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.

KAZAKSTAN EXCHANGE RATE and PRICES, 1994–95

(In percent change)

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

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

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KAZAKSTAN EXCHANGE RATE and PRICES, 1994–95

(In percent change)

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

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

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KAZAKSTAN EXCHANGE RATE and PRICES, 1994–95

(In percent change)

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

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

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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.

KAZAKSTAN and RUSSIA INDUSTRIAL OUTPUT and INFLATION, 1992–95

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

Sources: Goskomstat, and staff calculations.

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KAZAKSTAN and RUSSIA INDUSTRIAL OUTPUT and INFLATION, 1992–95

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

Sources: Goskomstat, and staff calculations.

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KAZAKSTAN and RUSSIA INDUSTRIAL OUTPUT and INFLATION, 1992–95

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

Sources: Goskomstat, and staff calculations.

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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).

KAZAKSTAN and RUSSIA GOVERNMENT BALANCE and WAGES, 1992–95

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

Sources: Goskomstat, and staff calculations.

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KAZAKSTAN and RUSSIA GOVERNMENT BALANCE and WAGES, 1992–95

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

Sources: Goskomstat, and staff calculations.

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KAZAKSTAN and RUSSIA GOVERNMENT BALANCE and WAGES, 1992–95

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

Sources: Goskomstat, and staff calculations.

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(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.

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.

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

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.

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/

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.

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)

Sources: NBK, Goskomstat, and staff calculations.

^1/Excluding the impact of exchange rate movements and changes in gold price.

^2/Includes the impact of profit transfers to the budget.

Sources of Monetary Expansion, 1994 ^1/

(In billion of Tenge)

			Year	First half	Second half
Base money increase			27.3	9.0	18.2
(in percent monthly growth)			(19)	(22)	(16)
Net international reserves			1.5	0.3	1.2
Net domestic assets			25.8	8.7	17.0
	Net credit to
		government	15.7	8.1	7.6
	Credit to banks		5.2	3.9	1.2
	Other items, net		5.0	-3.1	8.2 2/

Sources: NBK, Goskomstat, and staff calculations.

^1/Excluding the impact of exchange rate movements and changes in gold price.

^2/Includes the impact of profit transfers to the budget.

View Table

Sources of Monetary Expansion, 1994 ^1/

(In billion of Tenge)

			Year	First half	Second half
Base money increase			27.3	9.0	18.2
(in percent monthly growth)			(19)	(22)	(16)
Net international reserves			1.5	0.3	1.2
Net domestic assets			25.8	8.7	17.0
	Net credit to
		government	15.7	8.1	7.6
	Credit to banks		5.2	3.9	1.2
	Other items, net		5.0	-3.1	8.2 2/

Sources: NBK, Goskomstat, and staff calculations.

^1/Excluding the impact of exchange rate movements and changes in gold price.

^2/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.

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.

KAZAKSTAN NOMINAL and REAL EXCHANGE RATE INDICATORS, 1993–95

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.

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KAZAKSTAN NOMINAL and REAL EXCHANGE RATE INDICATORS, 1993–95

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.

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KAZAKSTAN NOMINAL and REAL EXCHANGE RATE INDICATORS, 1993–95

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.

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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)

Sources: NBK; Goskomstat; and staff calculations.

^1/At constant exchange rates and gold prices.

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

(In billion of Tenge)

		1994	Jan.-Sept. 1995
Base money		27.3	20.2
NIR		1.5	19.2
NDA		25.8	1.0
Memorandum item:
	CPI (end-of-period, rate of growth)	1,160	42

Sources: NBK; Goskomstat; and staff calculations.

^1/At constant exchange rates and gold prices.

View Table

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

(In billion of Tenge)

		1994	Jan.-Sept. 1995
Base money		27.3	20.2
NIR		1.5	19.2
NDA		25.8	1.0
Memorandum item:
	CPI (end-of-period, rate of growth)	1,160	42

Sources: NBK; Goskomstat; and staff calculations.

^1/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

Sources: NBK; Goskomstat; and staff calculations.

Quarterly Monetary Developments, 1995

		Jan.-March	April-June	Jul.-Sept.
Base money growth
	(percent)	6	32	18
CPI inflation, monthly
	(percent, end-of-period)	5	2	2
Income velocity
	(quarterly, end-of-period)	3.9	3.2	3.2

Sources: NBK; Goskomstat; and staff calculations.

View Table

Quarterly Monetary Developments, 1995

		Jan.-March	April-June	Jul.-Sept.
Base money growth
	(percent)	6	32	18
CPI inflation, monthly
	(percent, end-of-period)	5	2	2
Income velocity
	(quarterly, end-of-period)	3.9	3.2	3.2

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.

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.

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.

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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.

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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.

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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

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.

KAZAKSTAN COMMODITY COMPOSITION OF IMPORTS AND EXPORTS, 1994-95 ^1/

(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

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KAZAKSTAN COMMODITY COMPOSITION OF IMPORTS AND EXPORTS, 1994-95 ^1/

(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

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KAZAKSTAN COMMODITY COMPOSITION OF IMPORTS AND EXPORTS, 1994-95 ^1/

(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

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2. Developments in January-September 1995

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.

KAZAKSTAN REAL EFFECTIVE EXCHANGE RATE INDEX, 1994–95 ^1/2/

(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.

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KAZAKSTAN REAL EFFECTIVE EXCHANGE RATE INDEX, 1994–95 ^1/2/

(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.

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KAZAKSTAN REAL EFFECTIVE EXCHANGE RATE INDEX, 1994–95 ^1/2/

(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.

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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.