Republic of Kazakhstan
2008 Article IV Consultation: Staff Report; Staff Statement; and Public Information Notice on the Executive Board Discussion

The Republic of Kazakhstan’s 2008 Article IV Consultation shows that banks have lost access to new external financing, credit extension has stalled, and growth has slowed. Nevertheless, Kazakhstan has considerable public financial resources to help it weather the current situation and the country is benefiting from high oil and commodity prices. A realistic assessment of the health of banks needs to be made and steps taken to mitigate risks, including by bolstering capital bases, strengthening bank supervision, and further developing the financial safety net framework.

Abstract

The Republic of Kazakhstan’s 2008 Article IV Consultation shows that banks have lost access to new external financing, credit extension has stalled, and growth has slowed. Nevertheless, Kazakhstan has considerable public financial resources to help it weather the current situation and the country is benefiting from high oil and commodity prices. A realistic assessment of the health of banks needs to be made and steps taken to mitigate risks, including by bolstering capital bases, strengthening bank supervision, and further developing the financial safety net framework.

I. Recent Developments, Outlook, and Risks

1. At the time of the 2007 Article IV consultation, Kazakhstan’s economy was enjoying an extended period of very rapid growth. Between 2001 and 2007, real GDP growth averaged 10 percent annually, underpinned by the development of the oil sector, generally prudent macroeconomic policies, structural reforms, and increased access to global financial markets. As a result of this strong growth, real per capita incomes have doubled since 2000 and social indicators have improved.

2. The banking sector played a central role in this rapid growth. Banks dominate the financial system in Kazakhstan, accounting for 80 percent of total assets. They are mostly locally and privately owned, although foreign participation has increased recently. The system is highly concentrated, with the largest five banks accounting for 78 percent of market share. Banks are very reliant on external financing, with external liabilities making up about 45 percent of the aggregate balance sheet. Easy access to external funding fueled very rapid domestic credit growth, which expanded at an annual average rate of 70 percent from end-2004 to August 2007, bringing bank credit to around 75 percent of GDP by end-2007. Lending was mainly to the household, trade, and construction sectors (the oil sector is not reliant on domestic banks for its financing).

Balance Sheet of the Banking Sector, March 2008 ($ bns.)

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Source: Kazakhstani authorities; Fund staff calculations.

3. The economic situation in Kazakhstan has changed significantly since the onset of the global financial turmoil last summer (Tables 1-4). Market perceptions of risk on Kazakhstan’s assets rose sharply in September and, despite a substantial decline over the past month, remain elevated (Figure 1). Commercial bank access to external funding has been sharply reduced. Banks have been repaying syndicated loans and Eurobond issues as they have come due, while raising new financing through nonresident deposits, private loan replacements, government agency-guaranteed loans, and to some extent liquidating their own foreign assets. Some of this borrowing is reported to be at higher cost and shorter maturity than the maturing liabilities. Rating agencies downgraded the banks and the sovereign in early October 2007 (to BBB- by S&P for the sovereign long-term foreign currency rating). Several banks were downgraded again in December, while the sovereign rating outlook was revised to negative by S&P in late April. As confidence in the banks declined, household deposits contracted during August-October and nonresidents sold about $4 billion worth of tenge assets—mostly held in central bank notes—putting significant downward pressure on the exchange rate (Figure 2).

Table 1.

Kazakhstan: Selected Economic Indicators, 2005–13

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Sources: Kazakhstani authorities; and Fund staff estimates and projections.

Excludes deposits of the National Fund.

Excludes transitory domestic currency deposits.

Based on a conversion factor of 7.5 barrels of oil per ton.

Table 2.

Kazakhstan: Balance of Payments, 2005–13

(In billions of U.S. dollars, unless otherwise indicated)

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Sources: Kazakhstani authorities and Fund staff estimates.

Estimates and projections are based on GDP at market exchange rates.

Table 3.

Kazakhstan: General Government Fiscal Operations, 2005–13

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Sources: Kazakhstani authorities; and Fund staff estimates and projections.
Table 4.

Kazakhstan: Monetary Survey, 2004–2008

(In billions of tenge; end-period stocks unless otherwise indicated)

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Source: National Bank of Kazakhstan.

Excludes other nonfinancial institutions.

Transitory deposits in tenge not included.

Figure 1.
Figure 1.

Recent Financial Developments

Citation: IMF Staff Country Reports 2008, 288; 10.5089/9781451821017.002.A001

Source: Bloomberg and Kazakhstani authorities.
Figure 2.
Figure 2.

Recent Financial Developments (cont’d)

Citation: IMF Staff Country Reports 2008, 288; 10.5089/9781451821017.002.A001

Source: Kazakhstani authorities.

Commercial Banks’ Foreign Assets and Liabilities

(quarterly change, in millions USD)

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Source: National Bank of Kazakhstan; and Fund staff calculations.
uA01fig01

Bank External Borrowing, in billions USD

(liabilities excluding deposits and equity securities)

Citation: IMF Staff Country Reports 2008, 288; 10.5089/9781451821017.002.A001

uA01fig02

Credit, Deposits, and Property Prices

(12-mo. percentage change)

Citation: IMF Staff Country Reports 2008, 288; 10.5089/9781451821017.002.A001

Source: Kazakhstani authorities.

4. In response to the tightening of liquidity conditions, banks have sharply curtailed their lending, and growth and property prices are weakening. There has been no growth in bank lending since August, and this “credit crunch” is affecting the nonoil economy. Real GDP growth slowed to 6 percent (y/y) in the first quarter of 2008, from 8.9 percent (y/y) in the third quarter of 2007, and recent indicators of manufacturing and construction activity suggest that the nonoil economy remained weak into the second quarter (Figure 3). After several years of rapid gains, property prices are declining, most notably in Almaty where the prices of existing homes are down by 40 percent from their peak. This decline has partly corrected previous overvaluation, although the price adjustment may have further to go, particularly if credit availability and household incomes continue to weaken. Developments in Kazakhstan have also had repercussions in the region (Box 1).

Figure 3.
Figure 3.

Real Sector Developments

(12-month percent change)

Citation: IMF Staff Country Reports 2008, 288; 10.5089/9781451821017.002.A001

Source: Kazakhstani authorities; and Bloomberg.
uA01fig03

Actual and Equilibrium Nominal House Prices 1/

(Thousands of tenge/sq.m.)

Citation: IMF Staff Country Reports 2008, 288; 10.5089/9781451821017.002.A001

1/ Data shown for Kazakhstan (KAZ) and Almaty (ALM).2/ Based on equilibrium in the housing market that the expected annual cost of home ownership equals the annual cost of renting.3/ House price growth as a function of fundamentals (affordability ratio, income per capita growth, interest rate, and credit growth).Source: Kazakhstani authorities; Fund staff calculations.

Regional Linkages and Spillovers

Kazakhstan is becoming a more important player in central Asia. The primary channels linking the region’s economies are trade, workers’ remittances, and cross-border banking. The temporary ban on wheat exports in 2008 and the difficulties experienced by banks highlight the impact of policies and developments in Kazakhstan on the region.

Kazakhstani banks expanded rapidly in neighboring markets in recent years. The presence of Kazakhstani banks has become particularly notable in the Kyrgyz Republic, where they accounted for 48 percent of total lending in September 2007. The credit crunch led Kazakhstani banks to squeeze branches and subsidiaries abroad to shore up liquidity, causing a slowdown in credit extension in the Kyrgyz Republic. Credit growth has recovered in 2008 and the share of Kazakhstani banks’ credit has stabilized at 45 percent of total. In Tajikistan, one Kazakhstani bank in particular has lent a significant sum to the cotton sector, which is secured by Tajik central bank reserves. This makes Tajikistan vulnerable to any problems at this bank (although the exposure is low from the bank’s perspective). Finally, Kazakhstani banks’ activities in Russia have been growing; while this helps them to diversify their balance sheets, it exposes them to new risks.

The slowdown in Kazakhstan is having a noticeable impact on some neighbors. The country is an important net importer from the CIS and a source of remittances, particularly for the Kyrgyz Republic (although little is captured in official data). All-in-all, growth in the Kyrgyz Republic (excluding gold) and Tajikistan is projected to slow to 5 percent this year, from 8.7 percent and 7.8 respectively in 2007.

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Source: Kazakhstani and CIS country authorities. Data for 2007.

Country estimates. Most remittance flows travel “by road” and are not captured in official data.

5. Financial soundness indicators are showing signs of deterioration(Table 5). While capital adequacy is well above the regulatory minimum, falling liquidity ratios and deteriorating asset quality do raise concern, with the number of loans overdue by more than seven days rising sharply in recent months.1 Banks are heavily exposed to the deteriorating property market, face indirect exchange rate risk from lending in foreign currency, and have further large external debt repayments coming due. The authorities estimate that the maturing external liabilities of banks in 2008 total $14 billion ($17 billion with interest), including repos and short-term deposits of nonresidents, and repayments are estimated to have been the highest in the first quarter.

Table 5.

Kazakhstan: Selected Prudential Indicators of the Banking Sector, 2004–2008 Q1

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Sources: NBK reports various issues, FSA, FSAP, and staff calculations.

Includes contingent claims, contingent liabilities, transactions in foreign exchange and precious metals, and derivatives.

Loans or assets classified as doubtful and loss.

New classification scheme introduced in early 2003.

NPL-Narrow definition, consisting of loans overdue past 60 days and other qualified loans (FSA Category 5 and Loss). NPL definition closest to conventional 90-day norm.

NPL-Narrow definition, consisting of loans overdue past 60 days and other qualified loans (FSA Category 5 and Loss). NPL definition closest to conventional 90-day norm.

uA01fig04

Bank Capital Adequacy and Loan Quality

(in percent)

Citation: IMF Staff Country Reports 2008, 288; 10.5089/9781451821017.002.A001

1/ See text footnote 1.Source: Kazakhstani authorities.

Maturing External Liabilities of Banks, 2008 1/

(in millions USD)

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Source: National Bank of Kazakhstan; and Fund estimates.

Excludes interest payments. Includes Kazakhstan Development Bank, accounting for less than $200 million of maturing liabilities.

Short-term deposits of nonresidents redeemable in 2008 are distributed equally across quarters.

Includes repo operations with nonresidents of $1 billion.

6. The authorities reacted decisively to the sudden stop in capital inflows last year. The central bank (NBK) provided large-scale liquidity support to banks during August-October through repurchase agreements, foreign exchange swaps, early redemption of NBK notes, and the easing of reserve requirements. It also intervened heavily in the foreign exchange market, using $6 billion (25 percent) of its reserves (15 percent of total official foreign currency assets) during August-October, and has since effectively pegged the tenge to the U.S. dollar. NBK reserves have recovered this year, rising by $4 billion through early June. The government directed $1 billion to support ongoing construction and investment projects in November 2007 (another $3 billion is slated for this year, although only $130 million is additional spending). After initially spiking, interbank interest rates have eased (Figure 2).

7. Kazakhstan has large financial resources to help weather the current situation. Official foreign currency assets totaled $46 billion in early June, comprising NBK reserves of $21 billion and oil fund (NFRK) assets of $25 billion. Commercial banks also have foreign assets of which about $3.5 billion are thought to be liquid. Total foreign assets broadly match foreign liabilities when the intracompany debt of the oil sector is excluded, while liquid foreign currency assets comfortably cover potential short-term foreign currency drains.

uA01fig05

Foreign Currency Balance Sheet by Sector

($bns.)

Citation: IMF Staff Country Reports 2008, 288; 10.5089/9781451821017.002.A001

Source: Kazakhstani authorities; Fund staff calculations.

8. Looking forward, growth is expected to remain relatively subdued.2 Assuming limited bank access to external financing and only modest deposit growth, credit to the economy is likely to decline in real terms. Nonoil GDP growth is forecast to slow to 4.7 percent this year, from 9.2 percent in 2007, with spillovers from the oil sector partly mitigating the impact of the credit crunch. Oil output should support somewhat stronger overall growth of close to 5 percent in 2008. A strengthening in growth to 6¼ percent is projected next year assuming global financial conditions improve and pressures on bank balance sheets are reduced. The current account is projected to move into surplus in 2008, following the large deficit last year, due to higher oil and commodity prices and much slower import growth (Table 2 and Figure 5). With banks repaying debt, the external debt/GDP ratio is projected to fall sharply this year, and appears to be on a sustainable path under a range of scenarios (Table 6 and Figure 6). After surging late last year, CPI inflation has eased on a month-to-month basis this year, and in the absence of further oil or food price shocks, is expected to fall below 10 percent (y/y) by year-end, from 19.5 percent at present. Despite a weakening in nonoil tax revenues, the overall budget surplus is projected to increase to 6¾ percent of GDP in 2008 due to strong oil revenue growth.

Table 6.

Kazakhstan: External Debt Sustainability Framework, 2004-2013

(In percent of GDP, unless otherwise indicated)

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Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.