenses continue to apply.

2. The foreign exchange market

From July 1992 until the Tenge was introduced in mid-November 1993, official exchange rates in Kazakhstan were set on the basis of a par rate to the Russian ruble, and the exchange rate of the ruble to foreign currencies as set by the Moscow Interbank Currency Exchange. 2/ Although the official rates were used as the basis for the surrender requirement, interbank foreign currency transactions and auctions held in Almaty at the time produced rates consistently more depreciated than those implied by the official par to the Moscow rate. The gap between the Moscow and Almaty exchange rates widened to 40–50 percent by August 1993, and reached five to ten-fold in the weeks preceding the introduction of the Tenge. However, the local auction was thin, and practically nonexistent from the end of August until November. 3/ Exporters were penalized at that time by payment of the domestic currency counterpart to the surrender requirement on the basis of the official par exchange rate to the Russian ruble; but with payments made in the rapidly depreciating Kazakh ruble.

From mid-November 1993, auctions for U.S. dollars and Russian rubles were held at least once per week to determine the official exchange rate of the Tenge. Foreign exchange transactions outside the exchange auction, predominantly cash sales and direct foreign exchange sales between banks, are estimated to have declined from a peak in October-November 1993 of almost 100 percent of total volume, to around one-tenth of the market by September 1994. In the first two months after introduction, the Tenge depreciated in nominal terms by 35 percent relative to the Russian Ruble and by 90 percent relative to the U.S. dollar, but remained stable in real terms. Following the arrears clearing operation in the spring, there was a sharp real depreciation of the Tenge between March and May 1994. As a result of tightened financial policies from early May 1994, the nominal exchange rate virtually stabilized at the end-May level, and the real exchange rate returned back to its level existing at the time of the introduction of the Tenge (Chart 5).

The NBK has refrained from major interventions in the foreign exchange market since January 1994. The average volumes traded on auctions have exceeded US$70 million in each month since February 1994. Since the beginning of 1994, the Government’s foreign exchange needs have been covered from the foreign exchange auctions. The level of central bank net foreign reserves, which was under US$100 million at the end of 1992, has improved over the period under review to reach over US$650 million, or almost two months of imports, by mid-1994. 1/

3. External debt

Kazakhstan’s management of external debt in the period immediately following independence was neither coherent nor efficient. As a result, credits were contracted and government guarantees extended at an unsustainable rate, mainly to finance consumer goods imports. Debt management has improved substantially from mid-1993, and especially during 1994. Kazakhstan signed the “zero option” agreement with Russia and regularized its debt incurred through the central bank correspondent accounts with Russia. In addition, in several rounds, outstanding government guarantees in excess of US$2 billion were canceled on credits that had not yet reached the disbursement phase, reducing the stock of such guarantees by more than half. The Government has tightened the procedures for undertaking foreign loans and imposed a temporary moratorium on most new guarantees. The Ministry of Finance, in cooperation with the Ministry of Economy, has set up a unit to monitor the contracting and guaranteeing of external debt; the unit became operational in mid-1994. 1/ As a result, the stock of external debt as well as its composition and the implied debt service profile can be regarded as sustainable over the medium term.

Kazakhstan’s external debt stock at the end of 1993 was approximately US$1.9 billion, excluding disbursements from the Fund (Table 29). 2/ Of this, US$1.25 billion was owed to Russia as a result of the July 1993 conversion of outstanding correspondent account balances into medium-term intergovernmental debt, with a floating interest rate tied to the LIBOR. 2/ Russia also provided credits under a Rub 150 billion intergovernmental loan in the first half of 1994, so that Kazakhstan’s overall indebtedness to Russia, as of end-June 1994, was approximately US$1.32 billion. Total debt stock as of mid-1994 is estimated at around US$2.3 billion, excluding Fund disbursements taking into account: (i) additional disbursements of trade credits in the form of commodity credits or bank credits supporting exports to Kazakhstan on market terms; 4/ (ii) disbursements by the World Bank to Kazakhstan under the Import Rehabilitation Loan of US$117 million; and (iii) an official credit of US$22 million from Germany. Kazakhstan is estimated to have made external debt service payments (both amortization and interest) in excess of US$100 million in 1993, and US$50 million in the first half of 1994.

Kazakhstan has reached several important agreements that have influenced, or are expected to influence, its external debt obligations in the future. These agreements are the following:

(i) “Zero option” agreement with Russia. On September 6, 1993, Kazakhstan concluded an agreement (“zero option”) with Russia regarding the external debt of the former U.S.S.R., which stipulated that: (a) the definition of the external debt of the former U.S.S.R. was as agreed in a December 4, 1991 Interstate Agreement, signed by the U.S.S.R. and its successor states; 5/ (b) Kazakhstan’s share of the debt was 3.86 percent; (c) Russia accepts responsibility for repayment of Kazakhstan’s share of the debt; 1/ and (d) Kazakhstan relinquishes claims over its share of the assets of the former U.S.S.R. 2/

(ii) Agreements on debt with other FSU states. During the summer of 1993, Kazakhstan has reached agreement with Georgia, Turkmenistan, the Kyrgyz Republic, Tajikistan and Uzbekistan on the clearance of outstanding central bank correspondent account balances or their conversion into intergovernmental credits denominated in U.S. dollars. A similar agreement was reached with Ukraine in April 1994. With Turkmenistan, the agreement was to clear outstanding balances in Turkmenistan’s favor through commodity deliveries; in all other cases the balances were in Kazakhstan’s favor. The agreements were structured similarly to that reached between Kazakhstan and Russia, with varying length of grace periods and interest rates set at a margin over LIBOR.

(iii) The agreement on the Baikonur space center. Lengthy negotiations on the use by Russia of the Baikonur space station, which was built during the Soviet era on the territory of Kazakhstan, have resulted in an agreement under which Kazakhstan would lease the space center to Russia for at least 20 years. The annual lease payments would be US$115 million, and payments will be made to Kazakhstan for costs incurred for upkeep and maintenance during 1992 and 1993. 3/ Following a signature of the framework lease agreement on the Baikonur space facility, a possible debt write-off will take place, which could reduce Kazakhstan’s total debt outstanding by a significant amount (up to the full amount of Kazakhstan’s intergovernmental debt to the Russian Federation).

Kazakhstan: Background Paper and Statistical Appendix
Author: International Monetary Fund