Recent Economic Developments

This paper reviews economic developments in Kazakhstan during 1994–96. In early 1994, Kazakhstan embarked on an ambitious stabilization program aimed at reducing inflation sharply and implementing structural reforms. This program was based on tight financial policies and a package of structural measures, including privatization and trade and price liberalization; it was supported by a one-year stand-by arrangement from the IMF, approved in January 1994. However, the stabilization effort was quickly derailed by the authorities’ inter-enterprise arrears netting operation that began in February 1994.


This paper reviews economic developments in Kazakhstan during 1994–96. In early 1994, Kazakhstan embarked on an ambitious stabilization program aimed at reducing inflation sharply and implementing structural reforms. This program was based on tight financial policies and a package of structural measures, including privatization and trade and price liberalization; it was supported by a one-year stand-by arrangement from the IMF, approved in January 1994. However, the stabilization effort was quickly derailed by the authorities’ inter-enterprise arrears netting operation that began in February 1994.

I. Overview

1. Developments in 1994 1/

In early 1994, Kazakstan embarked on an ambitious stabilization program aimed at reducing inflation sharply and implementing structural reforms. This program was based on tight financial policies and a package of structural measures, including in privatization and trade and price liberalization; it was supported by a one year stand-by arrangement from the Fund, approved in January 1994. However, after some financial tightening in the first few weeks of the year, the stabilization effort was quickly derailed by the authorities’ interenterprise arrears netting operation that began in February 1994. 2/ The results of this operation were devastating: monthly inflation soared to 46 percent by June 1994; the exchange rate of the Tenge collapsed, depreciating by close to 600 percent between January and June 1994; real interest rates became highly negative, reaching almost minus 20 percent by May 1994; the overall fiscal deficit and the external current account deficit ballooned to 20 and 13 percent of GDP in the first half of 1994, respectively, and Kazakstan’s import coverage of net international reserves (NIR) remained equivalent to only about 1 1/2 months. Overall, there was a severe loss of confidence in the new currency, the Tenge, which had been issued in late 1993.

The failure of the interenterprise arrears netting operation led to a major turnaround in financial policies starting in June 1994, with the aim of bringing the Government’s program back on track. The policy mix adopted relied heavily on fiscal adjustment and was aimed at limiting the fiscal deficit to 4.6 percent of GDP for the whole of 1994--not far from the authorities’ original deficit objective of 4.0 percent of GDP. In addition, credit to banks was to be curtailed, supported by an active interest rate policy. At the same time, the authorities sought to strengthen the weak international reserves position so as to achieve an import coverage of over two months by end-1994.

While the authorities did not meet the targets of their revised (and quite ambitious) program for end-December 1994, economic performance in the second half of the year turned out markedly better than in the first half. The monthly inflation rate was gradually reduced to 10 percent by December 1994--albeit higher than the authorities’ target of 7 percent. At the same time, the depreciation of the nominal exchange rate slowed down significantly, amounting to 35 percent in July-December. The fiscal deficit was reduced from 20 percent of GDP during January-June to below 4 percent of GDP in the second half of the year; for 1994 as a whole, the deficit was slightly below 7 percent of GDP. The external current account deficit narrowed significantly, amounting to 2 percent of GDP in the second half of 1994; for the year as a whole it reached 8 percent of GDP. Net international reserves rose to more comfortable levels of about 2 1/2 months of imports by end-1994.

On the structural front, efforts in the second half of 1994 focussed primarily on accelerating price and external trade reforms, and enterprise restructuring. In addition to further progress in privatization, the authorities intended to liquidate firms failing to meet their debt repayment obligations to the budget associated with the interenterprise arrears netting operation. The actual outcome was mixed. On one hand, major progress was made in price and external trade reforms: bread and most energy prices were liberalized in the fall of 1994, and the applicability of export quotas was reduced to a limited list of items. On the other hand, some slippages occurred in implementing the privatization program, and there was virtually no progress in enterprise restructuring.

The generally weak macroeconomic performance was accompanied by an acceleration in the annual rate of output decline from 12 percent in 1993 to 25 percent in 1994. While industrial production showed some signs of stabilization around year-end, agricultural output--which in 1992-93 was able to avoid a contraction--started to decline sharply, and construction continued to shrink. Officially measured unemployment remained very low, less than 1 percent of the labor force in 1994, reflecting in part measurement problems. 1/ At the same time, real wages fell by 11 percent, in the face of a large decline in productivity.

2. Developments in January-September 1995

Failure to meet fully their end-1994 targets prompted the authorities to re-design their adjustment policies for 1995, so as to place greater emphasis on the crucial role of enterprise reform and privatization in supporting the macroeconomic stabilization effort. Monetary and credit policies were to be tightened so as to reduce the monthly inflation rate to 1 1/2 percent by end-1995. The fiscal deficit was to be halved, from close to 7 percent of GDP in 1994 to 3.5 percent in 1995, strict limits were introduced on credit to the budget and banks, and interest rates were to be maintained strongly positive in real terms. The external current account deficit was expected to decline from 8 percent of GDP in 1994 to close to 7 percent of GDP in 1995.

The authorities introduced at the outset of 1995 a series of structural measures, designed to accelerate institution building: the system of government-guaranteed directed credits--a major cause of high fiscal deficits and lack of enterprise financial discipline--was eliminated in February 1995; the moratorium on providing official guarantees on external debt was extended to beyond 1994; a new bankruptcy law was adopted; and export quotas and trade licenses--with the exception of a short negative list--were eliminated. A major focus was the revitalization and redirection of the enterprise restructuring program. A key institutional role was to be played by the Rehabilitation Bank (to be set up with assistance from the World Bank), which would financially control and restructure the 20-50 most indebted state enterprises. In addition, by the end of 1995, the second stage of the privatization program was to be completed, draft land reform legislation was to be developed, and holding companies were to be dismantled. The authorities’ program was supported by a stand-by arrangement from the Fund approved in mid-1995.

Macroeconomic developments in the first nine months of 1995 turned out to be somewhat different from the framework underlying the authorities’ program, particularly starting in late May 1995, when unexpected large foreign exchange inflows begun to occur. These inflows, which reflected higher-than-anticipated exports and capital inflows under foreign management contracts, initially boosted monetary growth, threatening the achievement of the Government’s inflation targets. The authorities’ policy response included a combination of fiscal tightening, sterilization measures, and a willingness to permit some nominal appreciation of the exchange rate, complemented by measures to reduce interest rates and to temporarily suspend credit auctions.

Overall, during the first nine months of 1995, the authorities’ macroeconomic stabilization efforts met with considerable success. Monthly inflation was brought down from 10 percent in December 1994 to 5 percent in March 1995, and stayed in the range of 2-3 percent through September 1995 (Chart 1). 1/ Much of the adjustment burden was borne by a compression of fiscal expenditures, with the overall fiscal deficit limited to 0.3 percent of GDP in the first nine months of 1995, well below the authorities’ target of 2.4 percent of GDP; however, this was achieved partly at the expense of accumulating expenditure arrears equivalent to about 2 percentage points of GDP. Credit to both the budget and banks was kept tighter-than-programmed throughout the period. External sector performance turned out to be much more favorable than expected, with the current account of the balance of payments recording a deficit of around 3 percent of GDP in January-September, mainly owing to an export-led trade balance improvement. Despite shortfalls in official financing, the overall balance of payments registered a sizeable surplus, leading to an increase in the NIR of the National Bank of Kazakstan (NBK) to a level equivalent to 3.6 months of merchandise imports by end-September 1995.

Chart 1
Chart 1


(In percent change)

Citation: IMF Staff Country Reports 1996, 022; 10.5089/9781451820768.002.A001

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

However, the implementation of structural reforms again lagged, particularly in the third quarter of 1995. The full operation of the Rehabilitation Bank, the dismantling of the grain monopoly Astyk, and land reforms were delayed. Moreover, financial discipline of some major state enterprises continued to be weak, so that sizeable government guarantees were called on, relating both to domestic and external borrowing by enterprises. 1/ Meanwhile, the privatization program in practice was not fully successful; while progress in small-scale privatization was satisfactory, targets for mass and case-by-case privatization were not met. Nevertheless, progress was substantial in other areas such as trade liberalization, including the abolishment of the export surrender requirement in August 1995, and the introduction of new monetary instruments.

The decline in real GDP continued through the first nine months of 1995, albeit at a much reduced rate (11 percent compared to the same period in 1994), and industrial output continued to remain stable. Officially registered unemployment rose from 1 percent of the labor force at end-1994 to 2 percent at September 1995; a survey, using for the first time the ILO definition for measuring unemployment, pointed to an unemployment rate of 6 percent, while broader measures implied an unemployment rate of close to 12 percent. Real wages rose by close to 10 percent compared to the same period of 1994, probably reflecting the distribution of terms of trade gains associated with export price increases, as well as the sudden drop in inflation.

3. Economic performance from a comparative perspective

A comparison of macroeconomic developments from 1992 onwards in Kazakstan and in its main economic and trading partner, Russia, reveals a number of features:

a. Since 1992, the cumulative decline in industrial output was somewhat less in Russia than in Kazakstan (Chart 2, upper panel). Output in Kazakstan declined at a lower rate than in Russia until about the third quarter of 1994, but the opposite occurred subsequently. In per capita terms, however, the decline may have been broadly the same since 1992 due to net emigration from Kazakstan, mainly to Russia, especially from 1994 onwards.

Chart 2
Chart 2


Citation: IMF Staff Country Reports 1996, 022; 10.5089/9781451820768.002.A001

Sources: Goskomstat, and staff calculations.

b. The broadly similar output decline in the two countries took place against the background of often very different macroeconomic environment (Chart 2, lower panel):

(i) In the ruble area, overall financial policies of the two countries were largely determined in the context of area-wide policies. 1/ However, fiscal policies were different, as evidenced by lower fiscal deficits in Kazakstan than in Russia through most of 1992 and 1993, implying that Kazakstan may have been a “negative free rider” in the ruble area (Chart 3, upper panel).

Chart 3
Chart 3


Citation: IMF Staff Country Reports 1996, 022; 10.5089/9781451820768.002.A001

Sources: Goskomstat, and staff calculations.

(ii) In the period between the break-up of the ruble area in late July 1993 and September 1994, Kazakstan experienced much higher inflation than Russia. In the latter half of 1993, this was associated with uncertainties relating to the (belated) introduction of Kazakstan’s own currency in November 1993. In the first half of 1994, as noted above, higher inflation in Kazakstan reflected the impact of the interenterprise arrears netting operation. Throughout this period, Kazakstan recorded much larger fiscal deficits than Russia.

(iii) Following the interenterprise arrears netting operation, from July 1994 onwards, inflation rates in the two countries began to converge more closely. Inflation fell in Kazakstan, while it rose in Russia during the last months of 1994; and in the first nine months of 1995, Kazakstan experienced considerably lower inflation rates than Russia. The two countries faced similar--largely unexpected--foreign exchange inflows at times during 1995. The response of the Kazak authorities to tighten sharply fiscal policies helped achieve their low inflation targets.

c. Until the break-up of the ruble area, cost competitiveness in the two countries, proxied by average wages expressed in U.S. dollars, were broadly the same (Chart 3, lower panel). From mid-1993 onwards, labor costs in Russia rose much faster than in Kazakstan, and as of end-June 1994, dollar wages in Russia were US$106 compared to US$32 in Kazakstan. However, this gap subsequently narrowed with the tightening of financial policies in Kazakstan, and by the second quarter of 1995, average wages in U.S. dollars in both countries had converged to broadly the same level. Since then, the wage gap widened again, to about 25 percent at end-September 1995.

II. Real Sector and Systemic Reforms

1. Output

As in other transition economies, Kazakstan experienced a large overall decline in real GDP following the start of the transformation process. Officially measured output in non-service related activities fell by a cumulative 55 percent in 1992-94. The decline was most marked in 1994, reaching around 25 percent on an annual basis (Table 1). The overall drop in 1994 reflected a sharp decrease in industrial production (Tables 2 and 5), and a disappointing grain harvest. 1/ However, industrial output began to stabilize from end-1994 onwards. Overall output in 1995 is expected to fall by 11 percent in 1995; output in the energy sector is likely to remain at around the same level as in 1994, while that of other sectors (agriculture, construction, transport, and communications and trade) is continuing to contract. 2/

Industrial production, which in January-September 1994 was 30 percent lower than in the same period of 1993, was broadly stable year-on-year in the first nine months of 1995 (Table 5). Disaggregated output data reveal some changes in the sectoral composition of industrial activity. Output in the ferrous and nonferrous metals sectors, sustained by export demand, continued to increase, while production of chemicals and petrochemicals rebounded from the severe slump in 1994. 3/ Output declines continued in machine-building and construction materials (reflecting the drop in investment) and in light industry and food processing. In terms of the production structure, industry is becoming increasingly dominated by the energy and metals sectors, which together account for more than two thirds of industrial production, while the share of machine-building, construction materials, consumer goods and food processing has been shrinking.

Energy production, after contracting in 1991-94, stabilized in 1995, with the exception of coal. Crude oil production, which had fallen by more than 5 percent in 1994, remained roughly unchanged as price and profit margin controls were abolished and purchases by Russian refineries and exports to the international markets increased. 4/ Gas output, after falling by more than 30 percent in 1994, rebounded in 1995, mainly as a result of an agreement with the Russian company Gazprom to export more gas and gas condensate from the Karachaganak field in North-West Kazakstan. Electricity generation was broadly stable in 1995, following a 15 percent drop in 1994. However, the coal subsector continued to be confronted with a serious financial crisis, and coal output was substantially cut from spring 1995 onwards.

Exporting Oil: The Existing Network and Proposed Alternatives

Importance of additional oil pipelines The exploitation and processing of Kazakstan’s enormous recoverable oil reserves--estimated at about 1/10 of the proven Russian oil reserves, and about 1/3 of the potential oil wealth of Russia--will play a crucial role for the country’s medium and long-term future. However, the existing pipelines do not appear to be sufficient to accommodate substantial increases in oil exports. Foreign direct investment, which so far has played a major role in the exploitation of Kazakstan’s oil reserves, will also critically depend on additional transportation routes for exports in the future.

The existing network The existing pipeline network in Central Ana, built before the dissolution of the Soviet Union, is composed of five major sections:

  • a 3000 km pipeline linking Omsk (refinery in Russia), Pavlodar (refinery in Kazakstan), Shymkent (refinery in Kazakstan), and Chardzhou (refinery in Turkmenistan);

  • a 3500 km pipeline linking Novorossisyk (Blade Sea harbor in Russia), Groznyy (Russia), Atyrau (refinery in Kazakstan), Tengiz (Kazakstan), and Aktau (Caspian Sea harbor, Kazakstan);

  • a 1400 km pipeline linking Novorossiysk, Groznyy, and Baku (Caspian Sea harbor and refinery in Azerbaijan);

  • a 1000 km pipeline linking Batumi (Black Sea harbor in Georgia), and Baku; and

  • a 1000 km pipeline linking Atyrau with Samara (refinery in Russia).

Alternatives There exists a variety of projects which could increase Kazakstan’s oil exports; the most advanced appear to be projects which would ship oil via Russia or via Turkey. The transport via Russia would connect the Tengiz oilfield with the Black Sea harbor Novorossiysk. This project involves two construction phases: the laying of a pipeline from Kropotkin (Russia) to a new sea terminal north of the city port of Novorossiysk and a pipeline from Tengiz to Tikhoretsk (Russia), which already has a 50 km pipeline leading to Kropotkin. For die transportation of oil to Turkey, several alternatives exist, which would connect the Kazak oilfields with a Turkish Mediterranean harbor via pipeline or via a combination of shipment and a pipeline system. Besides the above mentioned projects, various further options are being discussed: (i) to build a pipeline across the Caspian Sea through Azerbaijan to Iran; (ii) to ship oil through Turkmenistan to Kharg Island in the Persian Gulf; (iii) to link the Tengiz oilfield with Tajikistan through Uzbekistan and Kyrgyz Republic; and (iv) to transport oil from the Tengiz oilfield through China to markets on the Pacific Rim.

The agricultural sector, which had managed to limit the contraction in 1992-93, was hit severely in 1994, with output falling by nearly a quarter. The sector suffers from financial problems as well as technical difficulties. First, a sharp deterioration in the domestic terms of trade and the breakdown of the agricultural credit system have resulted in deteriorating profitability, a growing lack of liquidity, and increasing indebtedness. 1/ The sector as a whole is loss-making, has the highest arrears to suppliers and workers relative to output, pays the lowest wages of the sectors of material production, and has the highest unemployment rate. Second, a shortage of inputs (feed, fertilizers, fuel), machinery, qualified operators and maintenance, has contributed to a decline in productivity. Both crop production and the output of livestock-derived products, each of which account for about one-half of total agricultural output, have been affected. In 1994, Kazakstan harvested around 18 million tons of grain, compared to 22 million tons in 1993, and a harvest of only 12-14 million tons is expected in 1995. The area sown for cereals was reduced by around 7 percent in both 1994 and 1995, while average yields declined. In addition, the quality of the grain harvest deteriorated. 2/ However, with domestic consumption needs estimated at 5-7 million tons, Kazakstan will remain self-sufficient in grain. Production of sugar-beets, cotton and, to a lesser extent potatoes, also fell in 1994 and, most likely, in 1995. The production of livestock-derived products (meat and poultry, milk, eggs, wool) also declined significantly in 1994 (Table 3); a drop in the number of animals was accompanied by reduced productivity per head of livestock. 3/ In the first nine months of 1995, the contraction in livestock output continued, as the number of animals and productivity fell further (Table 4).

2. Inflation

The high-inflation regime which characterized the first stages of the transition process in Kazakstan came to an end in the course of 1994, and a gradual move towards price stabilization followed. An initial effort to bring down inflation after the introduction of the Tenge at end-1993 failed, due to the interenterprise arrears netting operation in February 1994. As a result, monthly inflation reached 46 percent in June 1994. Following a tightening of monetary and credit policies, from June onwards, inflation decelerated steadily to 10 percent per month by December 1994. Monthly inflation fell further, to about 5 percent at the end of the first quarter of 1995, and to around 2 percent at the end of the second quarter; during July-September, monthly inflation fluctuated in the 2 to 3 percent range, before increasing to 4.1 and 4.4 percent in October and November, respectively (Table 13).

In addition to the trend movement in inflation during 1994-95, occasional adjustments in administered prices and other price liberalization measures resulted in one-time hikes in prices (Table 11). 1/ In 1994, these inflation spikes mainly reflected pricing measures at the national level. A substantial increase in oil and oil product prices followed the partial decontrol of prices in April 1994; administered prices for energy products other than coal and oil, and communications and transportation fees were increased in May 1994; 2/ and prices for bread, bakery products, and flour were administratively adjusted in July 1994 and late September 1994, before being fully liberalized in October 1994. From end-1994 onwards, with price liberalization at the national level virtually completed, the month-to-month inflation rate has reflected occasional sharp adjustments for rents, utility fees (e.g. for heating, water), and local transportation fares at the regional level.

A multi-dimensional analysis of relative price movements (namely, across consumer goods, production sectors, regions and distribution channels) during 1994 and the first half of 1995 indicates that price changes became more synchronized, with all prices tending to rise more in accordance with the overall inflation rate. 3/ First, in tandem with the overall reduction in inflation, the relative price variability for food and nonfood consumer goods prices declined considerably by early 1995, suggesting that many of these prices may have moved to “equilibrium” levels, after the massive relative price shifts--characteristic of the first stages of the transition--were largely completed. In contrast, the relative price variability for services remained much higher, reflecting adjustments at the regional level, as prices for various public utilities continue to be brought up toward cost recovery levels. Second, the relative variability in producer prices diminished sharply by mid-1994. Third, regional inflation rates have been converging throughout 1994-95; however, the regional price dispersion for paid services has been consistently above that for food and nonfood goods, reflecting the nonsynchronous nature of administered price adjustments across regions. Fourth, from summer 1994 onwards there has been very little margin between market prices and prices in state retail stores.

Finally, during 1994-95, prices in Kazakstan have converged to the level observed in Russia and have continued to slowly converge to the U.S. level. Since mid-1994, the cost in Almaty of a basket for food and nonfood goods has fluctuated at around 90 percent of the cost for the same assortment in Moscow. 1/ Based upon an alternative basket of 19 staples, at end-1994, prices in Kazakstan were around the same level as in the average of Russian cities and were about 30 percent of the U.S. level. In line with the real appreciation of the Tenge vis-à-vis the U.S. dollar during 1995, by end-September 1995 the cost in Kazakstan of this basket of 19 staples had increased further, to around 36 percent of the U.S. level. However, prices of energy-based products and services in Kazakstan are still below the levels in comparable market economies. Assuming these prices continue to increase in real terms in coming years, the domestic price level will further converge to international levels.

3. Savings-investment balances

While the available data on national accounts by expenditure suffer from various shortcomings, 2/ an assessment of broad trends in the savings-investment balance is possible (Appendix I). In 1994, gross fixed capital formation was estimated at around 18 percent of GDP, with public and private sectors contributing roughly equal shares (Table 6). Public sector investment, 3/ of which less than a fifth was financed by the budget, fell noticeably, by around 4 percentage points of GDP compared to 1993, while private investment as a share of GDP increased significantly. Investment was largely concentrated in the industrial and the transport and communication sectors in 1994; capital outlays in the agricultural, construction, and trade and catering sectors had dwindled to almost zero (Table 7). Within the industrial sector, investment was directed toward the fuel industry and electric power generation. Stock building in 1994 was estimated at around 1 percent of GDP.

Total savings are roughly estimated to have reached around 19 percent of GDP in 1994, with domestic savings amounting to about 14 percent of GDP. Since the budget registered a large deficit (with the current deficit reaching 5.5 percent of GDP), all domestic savings came from the non-budget public sector, and households and private enterprises. During 1994 foreign savings (the mirror image of the external current account deficit) remained substantial, at 5 percent of GDP. 4/

Data on national accounts by expenditure for 1995 are not available. However, available data suggest that gross capital formation is likely to have declined, largely due to a further significant contraction of public sector investment. At the same time, government dissavings should decrease significantly, reflecting a lower current budget deficit, while foreign savings may also fall, reflecting the improvement in the external current account balance.

4. Employment and wages

During 1994-95, employment continued to decline in tandem with output. Reported actual employment in 1994 was around 12 percent lower than in 1993; in the first nine months of 1995 a further 10 percent period-on-period decrease occurred (Tables 17 and 18). 1/ With an output decrease of around 25 percent in 1994, labor productivity (real output per person actually employed) fell substantially, and was matched by a corresponding adjustment in the real wage, leaving real unit labor costs virtually constant. In particular, the two sectors which registered the smallest employment loss and the largest productivity fall in 1994--agriculture and budget supported activities in health care, social services, education and culture--also experienced the largest decline in real wages. During the first nine months of 1995, output and employment moved broadly in line, and labor productivity stabilized.

Official unemployment increased throughout 1994-95, but remained at low levels. As of end-September 1995, the number of officially registered unemployed was slightly above 100,000 (1.9 percent of the labor force), up from 70,000 at end-1994 and 40,500 at end-1993; only half of the officially unemployed receive unemployment benefits. Termination of employment through forced lay-offs is still an exception in Kazakstan: of the almost 1.5 million workers who left their enterprises during 1994, only 10 percent had to leave due to lay-offs; most workers quit voluntarily to move to a new job--in 1994, Kazak enterprises hired more than 1 million people--or to retire or emigrate. 2/ However, many formally employed workers are on reduced work hours or temporary leave. Considering all these persons as unemployed, the unofficial rate of unemployment increased from 2.7 percent of the labor force in 1993, to 7.8 percent in 1994 and, further to 11.5 percent in the third quarter of 1995 (Table 18). 3/ In 1995, an unemployment survey using the IL0 definition for the first time, pointed to an unemployment rate of about 6 percent in mid-1995.

On a year-on-year basis, real average wages fell more than 30 percent in 1994 compared to 1993, while real minimum wages declined by almost 60 percent. 1/ On a month-to-month basis, real average wages broadly stabilized from the second quarter of 1994 onwards, after a sharp drop following the introduction of the Tenge end-1993; real minimum wages followed a downward trend throughout the year, notwithstanding four discretionary upward adjustments (Table 15). Real wages rose by 10 percent during January-September 1995 compared to one year earlier, partly because disinflation was much faster than had been anticipated and partly reflecting the redistribution of external terms of trade gains (Section V). Minimum wages were adjusted upwards in March and July 1995 (by 25 and 12 percent, respectively) so as to broadly maintain their level as of end-1994.

5. Structural reforms

a. Privatization

In 1993, the authorities initiated the second stage of their privatization program covering 1993-95, which aimed at transferring most state enterprises and farms to the private sector. 2/ The program involves three components (tiers): (i) privatization of small-scale enterprises by cash auctions; 3/ (ii) privatization of medium and large enterprises by voucher/coupon auctions; and (iii) privatization of very large enterprises via tenders on a case-by-case basis. In addition, in 1994 the program was extended to include farms and agro-processing enterprises. 4/

Under the first tier (small-scale privatization), more than 8,000 enterprises were offered for sale against cash and housing coupons at approximately 800 auctions during January 1994-September 1995. More than 4,500 enterprises, mainly in distribution and catering, were sold, involving the transfer of over 1,000,000 employees to the private sector; about half of the enterprises offered for sale remained unsold, largely due to high auction floor prices and after-sale restrictions. 5/ The small-scale privatization tier also has two specific sub-programs relating to: (i) trucking, covering 20 percent of trucks operated by firms outside agriculture, railways and defense; and (ii) wholesale trade, covering the facilities of 205 warehouse enterprises. Trucking privatization proceeded broadly as scheduled, with an average of 350 trucks being sold monthly in 1995, privatization of the wholesale sector has fallen slightly behind schedule. In March 1995, the small-scale tier was extended to allow for the participation of foreign investors in the sale of certain attractive businesses.

Under the second tier (mass privatization), 18 coupon auctions have been organized between April 1994 and September 1995 (Table 19). Blocks of shares, representing 51 percent of enterprises’ capital, have been offered to 169 Investment Privatization Funds (IPFs), in which citizens placed their privatization investment coupons. Of the around 1,800 enterprises offered at these auctions, 756 were offered for the first time and, of these, only around 500 were qualifying enterprises in a strict sense. 1/ It is estimated that around 1,000 enterprises with more than 400,000 employees have been privatized (i.e., the private sector now has a majority share). In a typical enterprise following mass privatization, 51 percent of the shares are held by 5 to 10 IPFs, and 39 percent of the shares continue to be state-owned, with the remaining 10 percent stake given to employees on a non-voting basis. In early 1995, the Government adopted a plan to divest the state-held shares in enterprises under the second tier. These shares include the 39 percent stake that has been excluded from the auctions, as well as all shares that had been offered for sale but were not sold. The plan envisages: (i) transferring a 5 percent share package directly to the enterprises’ management, thereby raising the “insider” stake to 15 percent; and (ii) organizing cash auctions for the remaining shares in state ownership. The mass privatization program itself was scheduled to be completed by end-1995, but this timetable will be extended into 1996. 2/

Under the third tier (the case-by-case approach), about 180 very large/strategic enterprises were identified, to be sold to major--mainly foreign--investors. Almost 40 transfer transactions were prepared with the help of foreign consultants, but only five enterprises were actually sold; tenders for five more enterprises are currently being finalized. In June 1995 a special program for the oil and gas sector was approved. 1/ In recent months, for a considerable number of enterprises, this program has been overtaken by the initiative to conclude foreign management contracts for more than twenty major enterprises that also qualify for the case-by-case tier (see below). For most of the firms, foreign management companies are given “priority” rights for privatization after a specified number of years; this scheme puts the case-by-case approach effectively on hold in most instances. The case-by-case program is also affected by a government plan, initiated in mid-1995, to auction 10 percent of the shares of a number of major enterprises that qualify for the program; half these shares will be auctioned to IPFs against coupons and the other half will be sold for cash.

The extension of the privatization program to agriculture involved: (i) for state farms, the transfer to each farm worker of a share of the farm’s non-land assets as well as a lifetime and inheritable right to an identifiable piece of land; this right can be formally included in the lease. By end-September 1995, more than 1,600 farms, about three quarters of all state farms, were privatized in this way; the state farm subprogram is to be completed by early 1996; and (ii) for agroprocessing enterprises, a procedure transferring shares to insiders and exchanging shares against long-term supply contracts. However, in early 1995, the latter subprogram was terminated, as it was considered to be non-competitive and fostered vertical integration; the few remaining enterprises that had not yet been privatized, and the remaining state shares in each enterprise (typically 35 to 40 percent of the total), were included in the small-scale and mass privatization tiers.

The authorities have started to prepare for the third stage of the privatization program, covering 1996-98. The program is expected to involve: (i) left-over state shares in already privatized firms; (ii) enterprises that were supposed to be included in the small scale and mass privatization tiers of the Second Stage Program but which were not; (iii) major firms to be covered in the case-by-case track; and (iv) public utilities.

b. Enterprise reform in the non-agricultural sector

Enterprise restructuring has proceeded along two main lines depending on the likely future ownership of the firms. Restructuring of enterprises to be privatized was intended to be carried out by the new owners, while the restructuring of those to remain under state ownership would be dealt with by the state. 1/ In 1994-95, several initiatives were introduced to accelerate enterprise reform. These involved measures both to improve governance of financially healthy enterprises and to restructure or liquidate enterprises in financial distress.

Enterprises privatized through the mass privatization program have a majority shareholdership split between several IPFs. Governance over financially healthy enterprises in this category has been strengthened by: (i) raising the ceiling on a single IPF’s maximum permissible stake in a company from 20 to 31 percent (i.e. to a level representing more than one third of the voting stock, and therefore a controlling minority stake); and (ii) allowing different IPFs to coordinate their share acquisitions and subsequent governance activities. The affiliation of several IPFs with commercial banks that lend to the privatized enterprises further enhances their monitoring role. Mostly small-scale enterprises and enterprises privatized before the start of the second stage program are governed by insider coalitions (managers and/or employee collectives), and may be confronted with common problems of insider control. 2/ Empirical surveys, however, show encouraging behavioral changes and restructuring in small-scale enterprises privatized without restrictions on the business profile and on employment. Privatized--and newly established private--enterprises in financial distress are also monitored by major creditors; commercial banks, encouraged by the Government, have established internal work-out units to deal with problem borrowers.

The approach to reforming financially healthy enterprises, in which the state continues to hold the majority stake or controlling minority shares, changed significantly during 1994-95. 3/ Until end-1994, the main effort to improve governance involved the formation of state holding companies as an intermediate layer of control. Over 80 state holding companies were created, involving more than 2,000 state enterprises as subsidiaries, in the expectation that these holding companies would strengthen enterprise governance and reduce interference by ministries and governmental agencies. 1/ In practice, however, the holding companies tended to assume the tasks of the former branch ministries and to evolve into subsectoral monopolistic structures. As a result, at end-1994 the Government decided to dissolve all holding companies except those that are natural or administratively created monopolies. 2/ In early 1995, the Government established a timetable for the dissolution of 60 holding companies. By end-September 1995, an interministerial commission had approved concrete plans for the dismantling of more than 30 holdings; share packages are being withdrawn from their portfolio and included in the small-scale and mass privatization tiers. In addition, an interministerial commission started to prepare the dismantling of about 30 holding companies, while share packages were withdrawn from the portfolio of the 60 companies and included in the small-scale and mass privatization tiers.

From end-1994, two initiatives have been taken to recreate new types of enterprise groupings based on state shares. First, in the context of the foreign management contracts recently concluded for major enterprises, efforts are made to group several enterprises managed by related management companies. Second, consideration is being given to form so-called “financial-industrial” groups, often on a subsectoral (oil and gas, metallurgy) and cross-border (e.g. Russian-Kazak) basis.

In September 1994, the Government initiated a special enterprise restructuring program to deal with state-controlled enterprises in financial distress, in view of the limited capacities of the banking sector to handle the most highly indebted enterprises. Under this program, of almost 400 enterprises that had emerged from the interenterprise arrears netting operation in early 1994 as net debtors, 59 were scheduled for privatization, 8 were selected for quick liquidation, and 29 of the most heavily indebted were to be assigned to the new Rehabilitation Bank (see below). The remainder (almost 300 enterprises) were scheduled to be transferred to either a Restructuring Fund (to be established with the assistance of the EBRD to deal with about 30--promising--smaller enterprises with temporary financial problems) or to a new Restructuring Agency under the Ministry of Economy. A similar program for the agricultural sector identified about 1,200 distressed agro-enterprises and farms, with 250 marked for early liquidation.

Until the spring of 1995, there was little progress in implementing the program, as the legal framework for enterprise liquidation appeared to be inadequate and the establishment of the necessary institutions was delayed. Enterprise restructuring started to move ahead in March-April 1995, with the approval of a new bankruptcy law, which introduced procedures for out-of-court settlements, and the creation of the Rehabilitation Bank and the Restructuring Agency. 1/

The Rehabilitation Bank was established in close coordination with, and financial assistance from, the World Bank. A Presidential decree creating the Rehabilitation Bank was signed in April 1995; subsequently, the charter of the Bank was adopted, its senior staff appointed, and an initial list of enterprises to be assigned to the Bank was drawn up. The Bank is intended to control the financial transactions of the selected enterprises as the sole source of credit, including the financing of operating deficits. Access to the Bank’s resources is envisaged to be on a declining basis and to be conditional upon presentation and implementation of a restructuring program that provides for either a passive restructuring (i.e., turnaround without major new investment) and privatization, or, for enterprises without prospects for viability, liquidation in a maximum period of four years. The Bank is owned solely by the state and entirely funded from the state budget, but it is intended to operate on a fully autonomous basis, under the sole direction of its Board. The recent conclusions of management contacts covering many of the state controlled enterprises that would have been the core firms under the auspices of the Rehabilitation Bank appear, however, to have bypassed to some extent the Bank. 2/ Moreover, while it was initially envisaged that the Bank deal with the most heavily indebted, very large state controlled enterprises, it appears that the enterprises selected as of end-October 1995, are relatively small and only account for a minor fraction of the nonperforming net liabilities in the relevant enterprise category. Finally, precise guidelines governing access in practice to the Bank’s financial resources are in the process of being adopted and implemented.

The new Restructuring Agency under the Ministry of Economy is to take up the restructuring of other state controlled enterprises in financial distress. The Agency’s role includes initiating, preparing, and overseeing the liquidation of insolvent state-controlled enterprises, basing its authority on the state share. The Restructuring Agency was transferred to the State Property Committee in the fall of 1995.

c. Foreign management contracts

From October 1994 until October 1995, 27 management contracts were concluded covering 33 firms, mainly in the mining and metallurgy sector. Under a management contract, firms--mostly foreign--are given the right to manage selected state enterprises for a limited amount of time (usually for 5 years). The management companies receive bonuses and/or shares in profits. In return, they are obliged to redeem outstanding arrears, inter alia, to the budget and on wages. Estimates of the possible inflows of foreign exchange related to these payments are of the order of US$500 million in 1995. Many contracts contain various additional clauses, e.g., the provision of “soft” credits, or material and equipment by the managing company, a freeze on the number of employees, or the maintenance of production volume; in one contract, the management company agreed to raise investment or to execute a specified investment program. Only one contract awarded involved a tender process. There are plans to offer the remaining 10 firms designated for management contracts tinder a more competitive process. To date, 5 of the 27 contracts have been canceled, including a contract for a major firm in the metallurgy sector. As a reaction to these problems, a commission consisting, inter alia, of representatives of several ministries, the Anti Monopoly Committee, and the State Privatization Committee, was set up to review the management contract process, including the choice of firms eligible for contracts, the selection of the management companies, and the monitoring and enforcing of the contract.

Most of the firms under a management contract would qualify for the case-by-case privatization program. Of the 180 or so firms chosen for the latter program, about 40 underwent a tender process in which they were assigned to foreign consultants. These consultants assessed the firms in order to propose an appropriate strategy for their privatization; 8 of these audit processes were suspended following the conclusion of management contracts for the firms in question. For the firms under management contracts, alternative privatization methods are now under consideration. In a pilot project, the State Property Committee offered recently a small package of shares of one firm on money and coupon auctions; a significant share was taken over by the management company itself. Following this success, similar plans are under preparation for two other firms.

d. Other structural reforms 1/

During January 1994-September 1995, substantial progress was made in two other key structural areas: price liberalization and agricultural reform. Price liberalization at the national level was essentially completed by end-1994 (see Section II.2). Fixed maximum profit margins for crude oil and oil products were abolished in December 1994, 2/ while, based upon the Anti-Monopoly legislation, more general profit margin controls in the oil sector were eliminated in April 1995, thereby freeing prices completely at the producer level. By end-1994, only producer prices for electricity, natural gas and thermal energy, and consumer prices for gas, electricity and telephone services were administered at the national level. Rents, utilities fees (heating, water), and local transportation fares continue to be set administratively at the regional (oblast) level.

Efforts to improve the competitive structure of the agricultural sector have focussed on two main areas: (i) in 1994, compulsory deliveries under the “state needs” system were limited to the grain subsector, and purchases were reduced compared to the previous years; in 1995, the Government eliminated completely the “state needs” system for grain, and introduced a voluntary system of procurement at prices that are, in principle, market-determined; under the new procurement system, administered prices in the agricultural sector should be eliminated; and (ii) in early 1995, the Government moved to dismantle the 13 agricultural holding companies; the subsidiary companies of the holdings are intended to be privatized under the small-scale and mass privatization programs. Of special concern was the Astyk company, which controlled the marketing and processing of grain and bread products. The Government issued a decree in January 1995 detailing the procedures to be followed in dismantling the existing company and establishing a new company, also named Astyk, which was to meet only the direct consumption of government agencies and entities in the grain subsector. Moreover, as of mid-November 1995, privatization of the grain storage facilities and flour and feed mills controlled by Astyk had not taken place.

Little progress has been achieved to date in other two areas. First, following the decision to make the private right to use land transferable in early 1994, 1/ land reforms did not progress further, due to a lack of consensus on whether to allow private land ownership. Second, the traditional agricultural finance system, based upon government credits at below-market interest rates and characterized by non-repayment by farms, was eliminated at end-1994, but was not replaced by a new system. For the 1995 harvest, one bank proposed to finance the purchase of grain for “state needs” (less than 10 percent of the total output) by issuing promissory notes. These grain purchases (based on a tender) were organized solely by the grain procurement company, Astyk. This company received the promissory notes and transferred them to the farms in connection with futures contracts. Farms in turn used the promissory notes to purchase fuel, lubricants, and agricultural chemicals. To avoid previous experiences with farms spending money from credits on wages and other expenses, the responsible bank refused to discount the promissory notes from the farms and discounted them for suppliers, based on presentation of contracts with farms. For the remainder of the grain harvest (more than 90 percent of the total grain harvest) and for sectors other than the grain sector, no special bank financing was offered.

III. Budgetary Policies and Fiscal Developments

1. Fiscal developments in 1994

In 1994, the overall deficit of the General Government reached 6.8 percent of GDP, compared to a revised budget target of 4.6 percent of GDP (Table 20). Quasi-fiscal operations continued to dominate overall budgetary performance. Regular budgetary operations (including the special funds) were in approximate balance, in large part through expenditure sequestration and better-than-expected revenue performance in the final quarter of the year, while quasi-fiscal outlays amounted to about 7 percent of GDP.

Revenue collection reached 17.7 percent of GDP for the year as a whole, falling short of the revised budget target of over 20 percent. Regarding tax revenue, corporate income tax and investment fund collections surpassed expectations, as a result of tougher penalties for enterprises that were delinquent taxpayers. Income tax collections from individuals lagged as some enterprises incurred wage arrears while others resorted to paying their employees in kind. The yields from VAT and taxes on international trade were also below expectations due to a greater-than-envisaged prominence of barter transactions. Nontax revenues performed strongly, primarily as a result of larger-than-budgeted transfers of NBK profits and interest paid on government deposits from the NBK. 1/ Finally, there was a significant shortfall in revenues from the case-by-case privatization program.

Total expenditure (both regular budgetary expenditure and quasi-fiscal outlays), at 24.6 percent of GDP, was lower than the revised budget target of 26.7 percent. In the first half of the year, overall fiscal performance deteriorated, primarily due to unforseen budgetary outlays, comprising three elements: (i) net lending by the Government to debtor enterprises under the arrears clearing operation that was not repaid, as well as the associated interest owed by the Government to the NBK; (ii) debt service payments on government-guaranteed external loans; and (iii) takeover of enterprise debt by the Government following the nonrepayment of directed credits extended by the NBK. 2/ This deterioration was partially reversed in the second half of the year by implementation of a strict expenditure sequestration policy in the regular budget so as to offset unexpected quasi-fiscal outlays. All expenditure categories were affected, including subsidies, investment outlays, and allocations for operations and maintenance. This policy resulted in some expenditure arrears, although wage and pension arrears were virtually cleared by end-December 1994.

Net bank credit to Government, at 3.2 percent of GDP, significantly exceeded the budget target of 0.8 percent of GDP in 1994. This was due in part to the Government’s payment of only half of the interest accrued on credit extended for the arrears clearing operation. Also, external financing fell short of expectations, reaching only 2.6 percent of GDP, compared to the authorities’ projection of 5.1 percent of GDP. This was the combined result of administrative difficulties and rephasing of disbursements on the part of lenders, partly in response to the weak macroeconomic and policy performance in the first half of the year. The Ministry of Finance started to issue Treasury bills on an increasing scale as inflation gradually came down. Although modest in amount--0.1 percent of GDP--this step represented an important move toward finding non-monetary ways of financing the budget deficit.

2. The 1995 revised budget

The Parliament adopted the 1995 budget in March 1995, which aimed at a fiscal deficit of 3.5 percent of GDP. However, in light of the outcome in the first few months of the year, a revised budget was developed in early summer, which was formally adopted through a presidential decree in July. The July 1995 budget retained the March budget’s deficit target of 3.5 percent of GDP, but contained more realistic revenue and expenditure projections. In line with the authorities’ financial program, net foreign financing was projected to amount to about 3.9 percent of GDP, and domestic bank borrowing was envisaged to total 0.8 percent of GDP, with a portion (0.3 percent of GDP) earmarked for the capitalization of the Rehabilitation Bank. There was also to be some domestic non-monetary financing in the form of Treasury bills of about 0.2 percent of GDP, offset by a redemption of U.S. dollar indexed treasury bonds (issued at the time of the arrears clearing operation) of 1.3 percent of GDP.

Under the revised budget, total revenue was projected to reach about 16 percent of GDP, well below the 1994 outturn of 17.7 percent. There were three reasons for this projected downturn: (i) the implementation of the Tax Code would, in the short-run, result in lower collections; (ii) the transfer of profits from the NBK to the budget was projected to be significantly lower in 1995 compared to the previous year, reflecting a decline in seignorage as inflation fell; and (iii) revenue performance in the first quarter of 1995, at 12.4 percent of GDP, proved to be well below expectations.

Quasi-Fiscal Operations

Coverage As in most FSU countries, the Government of Kazakstan has undertaken substantial quasi-fiscal operations since 1992. However, due to lack of data, the systematic collection of information on such operations started only in 1994. Moreover, the coverage of quasi-fiscal operations is still not complete; for example, certain ministerial extrabudgetary funds, including those funded by foreign exchange deposits, and quasi-fiscal losses incurred by the central bank, are not fully reflected in the budgetary accounts.

Size Net quasi-fiscal outlays in 1994 were sizeable, reaching 7.3 percent of GDP. In 1995, in an effort to avoid budgetary overruns related to quasi-fiscal operations, the budget included explicit provisions for such operations in an amount of 0.9 percent of GDP (0.3 percent of GDP for external guarantees, and 0.6 percent of GDP for domestic credit guarantees). However, the former proved to be insufficient, and in November 1995 additional outlays of 0.5 percent of GDP were made on account of external guarantees. With quasi-fiscal revenues associated with tax payment arrears of about 0.4 percent of GDP, this is expected to result in an approximate balance for quasi-fiscal operations in 1995.

Main types of quasi-fiscal activities

(1) Net lending by the budget to enterprises, associated with the interenterprise arrears netting operation in 1994. In February-March 1994, die Government lent T 18 billion to (net) debtor enterprises to clear inter-enterprise arrears. The whole amount of net lending (and associated interest on it) was expected to have been repaid by enterprises by end-1994; however, in practice only a fraction was actually repaid. In 1995, a part of the dollar-indexed bonds--issued in 1994 to partially finance the arrears netting operation--was settled by notional tax arrears payments of the bond-holders to the budget, which was recorded as “revenue” for quasi-fiscal operations.

(2) Called-on government guarantees on external debt. In the turbulent times following independence, various government agencies issued large amounts of government guarantees for enterprise external borrowing; the stock of such guarantees peaked at US$4.3 billion in September 1994. The Government subsequently canceled US$2.8 billion worth of government guarantees on foreign credits which had been granted but not disbursed. On average, only about one third of these credits are serviced by enterprises at the due date; the remainder becomes the obligation of the budget.

(3) Called-on guarantees on domestic credit. These guarantees typically cover directed credits that were extended in 1993-94 as central bank credit to commercial banks, and which were earmarked for selected enterprises. Such credits were given at the instruction and under the guarantee of the Government, usually at market terms. The average default rate of enterprises on directed credit was around 75 percent in 1994. The Government typically takes over the principal of the debt but not the interest, resulting in a quasi-fiscal loss borne by the central bank. Such debt takeovers amounted to about T 7-8 billion in 1994 (as mentioned, in 1995 these debt takeovers were budgeted in an amount of T 7.6 billion).

(4) Takeover of privatized enterprise debt. In late 1994, in the context of privatizing certain agricultural enterprises, the Government took over their debt owed to commercial banks in an amount of T 1.6 billion.

The enactment of the Tax Code in July 1995 constituted a major structural improvement to the Kazak tax system. The Code specified a system of state, provincial, and local taxes, and represented a comprehensive and systematic body of law in line with international standards. The tax system was drastically simplified, as the previous 45 tax laws were reduced to one Code. Many specific tax exemptions were eliminated. Compliance was to be enhanced by instituting an array of registration, assessment, collection, and audit procedures. The Tax Code provided for three major state government taxes: corporate and personal income tax; VAT (including an extension of VAT coverage to all imports from non-CIS countries); and excises. Other state government taxes included a securities transaction tax and a mineral resource tax. In addition, the Code established the following sources of revenue for local governments: a land tax, a property tax, and a vehicle registration fee. Details on the taxes included in the Tax Code can be found in Appendix II.

The new Tax Code succeeded in improving the structural aspects of taxation. However, in the short run, it was expected to result in lower revenue collections compared to the past. 1/ Some temporary losses were likely to arise due to administrative difficulties arising from the Code’s initial implementation. In addition, an acceleration of the payment of VAT refunds (mandated by the Tax Code) was expected to result in a one-time revenue loss. A further revenue decline was projected following the enactment of a preferential corporate income tax rate for agricultural enterprises of 10 percent, well below the standard rate of 30 percent. Finally, the shift from a turnover-based corporate income tax toward a solely profits-based system (an important structural improvement) was also expected to result in some revenue loss.

Total expenditure was expected to fall to 19.9 percent of GDP, including an allocation equivalent to 0.6 percent of GDP for the initial capitalization of the Rehabilitation Bank. In order to ensure room for regular budgetary outlays, the authorities sought to avoid quasi-fiscal outlays in 1995 by eliminating, to the extent possible, the underlying sources of such operations, and by making explicit provision in the budget for outlays that could not be avoided. In this context, they extended the moratorium on new government-guaranteed external borrowing by enterprises beyond 1994, and ended all directed credits to enterprises through the banking system. Explicit provision was made in the budget for external debt guarantees which may be called (0.3 percent of GDP) and anticipated called-on domestic directed credits with government guarantee (0.6 percent of GDP). Called guarantees on directed credits would be converted to state debt and the budget included provision for its servicing at a 10 percent annual interest rate. The Government and the NBK also agreed to settle the outstanding interest accrued to the NBK, arising from the arrears netting operation, by lower NBK profit transfers to the budget. In addition, the budget included a reserve fund of 0.2 percent of GDP from which unexpected outlays could be undertaken. The budget outlays contained in the regular budget were considered sufficient to prevent delays in payments and to settle fully arrears accumulated at end-1994.

The wage policy set forth in the budget was based on partial adjustments relative to targeted inflation with envisaged increases in the minimum monthly wage from T 200 to T 230 for the first half of 1995 and to T 270 for the second half. Thus, the overall wage bill was projected to amount to 4.8 percent of GDP, broadly in line with the 1994 outturn. The social safety net embodied in the budget was also strengthened, with an increase in allocations from 3.5 percent of GDP in 1994 to 3.9 percent of GDP.

With the expected abolition of the Investment Fund, the Government’s investment program was to be channeled through the (existing) Road Fund and the newly created Development and Housing Banks. Furthermore, in order to provide financial support to the agricultural sector, an Agricultural Support Fund with allocations equivalent to 0.5 percent of GDP was established. Finally, in cooperation with the World Bank, the new Rehabilitation Bank was to be created in the first half of 1995 (see Section II. 5b).

3. The budget outturn through September 1995

The overall deficit of the General Government was limited to 0.3 percent of GDP in the first three quarters of 1995, compared to the authorities’ deficit target of 2.4 percent of GDP for the same period, and the budget’s 3.5 percent of GDP for the year as a whole. This was due in large part to strong expenditure compression--particularly in the first quarter of the year--leading to a build-up of expenditure arrears of about 2 percentage points of GDP by end-September 1995.

Revenue collection amounted to 14.8 percent of GDP in the first three quarters of the year, somewhat below the revised budget target of 16.2 percent (Table 21). Tax revenue was boosted by the continued collection of Investment Fund proceeds beyond the period envisaged in the budget, i.e. the first quarter of the year. With the implementation of the Tax Code effective July 1, 1995, the Investment Fund was abolished. The completion of several foreign management contracts for enterprises (which required the new management to settle budgetary and wage arrears within 90 days of the contract date) and intensified collection efforts resulted in particularly strong performance in corporate and personal income taxes and repayments of budgetary loans and directed credits. Export duties also did better than expected following a sharp increase in exports, despite a stronger-than-anticipated Tenge. However, there were disappointing yields from property and natural resource taxation as well as from privatization.

Expenditures on a cash basis amounted to 16.6 percent of GDP for the first three quarters of 1995. A strict expenditure sequestration policy was implemented across the board, with an emphasis on spending for national economy (principally subsidies and operations and maintenance outlays) and defense. Budgetary social safety net expenditures were also subject to sequestration, although some explicit budgetary savings on cash allowances were achieved due to a lower-than-expected number of families with dependent children qualifying for benefits. In contrast, some expenditure overruns occurred with respect to education outlays (in order to make partial salary advance payments to teachers prior to the summer recess) and higher-than-envisaged called external debt guarantees. In addition, new expenditure obligations arose from the nascent divestiture of social assets of enterprises (See Box 3). Overall, significant domestic expenditure arrears remained--in the order of 2 percent of GDP--particularly on wages, utility bills, and on cash allowances, as well as on called external debt guarantees.

The deficit was primarily financed by net external disbursements equivalent to 1.9 percent of GDP, albeit a lower level than had been expected. Domestic financing was negative in an amount of 1.5 percent of GDP, which reflected a substantial buildup of government deposits (including some related to inflows associated with foreign management contracts). Net sales of treasury bills, held mainly by the banking sector, exceeded expectations, reaching 0.3 percent of GDP during January-September. Nonbank financing was negative, as a result of the partial redemption of the U.S. dollar-indexed bonds issued in conjunction with the interenterprise arrears clearing operation in 1994. Out of the total amount of U.S. dollar indexed bonds outstanding (some T 13 billion), about three quarters (T 9.5 billion) were redeemed by end-September 1995 in the following manner: (i) payments in cash to holders of small denomination bonds (under T 1 million) amounting to T 1.2 billion; (ii) offsets against tax and other budgetary obligations amounting to T 4.8 billion; and (iii) issuance of non-interest bearing instruments (KOs) in an amount of T 3.5 billion, which would be redeemed by end-year. 1/

Divestiture of Social Assets

Brief history and extent of social assets A legacy of the Soviet period has been the widespread ownership, provision, and financing of social services by enterprises. It is estimated that about a third of all social services were made by enterprises, with some variation across regions. Of these, an estimated 63 percent involved the provision of housing, 11 percent municipal services, 10 percent health care facilities, and 5 percent educational facilities. Enterprises also provided other social services including sanatoria, children’s summer camps, sport and cultural facilities, and subsidized canteens. Overall, social assets accounted for about 31 percent of all capital assets of enterprises at the end of 1991.

Need for Government action In the context of enterprise restructuring and privatization, enterprises are divesting themselves of such social assets. However, the Government has recognized that a part of the associated services is essential to ensure an adequate social safety net, and that without a coherent strategy for the delivery of primary services, the sustainability of the reform program may be undermined. As a consequence, local authorities have been gradually assuming ownership and responsibility for such divested social assets.

Actions taken With technical assistance from the World Bank, the Government is developing a national strategy for the divestiture of social assets from enterprises and for the principles of continued operation of publicly provided essential social services. As a first step, an inventory of the social assets in all the oblasts and their respective cities was completed by end-September 1995. The inventory included basic expenditure and financing data for all social assets of enterprises (and budgetary institutions), except for housing. Using this inventory, a national strategy will be elaborated which will include: (i) development of appropriate basic standards and levels for service provision; (ii) closure and/or merging of facilities; (iii) restructuring of assets that will be kept operating; (iv) identification of cost reduction measures; (v) unification of operating costs between facilities currently operated by the municipalities and those transferred from enterprises; (vi) improvements in management and financial accountability; and (vii) the introduction and/or expansion of user fees as appropriate.

The Government is currently undertaking a pilot project for divestiture of kindergartens, hospitals and polyclinics in two oblasts, financed by a loan from the World Bank. This project features a rationalization plan for the management of social services, which the participating cities are beginning to implement based on approved annual work programs. On this basis, local administrations will be expected to manage the transfer of assets and maintain these services at an adequate level.

Costs of project It is fairly clear that despite all the envisaged improvements in efficiency and other cost reduction measures, the divestiture of social assets will place a significant additional fiscal burden on local authorities. Thus, it will be essential to ensure that adequate funding arrangements for local authorities are instituted in parallel with these new expenditure responsibilities, including possible transfers from the Republican budget, and an enhancement of the local authorities’ ability to raise tax revenue at the local level.

4. The social protection system and extrabudgetary funds

In the first three quarters of 1995, the extrabudgetary funds were in slight surplus (0.2 percent of GDP), in line with developments in 1994. However, this masked a slight deterioration in the financial position of the main social funds (Pension and Employment), which was offset by an improvement in the position of the Road Fund, following the extension of the strict sequestration policy to its expenditure.

The pressure on the social safety net is slowly becoming evident. The slight deficits of the Pension and Employment Funds through the first nine months of 1995 (compared to modest surpluses in 1994) were explained by several factors: (i) the number of pensioners has been steadily increasing; on July 1, 1995, there were 2.81 million individuals receiving pension benefits in Kazakstan, of which the majority (2.1 million) were old age pensioners; pensions were also provided to disabled individuals (270 thousand), survivors (244 thousand), and poor individuals (129 thousand); (ii) at end-September 1995, the average monthly pension amounted to T 1,752, which corresponded to a replacement ratio of slightly over 30 percent, as compared to 22 percent in 1994; and (iii) the number of those receiving unemployment benefits, while still relatively small, has been steadily increasing. Some 55 thousand individuals received unemployment benefits at end-September 1995 compared to 35 thousand at end-1994, with an estimated two thirds qualifying for the basic benefit equal to the minimum wage.

The authorities are in the process of implementing measures to ensure the soundness of the financial positions of both the Pension and Employment Funds. Amendments to the pension law have been submitted for presidential approval providing for a phased increase in the pension age (half a year per calendar year until the year 2001) from the present age of 60 for men and 55 for women, an elimination of early retirement with full benefits in certain sectors, and a reduction in the pension benefits of working pensioners.

Regarding the Employment Fund, in July 1995, the authorities widened its base to include the agricultural sector and intend to extend the Fund to the government sector from the beginning of 1996. In addition, the system of unemployment benefits is being reformed. In October 1995, the basic benefit rate was raised to three times the minimum wage, resulting in a replacement ratio of 16 percent. Larger unemployment benefits (up to 2-3 times the basic benefit depending on previous earnings and length of service) are to be provided to individuals who have been laid off from restructured or bankrupt enterprises, both in the private sector and in budgetary institutions. In addition, the duration of receiving benefits was set at six months, which could be extended up to one year.

A presidential decree was passed in June 1995 to institute a Compulsory Medical Insurance Fund, effective January 1, 1996. The main objective of this fund is to provide universal medical coverage. Significant work remains to be done to make this fund operational. Decisions still need to be taken regarding the pricing of contracted health services, the possibility of having private providers, and the interaction of the fund with local health administrations. Under the proposed plan, the fund would be financed from the existing payroll contribution; self-employed individuals would pay their own premia, while the Republican budget would provide the premia for the unemployed, students, and pensioners.

IV. Monetary and Exchange Rate Policies 1/

1. Developments in 1994

a. Evolution of monetary and credit aggregates

Monetary and credit policies in 1994 were generally lax, despite a tightening in the second half of the year (Tables 22 and 23). For the year as a whole, base and broad money rose by close to 700 and 560 percent, respectively. The main source of liquidity growth was the increase in net domestic assets of the NBK. Net credit to Government from the NBK rose by T 15.7 billion, (equivalent to 3.5 percent of GDP), while credit to banks increased by T 5.2 billion (1.2 percent of GDP), much of it in the form of government-guaranteed directed credit. Net Domestic Assets (NDA) were also boosted by an expansion of the “other items (net)” of the NBK reflecting, inter alia, a decline in net central bank profits. 2/ While inflation remained high throughout 1994, it exhibited a sharp downward trend in the second half of the year; the monthly inflation rate fell from a peak of 46 percent in June to 10 percent in December 1994.

Sources of Monetary Expansion, 1994 1/

(In billion of Tenge)

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Sources: NBK, Goskomstat, and staff calculations.

Excluding the impact of exchange rate movements and changes in gold price.

Includes the impact of profit transfers to the budget.

During the first half of 1994, base and broad money rose rapidly (by an average 22 and 17 percent per month, respectively). The expansion in liquidity stemmed almost entirely from large increases in NDA, mainly reflecting credit to the budget earmarked to finance the interenterprise arrears netting operation. Between late February and May 1994, T 18 billion (equivalent to 18 percent of first half year GDP), was injected into the economy, of which T 8 billion (8 percent of GDP) represented NBK credit for the arrears netting operation. Credit to banks also rose sharply during the same period, by T 4 billion, much of which was in the form of government-guaranteed directed credit earmarked to certain enterprises. NIR increased only slightly, to 1.5 months of imports of merchandise goods at end-June 1994.

During the second half of 1994, monetary and credit policies were to be tightened so as to offset, to the extent possible, the monetary impact of the interenterprise arrears netting operation. Base money was targeted to increase by a monthly average of 12 percent during the period, mainly via tighter limits on net credit to the Government (which provided for a repayment of the NBK credit granted for the arrears netting operation). The effort at tightening was not entirely successful, as slippages in the last months led to an average base money growth of 16 percent in the second half of the year. Net credit to the Government rose by T 7.6 billion (equivalent to 2.2 percent of GDP), reflecting entirely the Government’s takeover of directed credits as well as of debt of privatized agricultural enterprises from commercial banks. The increase in credit to banks was limited to T 1.3 billion in this period, due mainly to a higher repayment of credit extended previously by the NBK. 1/ In addition, there was a marked worsening in “other items (net),” reflecting, inter alia, losses incurred by the NBK, possibly as a result of large transfers of NBK profits to the budget. At the same time, the authorities succeeded in increasing net international reserves to a level equivalent to 2.6 months of merchandise imports by end-1994, mainly via net purchases of foreign exchange at the market, and continued purchases of gold from domestic producers.

b. Interest rate policy

During the first quarter of 1994, the NBK raised its refinance rate on several occasions, from an annual rate of 240 percent at end-1993 to 300 percent in March 1994, increasing the real monthly effective interest rate from close to -25 percent to below -5 percent (Table 25). 2/ However, despite the rise in inflation in the aftermath of the arrears netting operation, the refinance rate was not increased further, and became strongly negative in real terms. Following a gradual reduction in inflation after June, interest rates became positive in real terms in August, and in September the NBK reduced its refinance rate to 280 percent. Subsequently, the refinance rate was lowered further in several steps, reaching 230 percent by December 1994; however, interest rates remained strongly positive through the period, averaging around 3 percent a month. 1/

c. Exchange rate developments

Since the introduction of the Tenge in late 1993, the NBK generally limited its intervention in the foreign exchange market during 1994 to smoothing out short-term fluctuations in the exchange rate while attempting to build up international reserves to adequate levels. During the first half of the year, the rapid growth in liquidity, strongly negative interest rates, and the associated loss of financial confidence prompted a sudden and sharp shift away from the Tenge, and the exchange rate fell from about T 6 per U.S. dollar at end-1993 to over T 42 by end-June (Table 24 and Chart 4). The Tenge also depreciated sharply vis-à-vis the Russian ruble. The subsequent tightening of financial policies in the second half of the year slowed down the depreciation of the Tenge vis-à-vis the dollar, and the rate increased to slightly over T 54 per U.S. dollar by end-December 1994. 2/ At the same time, the depreciation of the Tenge against the Russian ruble was halted, and from June 1994 through the end of the year, the Tenge tended to appreciate against the ruble.

Chart 4
Chart 4


Citation: IMF Staff Country Reports 1996, 022; 10.5089/9781451820768.002.A001

Sources: Data provided by the NBK, and staff estimates.1/ An increase in the index is a real depreciation. November 1993=100.

2. Developments in January-September 1995

a. Evolution of monetary and credit aggregates

The authorities’ monetary and credit policy for 1995 sought to lower markedly the annual growth of base and broad money, to 37 percent and 40 percent, respectively. Net credit to Government from the banking system was planned to be limited to 0.8 percent of GDP, and NBK credit to banks was to be curtailed further. NIR of the NBK was targeted to rise only moderately for the year as a whole (by less than US$80 million), broadly maintaining the import coverage ratio at its comfortable end-1994 level. A key supporting measure was the elimination of the system of government-guaranteed directed credits in February 1995; it was also intended that interest rate policy would continue to play an active role.

In the event, from May 1995 onwards, macroeconomic developments turned out to be markedly different from expectations, when large foreign exchange inflows started to occur, leading to large increases in monetary aggregates. As a result, in the first three quarters of 1995 monetary expansion was much higher than had been anticipated. Base and broad money rose by 63 percent and 65 percent, respectively, over twice the authorities’ target rates. In contrast to developments in 1994, virtually all the increase in base money stemmed from the further accumulation of NIR by the NBK, which raised the import coverage ratio to 3.6 months by September 1995. NDA expanded by only T 1 billion, reflecting a moderate increase in net credit to Government. This increase, in turn, was accounted for entirely by the Government’s takeover of government-guaranteed directed credit of T 7.6 billion (equivalent to 1.0 percent of GDP), granted in 1993-94. Net credit to the budget from the NBK (i.e., excluding the directed credit takeover), actually declined by T 5.5 billion (equivalent to 0.7 percent of GDP). In addition, credit to banks declined by over T 2 billion.

However, greater monetary expansion did not lead to markedly higher-than-targeted inflation; the monthly inflation rate was gradually reduced from 10 percent in December 1994 to 2.4 percent in September 1995, broadly in line with the authorities’ program. The demand for money increased significantly; quarterly income velocity is estimated to have declined by about 15 percent between the fourth quarter of 1994 and the third quarter of 1995. This decline, especially marked from the second quarter onwards, is likely to have reflected a restoration of confidence in the Tenge following the pursuit of sounder financial policies during the preceding months.

Comparison of Sources of Monetary Expansion in 1994 and 1995 1/

(In billion of Tenge)

article image
Sources: NBK; Goskomstat; and staff calculations.

At constant exchange rates and gold prices.

Monetary developments proceeded unevenly through the first nine months of 1995. During January-March 1995, the authorities succeeded in limiting base money growth to 6 percent, and inflation fell from 10 in December 1994 to 5 in March 1995. An increase in the NIR of the NBK, mirroring the sales of foreign currency inflows to the budget, was almost fully offset by a decline in NDA, as the Tenge counterpart of those foreign currency inflows was not spent immediately by the Government. There was also a contraction in net credit to banks, mainly reflecting the Government’s takeover of directed credits from commercial banks.

Quarterly Monetary Developments, 1995

article image
Sources: NBK; Goskomstat; and staff calculations.

Developments in April-June were markedly different. Base money grew five fold, fuelled by the increase in NIR in the wake of large foreign exchange inflows associated with terms of trade gains, subdued imports, and capital inflows under foreign management contracts (see Section V). In addition, NDA rose as net credit to Government increased, reflecting government spending in conjunction with the national referendum in April. In contrast, credit to banks continued to decline, as the authorities attempted to partially sterilize the monetary impact of the foreign exchange inflows through sales of central bank notes to banks. Despite the expansion in base money, monthly inflation was again halved from 5 percent in March to 2.4 percent in June.

By mid-July, the authorities realized that continued high monetary expansion would lead ultimately to an upsurge in inflation and adjusted their exchange rate policy to place greater emphasize on base money targeting. This policy shift involved limiting the increases in NIR to the amount that could be sterilized through sales of NBK notes; the remaining market pressure would be reflected in an appreciation of the exchange rate. Complementing this approach, credit auctions were temporarily suspended, and interest rates were reduced. As a result, after an increase of 16 percent in July, base money growth was limited to a cumulative increase of only 1 percent in August and September. In the third quarter, the increase in NIR, albeit still sizeable, was already less than the increase in NDA. The rise in NDA reflected both a seasonal increase in credit to banks and some liquidity injection to banks following the very tight credit conditions during the first two quarters. There was virtually no increase in net credit to the Government/budget in the third quarter.

b. Exchange rate policies

In the first half of the year, the NBK followed a policy of letting the nominal exchange rate depreciate by a monthly average of 2-3 percent, slightly less than the inflation differential vis-à-vis the U.S. dollar; 1/ by mid-July the rate had depreciated to about T 62 per U.S. dollar (Table 24). The decision to place more emphasis on base-money targeting resulted in a sharp appreciation of the nominal exchange rate by about 13 percent between mid-July and the second week of August, and the rate moved to below 55 per U.S. dollar. At that point, market sentiment turned around, partly reflecting a perception that the Tenge had become overvalued. The supply of currency on the foreign exchange market fell, while demand rose rapidly, reflecting a pickup in imports. The NBK started selling foreign exchange on the market; and the nominal exchange rate gradually depreciated from below T 55 per U.S. dollar in the second week of August to slightly over 64 per U.S. dollar by end-November. 2/

The main foreign exchange market in Kazakstan has continued to be the Kazakstan Interbank Currency Exchange (KICEX), on which U.S. dollars, Russian rubles and deutsche marks have been traded on a daily basis since mid-May 1995. 3/ Total turnover for trading in all currencies on the KICEX auction increased from an average of approximately US$80 million per month during the first quarter of 1994, to around US$200 million per month in the second and third quarters of 1995. The share of U.S. dollars in the total volume has risen from 75-80 percent in the first half of 1994 to around 90 percent on average during 1995, with most of the incremental increases accounted for by transactions in dollars, while the dollar value of ruble trading has decreased by 30 percent. Trading in deutsche marks, although currently representing only 2 percent of total turnover, increased substantially in 1995. The elimination in early August 1995 of the surrender requirement for foreign exchange earnings has fostered the growth of the interbank foreign exchange market, 1/ which has grown very quickly, to represent about 30 percent of the global daily turnover as of September 1995.

c. Interest rate policy

The NBK continued to follow a very conservative interest rate policy in the first half of 1995. In tandem with the continued decline in inflation it gradually reduced the refinance rate from 230 percent per annum at end-December to 95 percent in May (Table 25). Real interest rates remained strongly positive, averaging around 3 percent a month. Following the surge in capital inflows, the NBK accelerated the reduction in the refinance rate. Thus, the nominal refinance rate was gradually lowered from 95 percent in May to 45 percent in September), 2/ in real terms falling to 1 percent by the end of September.

3. Interest rate structure

With the introduction of new monetary instruments and the development of new financial markets, 3/ the structure of interest rates has become more complex (Chart 5). At the bottom of the structure is usually the refinance rate of the NBK, which continues to play the role of signal and benchmark for the markets; 4/ while the penalty rate on shortfalls on required reserves, which equals 150 percent of the refinance rate, is at the top. 5/ A corridor was introduced for the Lombard rate, with a minimum rate of 120 percent of the refinance rate, and a maximum rate that could not exceed the highest interest bid on the last 3-month credit auction. The latter limit could lead to situations in which the penalty rate is lower than the Lombard rate, giving rise to a perverse incentive not to comply with the reserve requirement in case of a temporary liquidity squeeze. The authorities at present are reconsidering the Lombard interest rate structure with a view to addressing this potential problem.

Chart 5
Chart 5

KAZAKSTAN SELECTED INTEREST RATES, June 1994 – September 1995 1/

(In percent)

Citation: IMF Staff Country Reports 1996, 022; 10.5089/9781451820768.002.A001

Source: Data provided by the NBK.1 Annual uncompounded rates.2/ It started operations in April 1995; the rates are unweigted overage of 3 to 28 days maturities.

The structure of commercial bank interest rates vis-à-vis clients appear to have two main characteristics, which point to weak competition and/or segmentation of financial markets. First, interest rates depend heavily on the type of borrower/depositor, with households typically being offered much lower deposit and credit rates (Table 26). Second, for economic entities other than households, there appear to be very large interest margins which, as of October 1, 1995, were as high as 35 percentage points on average.

4. Monetary instruments

Since mid-1994, the NBK has gradually increased its reliance on indirect monetary instruments. Reserve requirements of 15 percent were introduced on foreign exchange deposits in November 1994, in addition to the existing reserve requirement on domestic currency deposits of 30 percent. In February 1995, the reserve requirement ratio was unified at 20 percent across all deposits. 1/ Sales of Treasury bills increased rapidly from December 1994 onwards, and the NBK has started to augment its holdings of Treasury bills through purchases on the emerging secondary T-bill market, with the aim of commencing open market operations in these bills in the future. Following the decline in inflation, the authorities were able to extend the maturity of Treasury bills to 6 months starting in July 1995. To facilitate short-term liquidity management, the authorities introduced short-term central bank notes starting in June 1995, with a maturity of 7-28 days; the NBK used mainly this instrument for its sterilization operations through the summer of 1995 in response to foreign exchange inflows. In addition, to deal with emergency liquidity situations, the NBK introduced a Lombard Facility in September 1995.

The functioning of credit auctions (which still continue to play a significant role in the conduct of monetary policy) has been enhanced through increasing the frequency of auctions (with the exception of a temporary suspension in August 1995 as part of authorities’ response to the foreign exchange inflows), 2/ and reducing the maturity of auctioned credit. As of January 1995, the NBK discontinued the auctioning of 6-month credits, and increased the share of one-month credit in total auctioned credit. In June 1994, the NBK started regional credit auctions; however, in view of their distortionary character, these are planned to be phased out by end-1995.

5. Developments in the financial system

a. Overall developments

Major structural reforms of the financial system have continued throughout 1994 and 1995. A Law on the National Bank of Kazakstan, which provided for increased autonomy for the NBK, and a law on commercial banks were passed in April 1995 and August 1995, respectively. Work has continued, albeit at a slower pace than desirable, to improve the local payments system and bank accounting (including preparing new charts of accounts for the NBK and the commercial banks). The NBK has continued to strengthen banking supervision and commercial bank capital requirements, with the result that nearly fifty banks have been closed in 1995 (Table 27).

The banking system in Kazakstan comprises different groups of banks: (i) five formerly specialized state banks, namely Agroprombank, Alembank, Kredsotsbank, People’s Bank and Turanbank (dealing with agriculture, foreign trade, construction, savings, and industrial operations, respectively); (ii) several new state banks established for specific purposes, such as housing construction, trade financing, project development and restructuring and liquidation of distressed enterprises; (iii) medium-sized commercial banks that have emerged in the past few years, including in the form of joint ventures with foreign banks; (iv) a small number of foreign banks; and (v) a large number of small commercial banks that were established in 1991-92, some of which no longer meet capital requirements and are gradually being closed or merged with other banks. Weaknesses in the banking system were revealed by diagnostic studies for the largest banks completed in early 1995, as well as by requirements initiated in April 1995 for the banks to submit a loan classification to the NBK.

Commercial relations among the banks have begun to develop, in particular, via a short-term money market, the Almaty Interbank Financial House, which began operations in April 1995, and which handles credits of several terms between 1-28 days. In addition, some commercial banks have begun to use new financial instruments, such as promissory notes. As in some other countries of the region, these commercial relations have developed mainly among a small group of banks in better financial condition.

The NBK has introduced new prudential norms and capital requirements during a phased period of familiarization for the commercial banks and NBK banking supervision staff, to be followed by full implementation and enforcement. During the interim period, however, only banks that meet NBK norms are permitted to undertake full operations, which provides the NBK with some increased leverage in encouraging banks to meet prudential requirements. 1/ To date, about 10-12 relatively stronger banks, which have the potential to eventually meet international standards, have emerged.

The NBK has developed new charts of accounts for both the NBK and commercial banks, with full implementation of the NBK chart of accounts expected in late 1995; implementation of the commercial banks’ chart of accounts will be delayed pending further discussions.

b. Banking supervision and payments system

The NBK has continued strengthening its role as regulator and supervisor of the banking system. Capital requirements were increased in April 1995, and those banks that did not meet these requirements--more than two-thirds of the licensed banks, mostly small banks with limited licenses--were given until July 1, 1995 to submit a business plan to the NBK. On the basis of such a plan, the NBK would decide on sale, merger, conversion into non-banks or liquidation. 1/ Monthly classification and reporting of loans became mandatory in April 1995. The NBK has increased the size of its supervisory staff, although low wages and competition in recruitment from the private sector have posed problems; inspection methods have been strengthened with the help of technical assistance and a new examination procedures manual has been adopted.

Payments system reform is proceeding on the basis of implementing interim improvements consistent with longer-term plans. The short term improvements include the establishment of: (i) electronic information systems for regional and inter-regional interbank payments; (ii) a central payments clearing house; and (iii) service bureaus for small- and medium-sized banks. A conceptual framework for the long-term payments system is being designed, albeit with some delays, by World Bank-financed consultants. The creation of a large value transfer system and an electronic book entry system for government securities are of major importance in this context; considerable efforts are being devoted to preparing a well-designed and sufficient risk management system for the long-term payments system.

Payment instruments such as letters of credit, promissory notes, and bills of exchange are beginning to emerge, but lack of legislation has made their use problematic. One of the emerging local commercial banks recently employed promissory notes to provide financing for the 1995 grain harvest. Kazakstan has joined the Geneva Convention and has prepared interim provisional regulations on promissory notes and bills of exchange. The use of checks and credit cards is very limited by administrative regulations regarding payment by check and by telecommunications bottlenecks. The lack of reliable telecommunications also presents difficulties for liquidity management among branches by banks.

The development of capital markets in Kazakstan is being overseen by the National Securities Commission, under a regulatory framework that is increasing in scope but still incomplete. 1/ Most trading remains outside of formal markets, due in part to taxation of distributed shares, high fees at the local Central Asian Stock Exchange, lack of over-the-counter operations, and initial sale of shares in privatized enterprises through vouchers. Trading of shares is at present quite minor; however, trading volume should increase in late 1995, when the population will begin trading shares in Investment Privatization Funds (IFFs), in which the privatization vouchers were initially placed. In addition, the lack of substantial improvements in enterprise accounting has hindered investment interest and capital market development. A central depository is being established, combined with a clearance and settlement system. Other institutional developments, such as private pension funds or well-capitalized insurance companies have not yet begun to emerge, although foreign firms with extensive operations in Kazakstan have begun to express interest in the former.

c. Major individual banks

As in many transition economies, the banking system in Kazakstan is undergoing a difficult phase, characterized by the weak financial position of major, formally fully state owned banks, as well as the fragile position of newly emerging private banks. The authorities’ supervision and enforcement efforts have identified weaknesses among the smaller commercial banks, many of which subsequently have been closed or merged. Efforts to liquidate banks have brought about lengthy legal disputes. The new Law on Commercial Banks seeks to cover issues relating to bankruptcy and closure of banks, with a view to minimize such disputes in the future.

More attention is now being devoted to the problems of the larger banks. The diagnostic studies of the ten largest commercial banks and the requirement for submission of loan classification has revealed significant financial and operational weaknesses among these banks, including: a large proportion of loans classified as uncollectible losses, although many of these were issued with government guarantee; insufficient capital to meet minimum international standards; poor or nonexistent policies related to risk management (credit, interest rate, currency, and liquidity aspects); inadequate accounting and reporting systems; and excessive exposure to a few large borrowers. With the exception of the People’s Bank (formerly Sberbank), the condition of the formerly specialized state banks is generally weak. People’s Bank has benefitted from a strong management team, which was put into place in mid-1994 following an earlier period of operational difficulties, and which has cut costs, scaled back and targeted more carefully commercial lending, and participated in retail foreign exchange operations through its extensive branch network in the oblasts.

Among the other formerly specialized banks, Agroprombank has experienced a substantial decrease in the real value of its assets, due to a sharp decline in the bank’s deposit base, a failure to collect on existing loans, the transfer of large portions of its portfolio to the Government’s Agriculture Support Fund, elimination of agriculture financing through directed credits, and continual ineligibility for NBK credit auctions; the remaining portfolio contains sizeable non-performing assets. Agroprombank maintains an extensive branch network and staff, and its operations are subject to considerable intervention from local administrations. As the bank no longer fulfills its former role as the sole lender in rural areas, nor provides for seasonal or term financing of the harvest, efforts have begun to consider ways to divide or restructure Agroprombank.

Alembank, the former Foreign Trade Bank, developed a US$1.5 billion portfolio of foreign exchange-denominated loans to local enterprises in 1992-93 on the basis of on-lent export credits. A part of Alembank was split off in late 1994 by the Government to form the Kazakstan Export-Import Bank (Eximbank). During 1994 and 1995, Alembank’s virtual monopoly on foreign exchange operations was substantially eroded by a growing number of exchange bureaus providing retail services and by other banks offering services to enterprises. In mid-1995, Alembank encountered difficulties in collecting from local enterprises repayments to service the export credit lines. In June 1995, its operations were suspended for a short time while the Government provided an emergency injection of funds and the NBK assumed management control. Subsequently, the management of Alembank was placed under the People’s Bank in a new United Bank of Kazakstan, and in August 1995, the authorities began to transfer Alembank’s loan portfolio to Eximbank. Although these transfers will ease the financial situation of Alembank--while dramatically reducing its size--the problem of collecting repayments from enterprises will remain.

Kredsotsbank is the smallest of the formerly specialized banks, providing services to public and budgetary organizations and municipalities. Kredsotsbank suffers from the same problem as the other specialized banks, namely, a large portfolio of non-performing loans, although its deposit (and client) base is much more restricted (mainly to budgetary organizations). Turanbank, the former Promstroibank, has had mixed success in recent years. On the one hand, it has had to confront the difficult problems of its industrial clients while, on the other hand, it has benefitted from an extensive network and contacts and from recent operational improvements, including in foreign exchange. Nevertheless, Turanbank is saddled with a very large portfolio of non-performing loans, many of them directed credits issued with government guarantee.

New state banks--the Housing Construction Bank, Eximbank, the Kazakstan State Development Bank, and the Rehabilitation Bank--were formed by the authorities during 1994-95 to address specific sectoral financing needs, in particular, housing construction, trade financing, project development and restructuring and closure of distressed industrial enterprises. 1/ The 1995 budget provided for substantial funds for the capitalization of these banks, most of which are only in their initial stages of operation. Recently, the Development Bank was merged with Eximbank to avoid overlapping operations and to enable the Development Bank to benefit from Eximbank’s experienced staff.

V. External Sector Developments

1. Developments in 1994

Kazakstan’s consolidated (FSU and non-FSU) external current account deficit widened from about US$440 million in 1993 to US$905 million in 1994 (equivalent to 8.0 percent of GDP), as a decline in export earnings more than exceeded the fall in imports (Table 28). Continued limitations on the use of Russian oil pipelines led to a drop of about 40 percent in the volume of oil exports. The decline in imports was associated with the further contraction in economic activity and incomes.

The capital account (including errors and omissions) recorded a surplus of US$908 million in 1994, exceeding the previous year’s surplus by US$162 million, mainly on account of a significant increase in foreign direct investments by the Tengizchevroil joint-venture. With the substantial widening of the current account deficit, the overall balance of payments surplus fell from US$307 million in 1993 to US$3 million in 1994. However, combined with a significant draw-down of commercial bank’s net reserves, this surplus enabled the NBK’s net international reserves to accumulate by US$325 million, and facilitated a reduction of interstate interenterprise arrears by US$121 million.

During 1994, the shift in trade toward non-FSU countries continued; trade with this group represented 41 percent of total trade, compared to 31 percent in 1993. This trend reflected, inter alia, relative price changes as well as a switch in the relative availability of trade financing from FSU and non-FSU sources. 2/ Regarding the geographical distribution of trade with non-FSU countries, China, Germany, and the United Kingdom accounted for a significant share of imports (about 50 percent of the total) (Table 31). Most of Kazakstan’s exports went to China, Germany, the Netherlands, Switzerland, the United Kingdom, and the United States (Table 30). Major exports to non-FSU countries during 1994 consisted mainly of ferrous and non-ferrous metals (Table 32 and Chart 6). The most significant trading partner of Kazakstan in the FSU was Russia, which accounted for two thirds of total exports in 1993-94; the share of imports from Russia was about 3/4 and 2/3, in 1993 and 1994 respectively. Other FSU states with significant shares in trade included Belarus, Turkmenistan, Ukraine, and Uzbekistan. Major export items included oil and gas condensate, natural gas, and coal, while import included mainly electric power (Tables 29 and 33). Barter trade, mainly with countries from the FSU, still plays a significant role for Kazakstan, accounting for an estimated 28 percent of total exports and 22 percent of total imports in 1994.

Chart 6
Chart 6


(In percentage of total)

Citation: IMF Staff Country Reports 1996, 022; 10.5089/9781451820768.002.A001

Sources: Goskomstat, NBK, and staff estimates.1 Excludes imports of gas and electricity.2/ Figures for 1995 are for the first five months3/ Such as zinc, lead, titanium and aluminium

2. Developments in January-September 1995

a. Current account developments

Kazakstan’s external current account deficit during the first three quarters of 1995 was estimated at about 3.2 percent of GDP (US$420 million), compared to about 12.7 percent of GDP (US$942 million) in the same period in 1994. This improvement reflects a substantial rise in export earnings and sluggish growth in imports as a result of the continuing contraction in output and incomes and reduced availability of trade financing. The increase in exports mainly resulted from significantly higher world market prices for metals (including zinc, copper and aluminum) and metal products, and a substantial increase in export volumes of vegetables.

The commodity composition of trade remained basically the same as in 1994. The exploitation and primary processing of energy and mineral resources enabled Kazakstan to export significant volumes of nonferrous and ferrous metals and metal products, mineral products, and oil. On the import side, Kazakstan has continued to rely on imported energy (natural gas and electricity); other important imported goods are machinery and equipment, and processed food. Kazakstan’s direction of trade pattern continued to shift toward non-FSU countries (including notably China, Germany, the Netherlands, Switzerland, the United Kingdom, and the United States), which accounted for just under 50 percent of total trade in the first three quarters of 1995. Nevertheless, Russia continued to be by far Kazakstan’s single most important trading partner, accounting for about 45 percent of total trade.

b. Capital account developments

Kazakstan’s capital account surplus (including errors and omissions) reached about US$840 million during the first three quarters of 1995. This substantially exceeded the US$536 million surplus recorded during the same period in 1994, as a significant reduction in net capital outflows associated with migrants more than offset lower disbursements from trade credits and higher amortization payments. Official foreign financing amounted to US$295 million through end-September, and consisted of relatively small amounts of official grants (US$28 million), US$127 million from bilateral sources (mainly from Japan, US$122 million), US$101 million from the World Bank (including US$90 million under the first tranche of the Structural Adjustment Loan (SAL), and some small amounts for technical assistance), and about US$14 million and US$25 million from the EBRD and the AsDB, respectively.

The highly favorable trade performance, together with a larger capital account surplus, led to an overall balance of payments surplus of US$421 million during the first three quarters of 1995, as compared to a deficit of US$407 million in the same period in 1994. After taking into account debt relief from Russia, the NBK increased its net international reserves by US$352 million, compared to an increase of US$110 million in 1994. By end-September 1995, the NBK’s net international reserves (including monetary gold) reached US$1.3 billion, equivalent to 3.6 months of merchandise imports; gross reserves reached US$1.7 billion (equivalent to 4.8 months of merchandise imports). As of September 30, 1995, Kazakstan had purchased a total of US$142 million from the IMF under the stand-by arrangement approved in June 1995.

Kazakstan continued to experience difficulties in making payments on its external debt on a timely basis. By end-July 1995, arrears on external debt service amounted to US$12 million; these were cleared in early August. In addition, other arrears on government-guaranteed loans had emerged, which the authorities considered at the time to be in dispute. By November 1, 1995, the stock of arrears had increased to US$96 million (both on disputed and non-disputed debt). Recognizing the adverse impact of arrears on Kazakstan’s international credit-worthiness, the authorities settled US$90 million of outstanding arrears in mid-November 1995, and discussions on the remaining US$6 million, which is in dispute, are continuing.

3. International competitiveness

In the first half of 1994, the real exchange rate of the Tenge vis-à-vis the dollar depreciated rapidly by 80 percent, reflecting a large nominal depreciation in the wake of the inter-enterprise arrears netting operation that filtered into domestic prices with a considerable time-lag (Chart 4, upper panel). The tightening of financial policies from mid-1994 onwards led to a sharp real appreciation of the Tenge, and by end-December 1994 the real rate was about 30 percent higher than at end-1993. During 1995, the real appreciation slowed considerably as relative price increases in Kazakstan exceeded only slightly the rate of nominal depreciation which, in turn, slowed down considerably. The rate of real appreciation temporarily increased slightly in July-August 1995 following the nominal appreciation of the Tenge in the face of large foreign exchange inflows; in September-October the real rate remained broadly constant.

The real rate of the Tenge vis-à-vis the Russian ruble exhibited a similar pattern of depreciation until June 1994, followed by a real appreciation (Chart 4, lower panel). However, between October 1994 and March 1995, the real rate remained broadly stable. Since then, the Tenge has depreciated in real terms vis-à-vis the ruble, reflecting first the strong nominal appreciation, and, subsequently, the relative stability of the ruble vis-à-vis the U.S. dollar. In terms of cost competitiveness, average U.S. dollar wages in Russia and Kazakstan were broadly the same until July 1993, when the ruble area broke up (Chart 7, lower panel); subsequently, dollar wages in Russia rose much faster than in Kazakstan. After July 1994, U.S. dollar wages in the two countries converged to reach about the same level of around US$71-73 by May 1995; since then wages in Russia have risen much faster, to a level some 25 percent higher than in Kazakstan as of September 1995.

Chart 7
Chart 7


(July 1994 = 100)

Citation: IMF Staff Country Reports 1996, 022; 10.5089/9781451820768.002.A001

Sources: Data provided by the NBK, and staff estimates.1/ Estimated as an equally weighted average of the real exchange rate of the Tenge versus the dollar and the ruble.2/ An increase in the index is a real depreciation.

The estimated real effective exchange rate for the Tenge (which combines the real rates vis-à-vis the U.S. dollar and the ruble with equal weights), suggests that a real depreciation (of about 100 percent) took place between end-1993 and mid-1994, followed by an appreciation of about 60 percent in the following 3 months (Chart 7, upper panel). Between October 1994 and June 1995, the exchange rate overall remained broadly constant, with an appreciation through March being offset subsequently. Following large foreign exchange inflows, the real rate appreciated by 5 percent in July-August; since September the rate has depreciated slightly.

4. Developments in the trade regime

Kazakstan made substantial further progress in liberalizing external trade during 1994 and 1995. The Government reduced the number of commodities subject to licenses and quotas as the number of goods whose domestic price is substantially below world market prices continued to decline. In February 1995, the Government: (a) eliminated all export quotas; (b) eliminated export and import licenses except for a short negative list of goods related to national security, health and safety reasons (the number of items subject to export licenses was reduced to 9 items and import licenses currently exist for only 11 items); and (c) annulled the monopoly rights of some 14 state-owned external trade organizations dealing with strategic commodities. 1/ In addition, export surrender requirements, which had been increased progressively from 10 percent to 30 percent in mid-1993, and to 50 percent on January 1, 1994, were abolished in August 1995. Finally the use of barter trade, which has been a significant element in Kazakstan’s external trade relations, was prohibited in July 1995.

In January 1995, Belarus, Kazakstan and Russia agreed to form a customs union in two stages. The first stage, which involved the elimination of tariffs between the three states, was completed in March 1995, and the second stage, aimed at establishing a Common External Tariff (CET), took place in early October 1995. Under Kazakstan’s previous (i.e. pre-CET) tariff schedule, there were 10 different duty rates for exports ranging from 0-30 percent, with most products falling in the range of 5-30 percent. With the exception of a handful of metal products, virtually all rates were expressed in ad valorem terms. Following the agreement on the CET, and the adjustments in Kazakstan’s export duties in October 1995, the number of duty rates was reduced to 7 1/ (0, 3, 5, 10, 15, 20, and 25), and the maximum rate was lowered from 30 percent to 25 percent. In addition, the number of major product groups subject to export duties was reduced from 70 to 27, including three new groups mainly related to military equipment. The new tariff structure relies to a significant extent on specific duty rates expressed in ECUs, in contrast to the previous reliance on ad valorem rates.

With regard to import duties, the previous tariff schedule (i.e. pre-CET) had 12 bands ranging from 0-100 percent, with duties for most products falling in the range of 5-50 percent. However, only a few imported items were subject to duty rates of 1 percent (ores, coal and railroad locomotives), 2 percent (automobile parts) and 100 percent (furniture, mattresses, and bedspreads). Under the CET, the number of import bands (including zero-rated items) remained unchanged at 12, although the previous rate of 2 percent was eliminated, and a new rate of 80 percent was introduced. 2/ With this new structure, the dispersion of rates has been narrowed as the duty rate for most products now falls in the range of 5-30 percent. At the lower end of the schedule, the duty rate of 1 percent is applied only to cereals and to beet roots and sugar; at the upper end, the 50 percent rate is applied to one group of products which includes genuine or cultivated pearls, gems or precious and semi-precious stones; and finally, the maximum duty rate of 100 percent is applied only to some alcoholic drinks, and weapons and ammunition.

5. External debt

Following independence, Kazakstan’s debt monitoring and control mechanisms were extremely weak. In particular, the responsibility for tracking external debt was dispersed among several institutions. This lack of a central monitoring system was associated with a haphazard issuance of large amounts of government guarantees on foreign borrowing by public enterprises during 1992 and early 1993. 3/ 4/ With the slow pace of enterprise reform, many enterprises have been unable to service their debt on a timely basis, and as a result, the guarantees have been called in, placing additional pressures on the budget.

Some progress has been made toward improving external debt management. In early 1994, the Ministry of Finance was designated the sole government agency authorized to issue loan guarantees on behalf of the Government, subject to approval of the Cabinet of Ministers. In March 1995, a Committee for Utilization of Foreign Capital (CUFC) was created under the Cabinet of Ministers with explicit responsibility for coordinating and managing Kazakstan’s overall relations with international financial institutions, bilateral aid agencies and the international development community. In early October 1995, the CUFC was placed under the auspices of the Ministry of Finance and, in a further effort to make the Ministry of Finance the key institution in this area and streamline the institutional responsibilities for debt management, all loan records on government-guaranteed loans previously kept by Alem/Exim bank and Turan bank have been made available to the Ministry of Finance, which is now responsible for ensuring that scheduled debt service payments are met on the due dates.

Kazakstan’s total external debt outstanding (including to the Fund and to Russia) 1/ rose from US$1.8 billion at end-1993 to US$2.7 billion (equivalent to about 24 percent of GDP) at end-1994, and to US$3.3 billion (equivalent to 25 1/2 percent of GDP) by end-September 1995 (Table 34). The sharp increase in the stock of debt reflected largely the disbursement of US$290 million from the World Bank, US$361 million from the IMF, US$395 million (on a net basis) of trade credits, and US$208 million from Japan. Over the past three years, the structure of Kazakstan’s external debt outstanding has changed substantially. The share of debt owed to multilateral institutions (including the Fund) rose from zero in 1993 to about 24 percent at end-September 1995, while debt relating to trade credits remained virtually unchanged at about 27 percent over the same period. 2/ In contrast, and notwithstanding increased disbursements from Japan, the share of debt owed to bilateral creditors declined sharply from 69 percent in 1993 to an estimated 49 percent at end-September 1995, as Russia ceased to provide significant new credits.

Discussions are continuing between Kazakstan and Russia in connection with the mutual cancellation of claims involving Russia canceling the stock of debt owed by Kazakstan accumulated during 1991-94, and in return, Kazakstan renouncing its claims on Russia for ecological damages associated with the operation of the Baikonour space complex in 1991-93. 1/ A cancellation of the debt owed to Russia would reduce Kazakstan’s outstanding debt (including Fund credit) at end-September 1995, by about 42 percent to US$1.9 billion, equivalent to about 15 percent of GDP. Discussions are also continuing with regard to Russia’s rental payments to Kazakstan for the use of the Baikonour space center.

Reflecting the sharp increase in the stock of debt, the ratio of Kazakstan’s debt service payments to exports of merchandise goods (before debt relief and including the Fund) rose from 1 1/2 percent in 1993 to 11 1/2 percent at end-September 1995--the debt service ratio at end-September 1995, after debt relief from Russia, is estimated to have increased to only about 5 1/2 percent.

The maturity structure of Kazakstan’s debt has been strongly influenced by the debt owed to Russia, the bulk of which was to have been amortized over a period of 5 years beginning in 1996. Excluding this debt, at end-1993, about 97 percent of debt outstanding had a maturity structure in the range of 1-5 years; by end-September 1995, the maturity profile had lengthened, as debt with maturity of 1-5 years accounted for only about 41 percent of total debt; debt with maturities in the range of 5-10 years accounted for about 30 percent of total debt, and debt of over 10 years’ maturity accounts for the remaining 29 percent of total debt. 2/

6. Foreign direct investment

Kazakstan is richly endowed with natural resources; in particular, its recoverable oil reserves are estimated at 16 billion barrels. In recent years, it has attracted significant investment in the oil and gas sector from several major Western and Russian oil companies, which signed contracts for periods between 15 and 60 years. Actual investment in the oil and gas sector in the next years, however, will depend on the development of various oil pipeline projects, as well as on an agreement on the status of the Caspian Sea between the five littoral states (Kazakstan, Turkmenistan, Iran, Azerbaijan, and Russia). Foreign investment contracts have also been concluded for other sectors, including the iron, food processing, and tobacco industries. Whereas the joint venture partners for the capital intensive projects are mostly Western companies, particularly from the United States, numerous smaller joint ventures have been established with China and Russia.

The authorities have been eager to develop a favorable climate for foreign investment in Kazakstan. Recently, Kazakstan adopted a number of laws protecting the interests of, and granting broad rights to, foreign investors. Under these laws, foreign investments cannot be nationalized, disputes between foreign investors and their Kazak counterparts can be submitted to any generally recognized international arbitration forum, and the adoption of the Law on Oil and the Law on the State Regulation of Relationships defines the rights of domestic and foreign entities regarding the extraction and sale of hydrocarbons and precious metals and stones, respectively. Foreign investors can freely repatriate their profits. Also, special agreements have been concluded under individual contracts, particularly in the oil sector, covering, inter alia, export duties on petroleum and import duties on capital goods. In order to promote foreign investment and to provide assistance to foreign investors, the Cabinet of Ministers established a National Agency for Foreign Investment in 1992, which, as noted above, has been recently replaced by the Committee for Utilization of Foreign Capital.

Kazakhstan: Recent Economic Developments
Author: International Monetary Fund
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    KAZAKSTAN SELECTED INTEREST RATES, June 1994 – September 1995 1/

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    (In percentage of total)

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    (July 1994 = 100)