Selected Issues

Abstract

Selected Issues

Kazakhstan—Oil Rules and Anchoring Fiscal Policy1

The sharp and sustained drop of oil prices since 2014 has reduced the value of Kazakhstan’s oil wealth and therefore calls for a reassessment of fiscal policy and rules. Fiscal policy in an oil-rich country should aim to: (i) promote macro-fiscal stability by cushioning the economy from short-term volatility in oil revenues; and (ii) foster long-term fiscal sustainability, consistent with saving for future generations, given the exhaustibility of oil resources. Kazakhstan’s non-oil deficit path has been higher than suggested by long-term benchmarks, and adjustment is needed in the coming years to avoid fiscal sustainability risks and to promote intergenerational equity. Price-based fiscal rules—with structural fiscal balance targets guided by long-term benchmarks—can help anchor short- and medium-term fiscal policy. The non-oil deficit path introduced in the new National Fund of the Republic of Kazakhstan (NFRK) concept is broadly consistent with the proposed approach, and should be followed by timely and decisive implementation of revenue and expenditure measures.

A. Introduction

1. Managing Kazakhstan’s significant oil wealth is one of the authorities’ main policy challenges. Oil accounts for more than 50 percent of exports, while government oil-related revenues averaged 10-12 percent of GDP over the last decade—more than 40 percent of total revenues. Oil revenues have enabled a relatively high level of government spending and helped sustain high growth rates, raise living standards, and lift Kazakhstan to the ranks of the world’s middle-income countries.

2. Fiscal policy has played a central role in managing Kazakhstan’s oil wealth. The authorities’ policies during the oil-price boom of the mid-2000s kept the non-oil deficit broadly unchanged and allowed for saving of a considerable share of the windfall. Later, during the global financial crisis, these savings helped finance a countercyclical stimulus and significant financial sector support, helping mitigate its impact on the Kazakh economy. The non-oil deficit declined after the crisis, but reducing it to the pre-crisis level proved difficult, and Kazakhstan entered the oil-price shock that began in 2014 with a relatively high non-oil deficit.

3. The 2014 oil-price shock and the authorities’ subsequent fiscal initiatives have further weakened the fiscal position. Oil revenues fell by more than 70 percent in dollar terms from 2013 to 2016, although they declined by just half as much in tenge terms, thanks to the authorities’ decision to allow the tenge to depreciate. The fiscal initiatives helped cushion the impact of the shock, but, together with some ad hoc measures, increased the non-oil deficit. As a result, the overall fiscal position reversed from an average surplus of 4½ percent of GDP in 2011-13 to a deficit of 5 percent of GDP 2015-16.

Figure 1.
Figure 1.

Kazakhstan: Oil Exports and Revenue

Citation: IMF Staff Country Reports 2017, 109; 10.5089/9781475598759.002.A001

Sources: National authorities; and IMF staff calculations.
Figure 2.
Figure 2.

Kazakhstan: Oil Revenue and Fiscal Balances (in percent of GDP)

Citation: IMF Staff Country Reports 2017, 109; 10.5089/9781475598759.002.A001

Sources: National authorities; and IMF staff calculations.

4. Fiscal policy now needs to adjust to the sustained oil-price shock to preserve sustainability. While short-term fiscal support to the economy was justified, the non-oil deficit is now at a level that is too high to secure long-term sustainability. These concerns have become more pressing, as the sharp and sustained oil price drop has reduced the value of Kazakhstan’s oil wealth, which informs long-term fiscal sustainability benchmarks that reflect intergenerational equity considerations. With the oil price unlikely to return to its pre-shock level, Kazakhstan needs to embark on medium-term consolidation to reduce the risk of a forced and disruptive fiscal adjustment.

5. This paper evaluates the current fiscal stance and its long-term sustainability and presents new fiscal benchmarks. First, the paper estimates Kazakhstan’s oil wealth consistent with the new normal in oil prices. Second, it introduces a set of benchmarks, securing which would support long-term sustainability and intergenerational equity. Third, it considers various price-based structural balance rules—with structural balance targets guided by long-term fiscal benchmarks—that could help anchor medium-term fiscal policies and consolidation. Finally, the paper evaluates the path of the non-oil deficit that is presented in the new concept for the National Fund of the Republic of Kazakhstan (NFRK) and assesses its consistency with the long-term sustainability targets introduced in the paper.

B. Managing Oil Wealth and Fiscal Rules in Kazakhstan

6. Kazakhstan has had in place a set of rules to govern oil revenue management and fiscal policy. The main elements include a fixed annual transfer (in U.S. dollars) from the NFRK to the budget, a floor on the NFRK’s assets, ceilings on interest and debt service payments on public debt, and a medium-term target for the non-oil fiscal balance.

7. The NFRK manages the oil wealth in Kazakhstan. Established in 2000, the NFRK aims to work both as a stabilization fund and a savings fund. The NFRK receives all oil-related revenues, including: (i) the government’s share of profits in oil projects; (ii) receipts from the export duty tax; and (iii) various mineral extraction taxes and fees. While the government’s share of oil revenues generated in Kazakhstan has averaged 30-35 percent historically, it has also varied considerably from year to year. This reflects oil price and output volatility, as well as changes in the government’s share of oil company profits, which also depend on the price and production. Earnings from investments are an additional source of NFRK revenue. “Guaranteed” and “targeted” transfers to the budget are the main expenditures of the NFRK. Under the current framework, guaranteed transfers are set at $8 billion (±15% depending on the cyclical position of the economy and the financing needs), while targeted transfers are discretionary and can be used to fund specific fiscal initiatives (e.g. the Nurly Zhol fiscal support package announced in 2014). The NFRK’s assets stood at $60 billion at end-2016, equivalent to 43 percent of GDP. By contrast, public debt stood at 21 percent of GDP and total external debt at 122 percent of GDP.

Figure 3.
Figure 3.

Kazakhstan: NFRK Assets

Citation: IMF Staff Country Reports 2017, 109; 10.5089/9781475598759.002.A001

Sources: National authorities; and IMF staff calculations.

8. In late 2016, the government adopted a new NFRK framework that will be effective from 2018. Under the new framework, guaranteed transfers will decline gradually to about KZT 2 trillion (about $6 billion at the current exchange rate) by 2020, NFRK assets cannot fall below 30 percent of GDP, and the budget will target a specific and pre-determined path for the non-oil deficit in the medium-term. The new framework aims to reduce the non-oil deficit from 8.3 percent of GDP in 2016 to 7 percent of GDP in 2020 and to 6 percent of GDP in 2025.

C. Long-term Fiscal Sustainability in the New Normal of Oil Prices

Sustainability risks at unchanged policies

9. Kazakhstan’s fiscal position will be eroded further if fiscal policies are not changed. While the authorities cut the non-oil deficit (in percent of non-oil GDP) by over 5 percentage points of non-oil GDP in 2016, more effort will be needed to ensure fiscal sustainability. Under a passive policy scenario that assumes a broadly unchanged non-oil deficit going forward, the government’s net financial assets—the difference between NFRK assets and government debt—would fall close to zero by 2021 (Figures 4-5). Keeping the debt-to-GDP ratio constant, thus covering government’s financing needs largely from the NFRK, would exhaust NFRK assets by the mid-2020s. While the debt-to-GDP ratio would remain low, market access on favorable terms could come under question, as markets may expect Kazakhstan to accumulate financial assets, rather than to drain them, given its oil resources. A weaker financial position could also make market access more sensitive to swings in investor sentiment due to external factors (e.g., global or regional developments). Staff calculations are sensitive to long-term assumptions; accordingly, for illustrative purposes, Table 1 shows the year when net financial assets would turn negative under various combinations of the long-term oil price and the (constant) non-oil primary deficit.

Figure 4.
Figure 4.

Kazakhstan: Fiscal Balances

(In percent of GDP)

Citation: IMF Staff Country Reports 2017, 109; 10.5089/9781475598759.002.A001

Figure 5.
Figure 5.

Kazakhstan: Net Financial Assets

(In percent of GDP)

Citation: IMF Staff Country Reports 2017, 109; 10.5089/9781475598759.002.A001

Table 1.

Kazakhstan: Year Net Financial Assets Turn Negative

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10. Adhering to long-term fiscal sustainability benchmarks could help the government sustain spending and tax policies in the long run, while limiting financial risks and accounting for the exhaustibility of oil revenues. Deriving these benchmarks involves, as a first step, estimating Kazakhstan’s net wealth—the sum of the initial stock of net financial assets and the present value to the government of oil assets in the ground. The latter depends on a variety of uncertain factors, such as reserves and their rate of extraction, future oil prices, the exchange rate, and the government’s share of oil revenues. The second step is to consider the period over which it is optimal - from a fiscal sustainability perspective - to spend oil wealth. This depends on long-term non-oil GDP growth, the real interest rate, and inflation, among other parameters. As the projection horizon is long, estimates are sensitive to changes in parameter assumptions (Box 1).

Baseline Long-term Assumptions

Oil revenues

  • Oil reserves. Kazakhstan’s proven oil reserves (Figure B1) were assumed at 30 billion barrels (Source: BP Statistical Review of World Energy, June 2015).

  • Oil extraction. Daily production is expected to reach 2.12 million barrels by 2021, up from 1.64 million barrels in 2016 (Figure B1). Most of this expansion hinges on the large Kashagan oil field reaching its full operational capacity by 2021. Thereafter, oil output is projected flat until the reserves are exhausted.

  • Oil price. The oil price forecast through 2021 comes from the latest IMF World Economic Outlook. Thereafter, the oil price remains unchanged in constant U.S. dollar terms, implying 2 percent annual growth in nominal terms in line with long-term U.S. inflation (Figure B2).

Figure B1.
Figure B1.

Kazakhstan: Oil Reserves and Extraction

Citation: IMF Staff Country Reports 2017, 109; 10.5089/9781475598759.002.A001

Figure B2.
Figure B2.

Kazakhstan: Oil Price, 1980-2016

Citation: IMF Staff Country Reports 2017, 109; 10.5089/9781475598759.002.A001

Net financial assets

  • Government net financial assets are defined as the difference between NFRK assets and the stock of government debt. They stood at 22 percent of GDP at end-2016.

Macroeconomic variables

  • Long-term non-oil GDP growth is assumed at 4 percent.

  • Domestic inflation is set at the NBK’s long-term target of 4 percent.

  • The long-term real interest rate is assumed at 4.5 percent consistent with the historic average. The long-term nominal interest rate is assumed to be the sum of the real interest rate and inflation. For simplicity, the same interest rate is assumed on assets and liabilities.

  • The tenge is projected to appreciate by 0.25 percent in real terms annually against the U.S. dollar, based on the assumption that Kazakhstan will continue gaining productivity relative to its trading partners (Balassa-Samuelson effect). The tenge’s historical trend real appreciation against the dollar has been higher—2 percent annually during 1995-2016, but this period includes recovery from the collapse of the U.S.S.R. and the oil boom of 2000s (Figure B3).

  • Targeting a constant NOPD as a share of GDP of 6.2 percent over 40 years would be consistent with net wealth as of end-2016. However, under this “annuity” approach, (net) wealth—the sum of the financial assets and the value of oil in the ground—would be fully exhausted by the end of the 40-year annuity period. This option allows for a considerably higher NOPD than the perpetuity option, but would not be consistent with the authorities’ stated policy intention of saving (at least part of) Kazakhstan’s oil wealth for future generations. If the NOPD is assumed constant in real terms over the 40-year horizon, the 40-year NOPD annuity would average 10 percent of GDP in the first decade before declining steadily through the projection horizon (not shown in figures).

Figure B3.
Figure B3.

Kazakhstan: Real Exchange Rate KAZ/USD

(1995Q1 = 100; upward movements indicate real appreciation of tenge)

Citation: IMF Staff Country Reports 2017, 109; 10.5089/9781475598759.002.A001

11. We employ the Permanent Income Hypothesis (PIH), considering two cases: perpetuity and annuity. The first case assumes that the transfer to the budget equals the revenues stemming from interest receipts on the stock of assets of the NFRK. The second case assumes a lifespan of the NFRK of forty years. In our analysis we consider four scenarios: (i) a perpetuity-non-oil primary deficit (NOPD) constant in percent of non-oil GDP starting from 2017; (ii) delaying the adjustment to Option (i) by 5 years, i.e. a constant perpetuity-NOPD in percent of non-oil GDP starting from 2022; (iii) a constant real perpetuity-NOPD; and (iv) a 40-year annuity-NOPD constant in percent of non-oil GDP. Figures 6a-b present the NOPD paths and the government’s net financial assets under the various cases. These benchmarks are compared to staff’s latest medium-term baseline projections.

Figure 6a.
Figure 6a.

Kazakhstan: Non-Oil Primary Balance

(In percent of non-oil GDP)

Citation: IMF Staff Country Reports 2017, 109; 10.5089/9781475598759.002.A001

Figure 6b.
Figure 6b.

Kazakhstan: Net Financial Assets

(In percent of non-oil GDP)

Citation: IMF Staff Country Reports 2017, 109; 10.5089/9781475598759.002.A001

12. Long-term fiscal sustainability benchmarks under the PIH point to a need for a consolidation. In particular, the PIH finds that:

  • A constant perpetuity-NOPD as a share of GDP of 1.1 percent would maximize Kazakhstan’s net wealth at end of our forecasting horizon. However, this approach could be argued as being too tight for an emerging market economy like Kazakhstan with still-considerable social and investment needs as it implies a sizeable adjustment in the near-term.2 As real GDP grows, future generations are expected to be better off, which argues in favor of higher “transfers” to (or use of oil resources by) earlier generations. One way to achieve this is to assume a constant NOPD in real terms. Under this approach, the NOPD would average 8.3 percent of GDP in the first decade of the projection but would have to decline in percent of GDP over time. Another option would be to delay the adjustment to the perpetuity benchmark: a 5-year delay would lead to a marginally lower NOPD perpetuity but much slower accumulation of assets. Figure 6a compares the PIH under the perpetuity case in the three different approaches.

13. The results are sensitive to long-term parameter assumptions. Therefore, we extend our analysis to see how the non-oil deficit implied by the PIH hypothesis is affected by the growth rate of the economy and oil prices. Tables 2a and 2b show the NOPD and projected net financial assets in 2056 under different combinations of long-run non-oil GDP growth and the oil price under the constant perpetuity NOPD option.

Table 2a.

Kazakhstan: PIH Perpetuity: Non-oil Primary Balance (percent of non-oil GDP)

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Table 2b.

Kazakhstan: PIH Perpetuity: Net Financial Assets in 2056 (percent of GDP)

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Sources: IMF staff calculations.

Price-based structural balance rules

14. Price-based rules could help anchor medium-term fiscal policy.3 Such rules target a certain level of the structural primary balance, defined as the primary balance calculated at a predetermined benchmark oil price. This approach helps delink primary spending from the price-cyclical component of oil revenue, thus helping to ensure that oil price volatility does not contribute to cyclical swings of fiscal policy.4 The benchmark price is usually based on long-term historical and future prices or their combination. As opposed to the PIH model, price-based rules have a short- to medium-term focus and can thus provide a near-term anchor for fiscal policy.

15. Two different oil price benchmarks are considered. In the first rule, the benchmark oil price is set to an 11-year average of the oil price that includes the past 5 years, the current year, and 5 years of the future price (“5.1.5” rule in the figures). In the second rule, the benchmark price is set to the lower of a 10-year historical average and a 3-year historical average of the oil price. This is the formula followed by Russia (“RUS rule” in the figures). The 10-year average aims to smooth the benchmark price, and therefore government spending, while the 3-year average helps avoid excessive deficits in the event of sustained oil price drop in preceding years. By forcing slower (faster) adjustment in the benchmark price to an increase (decrease) in the oil price, the minimum function builds in a bias toward savings. Figure 7 shows how the benchmark oil prices evolve over time.

Figure 7.
Figure 7.

Kazakhstan: Benchmark Oil Price (in USD)

Citation: IMF Staff Country Reports 2017, 109; 10.5089/9781475598759.002.A001

16. The choice of the benchmark price involves a trade-off between expenditure volatility and the level of financial savings. Using a long moving average of historical oil prices achieves the greatest degree of expenditure smoothing, but may also lead to insufficient savings or even dissaving if the oil price drops sharply. Conversely, a combination of past and future prices, or a short moving average of past prices, would generate higher spending volatility but also higher savings, thanks to faster adjustment of the benchmark to the price drop.

17. The target for the structural balance rule could be calibrated based on the savings generated by the PIH benchmarks. Under the constant perpetuity benchmark (non-oil deficit in percent of non-oil GDP), net financial assets of the government would be about 200 percent of GDP by the end of the projection period; a more gradual adjustment to this rule would yield financial assets of about 150 percent of GDP by 2056 (Figure 6b). A balanced structural balance rule (targeting zero structural balance) would be sufficient only to maintain roughly the current level of net financial assets, failing to save for future generations, even less than under the relaxed PIH option. A structural balance rule targeting a surplus of 2½-3 percent of non-oil GDP (under either of the two price benchmarks) though would generate savings in the 150-170 percent of GDP range in the long term (Figure 8b).5

18. Price-based structural balance rules would entail a large adjustment in the medium term. Figure 8a shows that the NOPD projected in 2017 under the staff’s baseline is only slightly higher (excluding the support to the banking sector) than the NOPD resulting from the price-based rules targeting 2-3 percent of non-oil GDP structural surplus. Going forward, however, the NOPD under the baseline would remain broadly constant while the rules targeting a structural surplus of 2-3 percent of non-oil GDP would require a considerable reduction in the NOPD, as the benchmark price adjusts to the oil price drop since 2014 to a fuller extent. Over time, this would result in a striking difference in net financial assets (Figure 8b.). This again underlies the case for the authorities to commit to a sizeable medium-term fiscal consolidation.

Figure 8a.
Figure 8a.

Kazakhstan: Non-Oil Primary Balance

(In percent of non-oil GDP)

Citation: IMF Staff Country Reports 2017, 109; 10.5089/9781475598759.002.A001

Figure 8b.
Figure 8b.

Kazakhstan: Net Financial Assets

(In percent of GDP)

Citation: IMF Staff Country Reports 2017, 109; 10.5089/9781475598759.002.A001

D. An Evaluation of the New NFRK Concept

19. The non-oil deficit path in the new NFRK concept adopted in late 2016 is broadly in line with the path suggested by the oil price-based rules. The new path targets a medium-term consolidation that is consistent with long-term fiscal sustainability, as it follows relatively closely the path implied by the Russian rule with zero balance (Figure 9). However, more consolidation efforts would be needed to accumulate more sizable NFRK assets. The Russian rule with zero balance would result in net financial assets of about 46 percent of GDP by the end of the projection period, well below the 150-170 percent of GDP range based on perpetuity PIH benchmarks.

Figure 9.
Figure 9.

Kazakhstan: New NFRK Concept - Non-Oil Primary Balance

(In percent of non-oil GDP)

Citation: IMF Staff Country Reports 2017, 109; 10.5089/9781475598759.002.A001

20. Steadfast implementation of the new NFRK concept and the fiscal adjustment that it implies is paramount. Lack of revenue and expenditure measures and a deviation from the path presented in the NFRK concept would result in a decline in net financial assets and could impair Kazakhstan’s long-term fiscal sustainability.

E. Oil Revenue Shocks

21. Adverse oil price shocks represent a downside risk for fiscal sustainability. The recent oil price drop led to higher non-oil primary deficits, increasing the probability of an unsustainable fiscal position. To analyze fiscal risks stemming from movements in oil prices, we compute the PIH and the RUS rule with zero balance under one- and two-standard deviation shocks in oil prices (one standard deviation corresponds to about $16). In both cases, positive and negative shocks are considered. This approach allows for a creation of confidence bands that could help guide fiscal policy to a sustainable path. The PIH-perpetuity is relatively inelastic to changes in oil prices while the PIH-annuity is highly sensitive (Table 3). This is because, in the annuity case, a finite life-span of the NFRK—which is directly affected by oil revenues—is assumed. The non-oil fiscal balance path implied by the RUS rule with zero balance is directly affected by the oil price shocks (Figure 10). Compared to the baseline case, in the case of a negative shock, a substantial fiscal consolidation is needed. In the most pessimistic scenario—an oil price shock of 2 standard deviations—the rule suggests a non-oil deficit of about 3 percent of non-oil GDP, a value that is consistent with the non-oil balance suggested by the PIH-Annuity. In turn, in the case of a positive shock, the rule allows for a higher non-oil deficit in the medium- and long-term.

Table 3.

Kazakhstan: Non-Oil Balance (percent of non-oil GDP)

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Figure 10.
Figure 10.

Kazakhstan: Non-Oil Balance Under the RUS Rule

Citation: IMF Staff Country Reports 2017, 109; 10.5089/9781475598759.002.A001

F. Conclusion

22. The sharp and sustained drop in oil prices since 2014 calls for a medium-term fiscal consolidation. With a broadly unchanged non-oil deficit going forward, the government’s net financial assets would fall close to zero by 2021 (see Table 1), which could put market access and fiscal sustainability at risk. To avoid this and to promote intergenerational equity, the authorities should reduce the non-oil deficit closer to the levels consistent with long-term fiscal benchmarks. The medium-term adjustment could be anchored by price-based fiscal rules targeting a structural surplus of 2-3 percent of non-oil GDP. Adopting these rules would entail a reduction of the NOPD of about 4-5 percent of non-oil GDP over the medium term.

23. The new NFRK concept introduces targets that preserve long-term fiscal sustainability; this is welcome, but the implementation of the implied adjustment is paramount. The non-oil fiscal deficit targeted by the new concept is line with the Russian rule with zero balance and in the medium-long term results in a positive accumulation of net financial assets. A deviation from this path, however, will result in higher deficits and could jeopardize long-term fiscal sustainability. Moreover, following the Russian experience, the consolidation efforts could be strengthened to allow for higher accumulation of net financial assets. This would be desirable to preserve a greater share of the oil wealth for future generations.

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1

Prepared by Matteo Ghilardi and Azim Sadikov.

2

However, it is useful to remind that this is the approach followed by Norway in managing the oil wealth.

3

Chile, Mexico, Mongolia and Russia use versions of a price-based framework. The paper does not estimate expenditure-based rules (e.g., limiting growth of spending to some rate), as these are most effective when oil or other commodity prices are increasing.

4

Price-based rules however may not help delink primary spending from volatility in oil revenue arising from changes in oil extraction. Oil production is assumed to be relatively smooth over the projection horizon. If this assumption was to break, a structural balance rule would need to be based on predetermined benchmark oil price and output.

5

Savings of 150-170 percent of GDP is illustrative. While the target for savings is a question for public policy, the authorities should aim for a sizable buffer and savings amount.

Republic of Kazakhstan: Selected Issues
Author: International Monetary Fund. Middle East and Central Asia Dept.