Republic of Kazakhstan
2011 Article IV Consultation: Staff Report; Supplement; and Public Information Notice
Author:
International Monetary Fund
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Publication Date:
28 Jun 2011
eISBN:
9781455288625
Language:
English
Keywords:
ISCR; CR; exchange rate; inflation pressure; rate; current account; foreign currency; monetary policy; broad money; GDP deflator
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Kazakhstan’s economic recovery and unemployment rate and other issues are discussed in this paper. The banking and corporate sectors have not recovered from the crisis despite strong economic growth. Ownership and partial financing of the envisaged centralized distressed asset fund by the National Bank of Kazakhstan (NBK) poses risks to the integrity of monetary policy, and may create conflicts with its new supervisory powers. The importance of fully implementing the announced macroprudential measures and enhancing liquidity management practices to manage a possible increase in capital inflows are outlined.

Abstract

Kazakhstan’s economic recovery and unemployment rate and other issues are discussed in this paper. The banking and corporate sectors have not recovered from the crisis despite strong economic growth. Ownership and partial financing of the envisaged centralized distressed asset fund by the National Bank of Kazakhstan (NBK) poses risks to the integrity of monetary policy, and may create conflicts with its new supervisory powers. The importance of fully implementing the announced macroprudential measures and enhancing liquidity management practices to manage a possible increase in capital inflows are outlined.

RECENT DEVELOPMENTS AND OUTLOOK

The recovery has gained speed, and the external and fiscal positions have strengthened with the rebound in commodity prices. Higher foreign inflows resulted in appreciation pressures on the tenge, but the central bank continued to limit its rise. Banks remain burdened by problem loans. Inflation pressures have emerged with rising food prices. Supported by favorable terms of trade, the economic outlook is promising, but subject to risks posed by changing external conditions, and a potential further deterioration of the financial system.

A. The Recovery is Gaining Momentum

1. An early presidential election took place on April 3, 2011. The snap election, which was not due until late 2012, followed the Constitutional Council’s rejection of the parliament’s proposal for legal changes to allow President Nazarbayev to remain in office until 2020. The president was re-elected to a new 5-year term, winning over 95 percent of the vote. The election was followed by modifications in the composition of the government, although the Prime Minister remained in office. Economic policies are not likely to change, and the policy agenda is now focused on the implementation of a medium-term plan—the Strategic Development Plan to 2020.

2. The medium-term plan aims at achieving inclusive and broad-based growth. It envisages diversification of the economy—with an increased share of manufacturing and agriculture in GDP—enhanced labor productivity across sectors, and higher living standards. Samruk-Kazyna (SK), the state investment holding company, now led by the President’s son-in-law, has taken the lead role in facilitating infrastructure development, including by lending to priority sectors and securing external financing.

3. The economic recovery gained speed in 2010. Aided by favorable commodity prices and continuing public sector support, real GDP expanded by 7 percent, up from 1¼ percent in 2009. Growth was substantially higher than expected by the authorities, the Fund, and most market analysts.1 The recovery continued to be driven by oil and minerals as well as related services, in particular transport and communications. Agriculture contracted due to a severe drought, while activity in construction and real estate remained flat.

4. Unemployment was not affected by the crisis, and resumed a declining trend as the economy started to recover. The authorities’ efforts to create temporary jobs during the crisis likely contributed to the decrease in the official unemployment rate to 5½ percent by end-2010. Notably, youth unemployment has declined significantly in recent years, from 13½ percent in 2005 to 5¼ percent by end-2010. However, there are concerns related to hidden unemployment2 and self-employment. The latter accounts for over 30 percent of the labor force and includes many rural poor. The official poverty rate also continued to decline, but poverty remains relatively high in rural areas, contributing to the migration to large cities (Box 1).

uA01fig02

Inflation

(Percent y/y)

Citation: IMF Staff Country Reports 2011, 150; 10.5089/9781455288625.002.A001

Source: Kazakhstani authorities

5. Driven largely by external factors, inflation pressures intensified. Inflation remained relatively contained during most of 2010 despite an accommodative monetary policy stance. Toward the end of the year, however, consumer prices picked up sharply, and annual inflation was 8½ percent at end-April 2011, exceeding the official objective range of 6-8 percent. The increase was primarily driven by global food prices (despite the use of administrative measures to limit the pass through to domestic food prices) as credit growth and demand-led pressures remained contained (see Chapter I of the Selected Issues Paper). As a result, standard measures of core inflation, excluding both food and energy, also remain subdued.

6. The external position strengthened, and foreign inflows began to pick up. The current account returned to surplus in 2010 (3 percent of GDP), as exports and imports rebounded in response to rising external and domestic demand. Trade with Russia expanded following the creation of the customs union; even though some of this trade may no longer be captured by the statistics (see Chapter II of the Selected Issues Paper). Part of this increase may reflect trade diversion, as the average tariff rate with countries outside of the union was nearly doubled. The capital account benefited from significant gross FDI inflows (albeit still 2½ percentage points of GDP lower than before the crisis) and from external sources of funding to the public sector. International reserves and assets in the oil fund rose by nearly $11½ billion during 2010, and reached $73 billion by end-April 2011. Credit default swap spreads declined faster than in other emerging markets.

uA01fig03

Tenge Exchange Rates 1/

Citation: IMF Staff Country Reports 2011, 150; 10.5089/9781455288625.002.A001

Source: Bloomberg 1/ The band widened from T/$150 (+/- 3 percent) to T/$150 (+10/-15 percent) in February 2010, and was officially abandoned at end-February 2011.

Kazakhstan’s Social Safety Net

Poverty and Inequality

Kazakhstan has succeeded in reducing the official poverty rate (the share of population with incomes below the subsistence level) from 40-50 percent in 1990s to 6½ percent in 2010. Nonetheless, the official subsistence level is low (KZT 15,338, or $105 a month), and poverty remains relatively high in rural areas. Inequality is on a declining trend, with the Gini coefficient falling by 24 percent since 2001.

General Assistance

A pay-as-you-go pension system was inherited from the Soviet era. This was replaced in 1998 by an accumulative pension system (including compulsory and voluntary elements) that covers the whole population. A minimum basic pension equal to 40 percent of the subsistence level is guaranteed by the government. The current pension age is 58 years for women and 63 years for men.

Targeted Assistance

Cash transfers to individuals or families with monthly incomes below 40 percent of the subsistence level, or $42. The amount provided is the difference between household income and 40 percent of the subsistence level times the number of people in the household. These transfers are currently received by 200,000 people, or 20 percent of the population with incomes below the subsistence level.

Housing assistance for low-income families with monthly expenses on housing (including utilities) above the maximum level, expressed as percentage of income. This benefit covers 200,000 families.

Unemployment benefits (equal to average monthly earnings of the last two years) cover employed and self employed residents, making them eligible after 6 months of coverage. The duration of the benefit depends on the period for which the insured was covered.

uA01fig04

Share of Population with Incomes Below Subsistence

(Percent)

Citation: IMF Staff Country Reports 2011, 150; 10.5089/9781455288625.002.A001

Source: Kazakhstani authorities

State social benefits provide periodical transfers to persons in need due to disability, loss of breadwinner, or old age. The size of benefits is tied to the minimum wage.

Other benefits include sickness, work injury and maternity benefits (paid by employers), as well as family assistance for the birth of a child and for caring for a child.

Is There Room for Improvement?

Government assistance would benefit from better coverage and more appropriate levels and organization. Reports from UNDP and the World Bank emphasize the need to improve the household income databases and increase awareness of existing social benefits, especially in rural areas. Targeting could also be improved, as some benefits (such as child support) are not dependent on income. The authorities recognize these issues, and are setting up local committees in rural areas to monitor the beneficiaries, verify the needs for targeted assistance, and improve awareness of the population.

7. With market sentiment supportive of the tenge, the official trading band was abandoned in February 2011. The rebound in global commodity prices and the related appreciation of the ruble resulted in strong appreciation pressures on the tenge. Nevertheless, the currency has gained little more than 1 percent in nominal terms since the start of this year as the National Bank of Kazakhstan (NBK)—focused on managing the effective exchange rate—has limited the bilateral appreciation of the tenge against the U.S. dollar through intervention amounting to around $7 billion (70 percent of total international reserve accumulation) in the first four months of 2011. The NBK sharply increased its issuance of short-term notes to sterilize the inflow of capital.

8. The authorities are beginning to adjust policies to the increase in commodity prices and related inflows.

  • Emergency support to the financial sector was significantly reduced. Nonetheless, deposits in the banking system, subsidized lending to priority sectors, and increases in wages and pensions continued in 2010. The overall fiscal balance returned to a surplus of 1½ percent of GDP.3 Oil proceeds above the fixed budget transfer of $8 billion were saved in the oil fund, and the resulting budgetary gap was financed by domestic and external borrowing, including the $1 billion loan from the World Bank.

  • Although the growth of monetary aggregates remained relatively contained—with reserve and broad money expanding at annual rates of 3 and 15 percent, respectively—the NBK raised its policy rate by 50 bps to 7½ percent in March, signaling a reversal of the easing cycle implemented during the crisis. Nevertheless, reserve requirements, at 1½ and 2½ percent on domestic and foreign currency deposits, remain at historical lows.

  • The supervisory authorities have improved crisis management capabilities and strengthened prudential regulations to limit foreign exchange borrowing. The Financial Supervisory Agency (FSA) was integrated into the NBK to safeguard financial stability.

  • The authorities are taking steps to improve the AML/CFT framework, which is undergoing a mutual evaluation of compliance with the FATF recommendations by the Eurasia Group.

B. Significant Challenges Persist

9. The banking and corporate sectors have not recovered from the crisis despite the return of strong economic growth. The sudden shut-off from international capital markets and the consequent forced deleveraging reduced the size of the banking system as a share of GDP. On average, banks’ reported regulatory capital adequacy ratios improved to near pre-crisis levels following the restructuring of external liabilities and increased holdings of government securities.

uA01fig05

Provisioning Coverage of Overdue Loans

Citation: IMF Staff Country Reports 2011, 150; 10.5089/9781455288625.002.A001

Source: FSA 1/ Loans with overdue payments.2/ Loans overdue on a 90-day basis.

However, nonperforming loans (NPLs) on a 90-day overdue basis, heavily concentrated in the construction and real estate sectors, remain high at over 25 percent of total loans. Provisioning coverage of overdue loans declined and may be overstated by doubtful recoveries of restructured loans, reinforcing downside risks to banks’ capital adequacy ratios. This has been reflected in the continued rise in accrued (but not received) interest income of banks, equivalent to about 60 percent of regulatory capital. Against this, banks have been reluctant to write off bad loans, given expectations of economic recovery, difficulties of managing collateral, and tax disincentives. The restructuring of external liabilities has been insufficient on its own to ensure the health of BTA and Alliance Bank as the continued decline in asset quality has led to negative equity positions (on an IFRS basis).

Banking Sector Vulnerability Indicators

(in percent)

article image
Source: FSC; and staff estimates

End Q1 2011

Reported capital was negative during 2009

10. Banks’ lending activity remained weak, lagging the pace of economic recovery. Credit to the economy grew by just under one percent year-on-year at end-2010, reflecting ongoing balance sheet uncertainties, and constrained demand from highly indebted non-oil corporate borrowers. While the recent strengthening of the currency encouraged a modest shift into tenge-denominated deposits, the overall level of dollarization remained significant at around 40 percent, and the tenor of deposits is largely short-term in nature. The increase in deposits improved banks’ aggregate liquidity position, but profitability remained weak and driven mainly by non-interest income derived from the release of provisions on restructured loans.

11. The levels of external and public debt remain sustainable. Total external debt declined from 100 to about 85 percent of GDP during 2010, partly as a result of the writing-off of banks’ external liabilities. However, there are recent indications of significant borrowing activity by public enterprises.4 This is mainly attributable to a $13 billion credit line from China, but also to the renewed issuance of international bonds by the SK developmental entities.

C. The Outlook is Broadly Favorable but not Without Risks

12. Staff projects strong real and external balances, but inflationary pressures may intensify. Growth of oil output is expected to decline as existing fields approach their capacity. The non-oil sector is projected to continue recovering, notably agriculture with an expected return to more normal weather, retail trade favored by improved incomes, and mineral and oil-related activities. The direct benefits of higher hydrocarbon prices on other domestic sectors are limited, as windfall revenues above the fixed budget transfer are saved (see Chapter III of the Selected Issues Paper). With global food prices remaining high and potential demand pressures beginning to emerge, inflation is likely to exceed the objective range, reaching 9-10 percent by the end of the year. The external current account balance and the oil fund assets are projected to strengthen further. In the medium term, growth is projected to remain at the estimated potential of 6 to 6½ percent, provided that the economic diversification plans are successful and that financial intermediation improves.

13. A deterioration of external and financial sector conditions presents the main downside risk to the outlook. Kazakhstan would be particularly affected by negative developments in major trade and financial partners (Box 2). A fall in commodity prices would undermine the improvement of the fiscal and external positions, and the recovery of incomes. Furthermore, renewed volatility in global financial markets could adversely affect the ability of banks and corporations to access international markets, impairing their ability to service maturing external liabilities (estimated at $13 billion for 2011). A potential deterioration of financial sector conditions would be another key risk to the outlook.

Selected Economic Indicators, 2010–16

article image

Does not include NFRK.

In billions of U.S. dollars.

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

External Spillover Risks for Kazakhstan

China

Economic linkages with China have grown in recent years. China is now Kazakhstan’s biggest trading partner (24¼ percent of total trade) and the fourth largest foreign investor (nearly 10 percent of total foreign investment). It is also a strategic lender to projects in key sectors such as oil refining, energy generation, chemical production, transport and communications. Given the influence of Chinese demand on global commodity prices, a deterioration of economic activity in China would lower Kazakhstan’s commodity-related investment and exports.

Euro Area

While Kazakhstan’s financial exposure to the euro area periphery is limited, more widespread problems in Europe could have significant implications. Kazakhstani holdings of assets in Greece, Ireland, Portugal and Spain account for only 1½ percent of total assets abroad, and recent experience shows that the impact of adverse developments in these countries on Kazakhstan’s spreads appears to be short-lived. However, the eurozone as a whole remains an important financial and trading partner. Kazakhstan’s trade with the eurozone accounts for 23 percent of total trade, and euro area investors account for 33 percent of the stock of foreign investment in Kazakhstan. Furthermore, about 30 percent of foreign assets held by Kazakhstani residents are eurozone claims.

Therefore, more widespread problems in Europe could translate into weaker demand for Kazakhstani exports and higher borrowing costs at both the sovereign and corporate levels. In addition, intensified banking sector problems in the eurozone could undermine the foreign asset positions of Kazakhstani banks.

uA01fig06

CDS Spreads

(basis points)

Citation: IMF Staff Country Reports 2011, 150; 10.5089/9781455288625.002.A001

Source: Bloomberg

Russia

Kazakhstan’s significant trade and financial linkages with Russia are expected to deepen. The customs union has begun to enhance the already strong economic ties between these countries, and the Common Economic Space (planned for 2012) will deepen the exposure of Kazakhstan to the impacts of commodity price developments on the Russian economy. This prospect is clearly reflected in the rapid convergence of Russian and Kazakhstani CDS spreads.

POLICY PRIORITIES

The main policy priority is to restore the health of the banking and corporate sectors. In parallel, there is a need to maintain macroeconomic stability by continuing to withdraw the accommodative bias in monetary policy, pursuing greater exchange rate flexibility, and strengthening the fiscal position. Over the medium term, structural reforms are needed to ensure broad-based and inclusive growth.

A. Financial Sector: Resolution of Problem Loans

14. The legacy of the crisis needs to be comprehensively addressed. Staff noted that the ongoing strategy of targeting assistance to specific economic sectors and entities is not succeeding in effectively resolving banks’ problem loans, despite the economic recovery. Moreover, impaired balance sheets and uncertainty over capital adequacy will likely remain a constraint to credit growth, undermining the authorities’ plans to sell the public stakes in banks and make the system compliant with Basel III standards by 2013. The authorities remain optimistic that the ongoing recovery and improved regulatory framework will help restore banks’ health. Nonetheless, they are developing a new strategy to help improve banks’ asset quality (Box 3).

Key Bank Ratios and Vulnerabilities

(end-March 2011, in percent) 1/

article image
Sources: FSA; and IMF staff estimates

Kazakhstani accounting standards.

New Conceptual Plan to Reduce Problem Loans in Kazakhstan

The Plan

The Council for Financial Stability has approved a new conceptual plan to improve the quality of banks’ assets. The plan aims to remove NPLs with an approximate face value of $6 billion (about 37½ percent of the total) from banks’ main balance sheets in order to facilitate a resumption of lending, while limiting costs and mitigating moral hazard. If successful, the plan is expected to be expanded, drawing the participation of both domestic and foreign investors. Although details remain preliminary, the plan is designed to proceed in three complementary directions:

  • Establishment by banks of special purpose vehicles to act as private asset management companies (AMCs). These AMCs would receive problem assets related to real estate and land assets with a face value of around $4 billion.

  • Establishment of a distressed asset fund. This fund would be owned by the NBK, and capitalized with $1 billion raised through a restricted domestic debt placement (among pension funds, banks, and the NBK). The fund will purchase and dispose of other NPLs worth $2 billion (with an assumed average discount of 50 percent). The interest rates on the bonds would vary, favoring pension funds as the senior bondholders.

  • Enhancement of prudential regulations and capital adequacy. Regulatory standards would be harmonized with best international practice and the Basel III framework, including by strengthening core capital and reducing systemic risks through dynamic provisioning and enhanced capital buffers.

Institutional and Funding Structures

  • The AMCs would be owned by banks, either singularly or collectively. No new funding would be involved.

  • The distressed asset fund would be time-bound (with a maximum five year life) and consolidated into the balance sheet of the NBK.

Valuation

  • Under both schemes, asset valuation would be undertaken by independent external advisors, including the big four accounting firms, and based on an assessment of cash flows and net realizable values.

Management

  • The AMCs would be managed by both bank staff that is familiar with the loans and outside professionals.

  • The distressed asset fund would be managed by external managers who would report to the NBK.

Governance

  • Transparency of the bank level AMCs would depend on the extent to which they are consolidated into the main balance sheets of banks.

  • The distressed asset fund would be audited, and the results made public.

Net impact

  • Under the AMCs, assets would be transferred at an agreed valuation. However, they will be subject to more lenient provisioning requirements, which may boost capital positions under local accounting rules. Under IFRS accounting there would be no change. The better focused and more professional management of bad assets should allow a higher rate of recovery.

  • Under the distressed asset fund, banks would swap provisioned NPLs for bonds at a value determined by independent assessors. To the extent that the valuation differs from the net book value, the balance sheet would be impacted. Banks would gain extra liquidity as they could use the bonds in repurchase agreements with the NBK.

15. The new strategy combines enhanced efforts by individual banks and a centralized distressed asset fund established by the NBK. The authorities acknowledged that this plan represents only a partial solution to the large stock of NPLs since it only deals with a subset of these assets. Moreover, enhanced bank efforts represent accounting adjustments rather than true economic restructuring. While recommending a more comprehensive approach, staff stressed the need for an accurate valuation of problem assets and full recognition of bank losses. This will require an independent and forward-looking diagnostic assessment of banks’ asset quality. The authorities are confident that banks currently meet prudential norms, mitigating the need for an additional diagnostic assessment. They explained that asset valuation will be determined by independent professional appraisers, and that the improved prudential standards contemplated in the plan would help strengthen bank positions. Staff supported the authorities’ plan to remove the existing tax impediments to the recognition and writing-off of problem assets. Staff also stressed that ownership and partial financing of the centralized fund by the NBK pose risks to the integrity of monetary policy, and may create conflicts with the NBK’s new supervisory responsibilities.

16. A contingency plan needs to be put in place if bank capital is eroded by a fuller and proper recognition of losses. Rapid action should be taken to attract new capital if it is needed, ideally from existing shareholders and other private investors. Staff reiterated the complementary findings and recommendations of a recent MCM/LEG technical assistance mission that if private funds are insufficient to replenish any identified capital needs, contingency plans based on the use of budgetary funds rather than central bank resources should be implemented. The authorities hope to avoid additional public capital injections to banks following the government’s crisis-related equity support of about 80 percent of system capital at April 2009.5

17. In tandem with rehabilitating banks’ balance sheets, the system would benefit from a more effective prudential framework to minimize the risks of boom-bust cycles. To this end, staff emphasized enforcing existing regulations and refraining from regulatory forbearance; implementing prudential standards that limit banks’ vulnerabilities (including macro-prudential measures to limit foreign currency borrowing and credit expansion); and assessing the new business models of the restructured state-owned banks to ensure their viability. This should be supported by additional legal and governance reforms. Coordinated action across government entities, led by the Council for Financial Stability, should facilitate these efforts and ensure independence between the operational aspects of regulation and supervision and monetary policy. In addition, it is crucial that supervisors have sufficient legal protection, enforcement capabilities, and the budgetary resources to credibly perform their role.

18. As the financial system’s health is restored, the non-oil corporate sector should pursue an orderly deleveraging. While targeted government support has helped to ease some of the debt burden in the real estate and mortgage sectors, banks’ exposure to the non-oil sectors remains considerable. Staff emphasized that successfully deleveraging corporations and attracting capital from abroad will require strengthening bankruptcy and insolvency regimes, as well as sequencing and harmonization with the resolution of the banking sector.

B. Fiscal Policy: Consolidation and Transparency

19. The authorities are planning a gradual fiscal consolidation in 2011 and over the medium term. The non-oil deficit is projected to decrease slightly in 2011.6 Proceeds from higher export duties will be offset by a further 30 percent increase in public sector wages in the middle of the year and by rising expenditures on development programs. In 2012-13, a further reduction in the non-oil deficit by about 2 percent of GDP is planned, through better tax collection and administration, and restraint on all categories of expenditure. While off-budget spending is expected to continue to decline, public and quasi-public companies, led by SK, will maintain their large role in industrialization and modernization initiatives. In this regard, the authorities noted their interest in public private partnerships to help attract FDI and ease the burden on the budget.

20. The non-oil deficit needs to be brought back to the conservative path that prevailed before the crisis. To achieve their target of reducing the non-oil deficit from the current level of over 10 percent of GDP to 3 percent by 2020, the authorities intend to improve tax collection and impose expenditure restraint.7 Staff broadly supported this goal, as well as the intention to improve the quality of expenditures. In particular, to achieve the targeted deficit reduction while ensuring the implementation of the development programs, the authorities should try to avoid further real increases of hard-to-reverse items, such as wages and pensions. Staff also recommended ensuring that the assistance provided through the existing social safety net reaches all low income groups, especially in rural areas, as the most effective way to maintain social stability and protect the population from the effects of rising inflation. This would allow the phasing out of current administrative measures to control price increases. The upcoming technical assistance from FAD on public financial management should be helpful in this regard.

21. Fiscal policy should be formulated within a credible and transparent medium-term framework. Staff strongly supported the prudent strategy of continuing to save a significant part of oil revenue in the oil fund. The optimal balance between the use of commodity revenues and their accumulation in the national fund, however, should be determined within a medium term framework containing intermediate targets for the non-oil deficit. This would allow flexibility in the size of the transfer of oil revenues to the budget, which would in turn ensure that the oil fund plays its role in stabilizing the economy against cyclical macroeconomic fluctuations. The authorities saw the benefits of this approach and indicated that the fixed annual transfer of $8 billion from the oil fund to the budget may be subject to revision. Nevertheless, they felt that setting a limit on the use of the oil fund was important to avoid use of fund resources for ambitious development projects or other spending demands.

22. Staff stressed that the fiscal framework should incorporate the enlarged government, including all public and quasi-public enterprises. With public and quasi-public enterprises continuing to be actively involved in many off-budget transactions, the position of the general government, as reflected in the budget, is a misleading indicator of the overall fiscal policy stance. Furthermore, the recent increase in borrowing activity of public corporations makes their inclusion in the public debt sustainability analysis desirable. Staff recommended enhanced disclosure and transparency of statistics, including on the consolidated balance sheet of SK and public enterprises’ debt. The authorities agreed that off-budget transactions with public and quasi-public enterprises should be taken into account in formulating fiscal policy, and noted that they are planning to conduct a full assessment of quasi-public debt.

C. Monetary and Exchange Rate Policies: Inflation may Pose a Challenge

23. Monetary policy will need to focus on keeping inflationary pressures under control. Despite the recent small increase in the policy rate, the monetary stance remains accommodative. While evidence of second round inflationary effects is so far limited, planned public sector spending, prospects for increased foreign exchange inflows, and continued volatility of global commodity prices underscore the risks to both inflation expectations and more broad-based price pressures. Staff advised the NBK to closely monitor inflation and monetary aggregates and continue to gradually remove monetary policy accommodation, including by mopping up liquidity through short-term notes, if headline inflation keeps increasing or core inflation starts to rise. In doing so, it should stand ready to manage a possible increase in the inflow of short-term capital through enhanced liquidity management (in coordination with the treasury) and full implementation of the announced macro-prudential enhancements. The NBK reiterated its commitment to tighten policies, adding that for now it intends to keep the 6-8 percent inflation objective. Staff emphasized the importance of communicating clearly the causes and outlook for inflation to anchor expectations.

24. The economy would benefit from greater exchange rate flexibility. While the authorities have announced a switch to a managed float, in practice the NBK continues to intervene, limiting the movement of the tenge against the U.S. dollar within a narrow range. Given the prospect for medium-term capital inflows, staff estimates that the real exchange rate is slightly undervalued, although there is no clear evidence that the tenge deviates significantly from its long-run equilibrium (Appendix). Staff highlighted the benefits of greater exchange rate flexibility to enhance the economy’s response to external shocks, including commodity price movements and exchange rate developments of trading partners. In parallel, staff recommended that the NBK continue to assess the likely implications of this flexibility for the balance sheet exposures of banks and corporates, particularly given that large corporations in the extractive industries maintain high foreign currency to equity ratios. The NBK expressed agreement with this approach. Nonetheless, it indicated that its pursuit of relative exchange rate stability is aimed at preserving external competitiveness. The NBK also preferred to limit rapid appreciation to avoid excessive exchange rate volatility, and the chances of abrupt reversals caused by sharp movements in commodity prices.

25. The authorities remain interested in strengthening the transmission of monetary policy and promoting dedollarization through financial market development. Staff stressed that efforts to mobilize domestic deposits should be supported by those to strengthen the monetary toolkit, deepen domestic money markets, promote tenge term liquidity, and facilitate better risk management and hedging practices. The establishment of a well-functioning government benchmark yield curve, with full market determination of prices and interest rates, is crucial to these efforts. Progress in this direction, including by strengthening the transmission of monetary policy, remains contingent on banks’ health and ability to effectively manage liquidity being fully restored.

D. Achieving Broad-Based and Inclusive Growth over the Medium Term

26. The key medium-term challenge is to achieve sustained growth and ensure that the oil wealth benefits the whole economy. The development of the non-oil sector critically depends on reforms to ensure that the domestic financial system effectively contributes to finance activities other than extractive industries, and on improvements in the business environment in order to boost competitiveness and productivity in the non-oil sectors. With these efforts, the public sector’s role in the economy should decrease in favor of greater private sector involvement (Box 4).

27. Discussions on the medium-term focused on four key areas for improvement:

  • Investing in human capital through education and health reforms.

  • Improving infrastructure and removing barriers to trade, increasing the benefits of closer economic integration with Russia (including the single economic space by 2012), acceding to the WTO, and promoting trade with neighboring countries.

  • Meeting the demands for a higher level of governance, greater predictability in the formulation and application of rules, and more transparency and accountability, as the economy becomes more sophisticated.

  • Addressing existing inequalities by promoting employment creation and strengthening the existing social safety net.

Governance and Doing Business Indicators

(Percentile rank; a higher value indicates better performance)

article image
Source: Worlwide Governance Indicators, World Bank; Doing Business 2011, World Bank.

The Role of the Public Sector in Kazakhstan’s Economy

General Government

The role of the general government is relatively limited. Revenues and expeditures (including on social services) remain lower than in major trading partners. According to the World Bank, spending on education stood at 2¾ percent of GDP in 2007, below the median level of 4¾ percent among emerging economies. Similarly, spending on public health in 2009 stood at 2⅔ percent, lower than 4⅓ percent more typically seen in other emerging economies.

uA01fig07

General Government Expenditure

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 150; 10.5089/9781455288625.002.A001

Source: WEO
uA01fig08

General Government Revenue

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 150; 10.5089/9781455288625.002.A001

Source: WEO

Enlarged Government

Public and quasi-public enterprises dominate the economy. Samruk-Kazyna controls $77½ billion in assets, or nearly 55½ percent of GDP in 2010 (45 percent of GDP in 2007). Its holdings include interests in mining, finance, energy, transportation, property and construction. The agency is also the sole shareholder of the Development Bank of Kazakhstan.

Samruk-Kazyna

Samruk-Kazyna not only safeguards the public sector’s interests in its companies, but also supports economic stabilization and development. It has engaged in significant quasi-fiscal spending since 2009, mainly by taking majority stakes in banks and placing significant deposits in the banking system. It also has a catalytic role in promoting economic diversification by supporting specific sectors. Through joint-ventures with investors from China, Russia, Korea and European countries, the agency plans to invest up to $40 billion in the coming years in strategic projects in transport, energy, oil refining, chemicals, pharmaceuticals and related infrastructure. Its national gas company has doubled its stake in the large Kashagan oil field project to almost 17 percent.

Looking Ahead

The president recently announced an increasingly commercial role for the agency, with partial privatization of some of the companies through the “People’s IPO Program”. A more ambitious privatization program, with a larger role for domestic and foreign private investors, has not been ruled out. The possibility of transferring the agency’s development-related functions to line ministries and government departments has been under discussion.

STAFF APPRAISAL

28. Following President Nazarbayev’s reelection, the authorities’ policy agenda is now focused on the implementation of a medium-term development plan. The objective of nearly doubling the income level to $15,000 per capita by 2015 is ambitious and commendable, but it is crucial that the gains are shared by all segments of the population. A combination of decisive action to resolve the financial sector difficulties, sound macroeconomic policies to address the emerging inflation and spending pressures, and structural reforms to encourage economic diversification are the key pillars for success of the development plan.

29. Driven by favorable external market conditions and an appropriate policy response, recent and near-term economic developments in Kazakhstan are promising. High global commodity prices boosted the recovery and strengthened the external accounts and the net foreign asset position in 2010, and are expected to continue to drive this year’s economic growth. Rising oil revenues are also benefiting government finances and contributing to a marked improvement in the perception of Kazakhstan’s sovereign risk. In response to high foreign exchange inflows, the authorities have appropriately started to adjust policies by tightening the fiscal stance, signaling a removal from monetary accommodation, eliminating the currency trading band, and improving the AML/CFT framework. A deterioration of external and financial sector conditions presents the main downside risk to the outlook.

30. Action to forcefully address banks’ problem assets would add significantly to the pace of investment and growth. The stubbornly high level of NPLs is a matter of serious concern as it constrains credit growth, poses risks to financial sector stability, and undermines the achievement of the medium-term growth plans. The new conceptual plan for the resolution of problem assets is a step in the right direction. However, ownership and partial financing of the centralized distressed assets fund by the NBK pose risks to the integrity of monetary policy, and may create conflicts with NBK’s new supervisory responsibilities. To be successful, the plan should ensure that loans are adequately provisioned and properly valued, bank losses on the balance sheets are appropriately recognized, restructuring is undertaken by independent professional managers, and tax impediments to the writing-off of bad loans are removed. For this scheme to be credible, bank balance sheets should be subject to appropriate stress testing. Crucially, this process should reflect international best practices, and be preceded by a forward-looking, independent and rigorous assessment of banks’ balance sheets, accompanied by strong supervision, and followed by credible plans for any needed bank recapitalization.

31. Macroeconomic policies need to continue to adjust to changing conditions. The commodity price-driven trend in inflation presents an immediate challenge, given the large role of food and fuel in consumption. Although domestic demand-based price pressures appear relatively contained, the NBK should stand ready to respond to potential wider price pressures by further tightening policies. Given the prospect for medium-term capital inflows, staff estimates that the real exchange rate is slightly undervalued, although there is no clear evidence that the tenge deviates significantly from its long-run equilibrium. Looking forward, exchange rate flexibility should support monetary policy. In parallel, following three consecutive years of large public sector wage increases, fiscal management should give priority to investment and social outlays, including enhancing the existing safety net to protect the most vulnerable groups from the higher cost of living. This would also reduce reliance on administrative measures—such as export restrictions, price controls, and moral suasion—to contain price increases.

32. Efficient public financial management is a critical element of the authorities’ growth strategy. A significant part of oil revenue should continue to be saved. Nonetheless, the balance between the use of oil resources and accumulation in the oil fund needs to be aligned with intermediate targets for the non-oil balance within the medium term framework. This would ensure that development needs are addressed, macroeconomic stability and fiscal sustainability preserved, and savings for future generations guaranteed. Such a strategy would also allow the government to meet its liquidity requirements while deepening domestic capital markets.

33. Looking ahead, structural reforms would allow Kazakhstan to benefit more from its mineral resource wealth, ensuring positive spillovers to the domestic economy. The needed diversification of the economy and higher reliance on private consumption and investment as sources of growth will require enhancements in the business environment. Improved governance and transparency and better institutions are key components of this strategy in several areas:

  • In the banking and corporate sectors, greater transparency of shareholder structures and more stringent regulation of related party lending would allow banks to focus on sustainably financing productive activities.

  • In the public sector, large companies should be commercially oriented and professionally managed, statistics transparently disseminated, and relevant operations properly consolidated into the enlarged government accounts.

  • More generally, ensuring independence of central bank operations, uniformity of treatment across supervised institutions and taxpayers, and accuracy of economic data are key steps to attract domestic and foreign investment.

34. It is proposed that the next Article IV consultation take place on the standard 12-month cycle.

Figure 1
Figure 1

Kazakhstan: Macroeconomic Developments

Citation: IMF Staff Country Reports 2011, 150; 10.5089/9781455288625.002.A001

Sources: Kazakhstani authorities, and IMF staff estimates.
Figure 2
Figure 2

Kazakhstan: Financial Market Developments

Citation: IMF Staff Country Reports 2011, 150; 10.5089/9781455288625.002.A001

1/The band widened from T/$150 (+/- 3 percent) to T/$150 (+10/-15 percent) in February 2010, and was abandoned at end February 2011.2/ Simple average of CDS spreads for Albania, Bosnia, Bulgaria, Croatia, Hungry, Lithuania, Latvia, Macedonia, Montenegro, Poland, Russia, Serbia, Turkey and Ukraine.
Figure 3
Figure 3

Kazakhstan: Banking Sector Developments

Citation: IMF Staff Country Reports 2011, 150; 10.5089/9781455288625.002.A001

Sources: Kazakhstani authorities, GFSR, and IMF staff estimates.1/ Excluding restructuring banks.2/ Accounting for exchange rate valuation effects.
Figure 4
Figure 4

Kazakhstan: External and Fiscal Sector Developments and Outlook

Citation: IMF Staff Country Reports 2011, 150; 10.5089/9781455288625.002.A001

Sources: Kazakhstani authorities and IMF staff estimates.
Figure 5
Figure 5

Kazakhstan: Public Debt Sustainability: Bound Tests 1/

(Net Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2011, 150; 10.5089/9781455288625.002.A001

Sources: International Monetary Fund, country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance. 3/ 10 percent of GDP shock to contingent liabilities occurs in 2012
Figure 6
Figure 6

Kazakhstan: External Debt Sustainability: Bound Tests 1/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2011, 150; 10.5089/9781455288625.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks.Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent ¼ standard deviation shocks applied to real interest rate, growth rate, and current account balance.3/ One-time real depreciation of 30 percent occurs in 2011.
Table 1

Kazakhstan: Selected Economic Indicators, 2008–16

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

Reflects data available at the time of the mission.

From the Monetary Survey of the Banking System. In 2009, credit growth would be -2.5 percent, if adjusted for the devaluation.

The GDP in U.S. dollars is calculated using the period average exchange rate.

Does not include NFRK.

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

Table 2

Kazakhstan: Balance of Payments, 2008–16

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

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

Table 3a

Kazakhstan: General Government Fiscal Operations, 2008–16

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

National Fund of the Republic of Kazakhstan. (-) is accumulation in the Fund.

Includes expenditures financed by Samruk-Kazyna under the anti-crisis plan.

Table 3b

Kazakhstan: Statement of Operations - General Government, 2008–16 1/

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

Fiscal data in this table is presented in line with the Government Finance Statistics Manual 2001 (GFSM 2001).

Includes accumulation in the National Fund of the Republic of Kazakhstan.

Table 4

Kazakhstan: Monetary Accounts, 2007–12 1/

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

Reflects data available at the time of the mission.

Does not include oil fund resources.

Commercial banks only.

Table 5

Kazakhstan: Selected Prudential Indicators of the Banking Sector, 2007–11

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Sources: FSA; and IMF staff calculations.

Loans or assets classified as doubtful and loss.

The share of 5th category of doubtful loans and the bad loans, percent

Deposits of residents in foreign currency to total deposits, percent

Loans to residents in foreign currency to total loans to residents, percent

Calculation of this coefficient was changed from the 1-st of July, 2008 (excluding demand liabalities) (k4-3).

Table 6

Kazakhstan: Gross Financing Requirements and Financing, 2010–12

(In billions of U.S. dollars; unless otherwise specified)

article image
Sources: Kazakhstani authorities, and Fund staff estimates and projections.

Includes bilateral credit lines totalling $13.5 billion from Chinese state-owned entities, and the World Bank’s Development Policy Loan approved in May 2010.

Table 7

Kazakhstan: Public Sector Debt Sustainability Framework, 2008–16

(In percent of GDP, unless otherwise indicated)

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Defined as net debt of the general government.

Derived as [(r - p(1+g) - g + ae(1+r)]/(1 +g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Table 8

Kazakhstan: External Debt Sustainability Framework, 2008–16

(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).

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.

The implied change in other key variables under this scenario is discussed in the text.

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.

Appendix 1. External Stability and Exchange Rate Assessment for Kazakhstan

External stability

Kazakhstan’s current account returned to surplus in 2010, which will be sustained over the medium term. The surpluses reflect both higher prices and production of commodities, primarily oil. As the recovery in domestic demand takes hold, the current account surplus is projected to decline gradually to 2½ of GDP by 2016.

Following the restructuring of banks’ foreign liabilities, external debt fell from nearly 100 percent of GDP in 2009 to 85 percent in 2010. Excluding inter-company obligations, debt declined from 55½ percent to 47¼ percent. Looking ahead, overall debt is projected to fall to 64 percent by 2016 (31¼ percent excluding inter-company debt). The external debt sustainability assessment indicates that debt is sustainable under all the shocks considered.

Exchange rate assessment

Staff’s assessment points to some undervaluation of the real exchange rate, but there is no clear evidence that the tenge deviates significantly from its long-run equilibrium. Both the augmented CGER methodologies for oil exporters developed by the Middle East and Central Asia Department of the Fund and more standard CGER methodologies were used in this analysis. All models indicate some undervaluation, though the range of estimates varies somewhat. The results of the external sustainability methodology show a higher undervaluation, but should be interpreted with caution as it is based on the current account balance needed to stabilize the 2010 net foreign asset position, during which period a large proportion of Kazakhstan’s external debt was restructured.

Kazakhstan: Methodologies to Assess Real Exchange Rate Misalignment

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Based on augmented specifications of “Methodology for CGER Exchange Rate Assessments,” SM/06/283.

Based on 2016 projections. The current account excludes net outflows in the income account.

Based on medium term fundamentals (2016 projections).

Norm and underlying current account positions exclude net income flows. The norm is the adjusted current account balance needed to stabilize the 2010 net foreign asset position.

Adequacy of international reserves.

The level of international reserves at end-2010 was in line with many other commodity exporting emerging market economies. However, once the oil fund is taken into account, Kazakhstan’s foreign assets are closer to the largest reserve holders. Kazakhstan’s international reserves rose by $5¼ billion in 2010, while the oil fund increased by $6¼ billion. Total official foreign assets stood at nearly $59 billion by the end of the year, equivalent to about 38½ percent of GDP and sufficient to finance about 11½ months of imports. At the end of April 2011, international reserves and the oil fund together amounted to over $73 billion.

Among oil exporters, Kazakhstan’s total foreign assets are fairly typical and do not show any indication of unusual accumulation. Going forward, staff projects that as the current account surplus narrows in the medium term, reserve accumulation will slow and stabilize. However, inflows into the oil fund are expected to remain large. As a result, total official foreign assets are anticipated to rise to $131½ billion, and stabilize as a percentage of GDP over the medium term.

Figure 1
Figure 1

Kazakhstan: Measures of International Reserves Adequacy

Citation: IMF Staff Country Reports 2011, 150; 10.5089/9781455288625.002.A001

Reserves as months of imports are based on reserves overs prospective imports of goods and services for 2011, except in the case of Libya, where the import data for 2010 was used.
1

For the second year in a row, the annual growth number was largely determined by a strong surge in the fourth quarter of the year, which could be partially explained by higher hydrocarbon production.

2

During the crisis, employers were reported to have stopped paying salaries to workers, without formally laying them off.

3

Staff estimates suggest that, even after excluding the effect of the oil prices, the structural balance improved by over 1 percent of GDP in 2010.

4

Statistics on debt of public corporations are not available.

5

BTA stopped making principal payments on its external debt in April 2009, which was then followed by Alliance Bank, Temir Bank, and Astana Finance.

6

Some elements of the off-budget anti-crisis spending (about 0.5 percent of GDP in 2010) are being discontinued in 2011, resulting in a greater improvement in the augmented fiscal position than indicated by the budget numbers.

7

The 2020 target is equivalent to about 4½ percent of non-oil GDP, compared to the current level of almost 15 percent. Staff had estimated sustainable levels of non-oil fiscal deficit at 8½-10 percent of non-oil GDP.

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Cover IMF Staff Country Reports
Republic of Kazakhstan: 2011 Article IV Consultation: Staff Report; Supplement; and Public Information Notice
Author:
International Monetary Fund
Volume/Issue:
Volume 2011: Issue 150
Publisher:
International Monetary Fund
ISBN:
9781455288625
ISSN:
1934-7685
Pages:
55
DOI:
https://doi.org/10.5089/9781455288625.002

Inflation

(Percent y/y)

Tenge Exchange Rates 1/

Share of Population with Incomes Below Subsistence

(Percent)

Provisioning Coverage of Overdue Loans

CDS Spreads

(basis points)

General Government Expenditure

(Percent of GDP)

General Government Revenue

(Percent of GDP)
Figure 1

Kazakhstan: Macroeconomic Developments
Figure 2

Kazakhstan: Financial Market Developments
Figure 3

Kazakhstan: Banking Sector Developments
Figure 4

Kazakhstan: External and Fiscal Sector Developments and Outlook
Figure 5

Kazakhstan: Public Debt Sustainability: Bound Tests 1/

(Net Public debt in percent of GDP)
Figure 6

Kazakhstan: External Debt Sustainability: Bound Tests 1/

(External debt in percent of GDP)
Figure 1

Kazakhstan: Measures of International Reserves Adequacy