Republic of Kazakhstan: 2018 Article IV Consultation—Press Release; and Staff Report
Author: International Monetary Fund. Middle East and Central Asia Dept.
Publication Date:
14 Sep 2018
eISBN:
9781484376881
Language:
English
Keywords:
ISCR; CR; exchange rate; banking sector; NBK note; Aqsay; government; current account; monetary policy; bank balance-sheet issue; base rate
Download PDF (2.5 MB)

2018 Article IV Consultation-Press Release; and Staff Report

Abstract

2018 Article IV Consultation-Press Release; and Staff Report

Context

1. Economic recovery is gaining strength. After two years of subdued growth, economic activity increased in 2017, with GDP growing at 4 percent y/y, due to higher oil production and increased trade and manufacturing. However, consumption increased only modestly, reflecting flat employment and declining real wages. The reported unemployment rate has remained broadly constant at 5 percent. GDP growth increased to 4.1 percent in the first quarter of 2018, and high-frequency indicators through June pointed to a further strengthening in economic activity. Reforms in next-door Uzbekistan have provided a boost to cross-border trade, especially in south Kazakhstan.

uA01fig01

Contributions to Growth and Oil Prices

(Percent and dollars per barrel, respectively)

Citation: IMF Staff Country Reports 2018, 277; 10.5089/9781484376881.002.A001

2. Inflation has been on a declining path and within the target band of the National Bank of Kazakhstan (NBK). For most of 2017–18, inflation has followed a downward trend. In June, CPI inflation stood at 5.9 percent, close to the middle of the NBK’s 5–7 percent target band. Recently, nonfood prices have increased faster than the overall CPI, while services inflation has lagged. Expectations have stabilized—a May 2018 survey pointed to expected inflation one year ahead of 6.0 percent.

uA01fig02

Consumer Prices

(year-over year percent change)

Citation: IMF Staff Country Reports 2018, 277; 10.5089/9781484376881.002.A001

uA01fig03

Interest Rates

(Shaded region indicates base rate corridor)

Citation: IMF Staff Country Reports 2018, 277; 10.5089/9781484376881.002.A001

3. With falling inflation and anchored expectations, the NBK has continued with policy easing. The NBK cut the base rate from 12 percent in early 2017 to 9 percent in June 2018, mostly this year. The target money-market rate has stayed within the NBK’s interest rate corridor (base rate +/- 100 bps), but close to the lower bound, reflecting surplus liquidity. The liquidity situation is evident in the stock of NBK notes, which increased from KZT 2.7 trillion (US$8 billion) in September 2017 to over KZT 4.0 trillion (US$12 billion) in May 2018.1 In addition to standard 7-day notes, the NBK has offered (small) issues with maturities up to one year to develop the short end of the yield curve. The tenge has continued to float, although the NBK has intervened in the market on occasion to curb excessive volatility, usually linked to oil prices or the Russian ruble. Most of the interventions took place in the summer and fall of 2017, with total net sales of US$620 million; since October the NBK’s participation in the market has been neutral.

4. Robust export growth has helped reduce the external current account deficit, but the external position in 2017 was moderately weaker than implied by fundamentals. The current account deficit declined to 3.4 percent of GDP in 2017 from 6.5 percent a year earlier, as oil exports rose by 38 percent, reflecting both favorable prices and a sizeable increase of production. Non-oil exports increased by 26 percent, led by mining and metals. A countervailing factor for the current account improvement was primary income, which deteriorated by 2 percentage points of GDP, due to larger dividend withdrawals under production-sharing agreements. Staff assessment based on the IMF’s Current Account model indicates that in 2017 Kazakhstan’s external position was moderately weaker than implied by fundamentals and desirable policies (Annex I). In the financial account, a substantial decline in net FDI due to large repayments of intercompany debt and sale of foreign company shares by a resident was partially offset by increased inflows of portfolio investment, largely reflecting sales of securities by the National Fund (NFRK). Total external debt declined from 119 percent to 105 percent of GDP in 2017, while the net IIP remained broadly unchanged at -35 percent of GDP. NBK gross reserves increased by US$1 billion in 2017 to US$30.7 billion and are above the adequacy range for a floating exchange rate country. Finally, a new currency law was approved by parliament; the main change involves residency status of branches and offices of foreign entities, implying that transactions with other residents should be settled in tenge.2

5. State support to banks led to a higher fiscal deficit in 2017, although there was underlying adjustment. The government spent KZT 2 trillion (US$6 billion, 4 percent of GDP) to purchase assets from the largest bank, Kazkommertzbank (KKB), to facilitate its acquisition by the second-largest bank, Halyk.3 Reflecting this and other developments, the overall deficit widened to 6.5 percent of GDP from 5.4 percent in 2016; the non-oil deficit rose to 12.6 percent of GDP from 9.5 percent in 2016. Other expenditures remained broadly constant as a share of GDP, while oil revenues picked up. Excluding bank support, the non-oil deficit declined from 9.5 percent of GDP in 2016 to 8.6 percent in 2017.

Fiscal Indicators 2015–17

(in percent of GDP)

article image

Includes a transfer from KazMunaiGas of 1.8 percent of GDP in 2015 and support to the financial sector of 4 percent of GDP in 2017

6. The 2018 budget envisages adjustment and ambitious expenditure reforms. With the phasing out of the Nurly Zhol stimulus initiative and spending on the Astana Expo, plus a favorable macro environment, the consolidated overall balance is expected to record a surplus of 1.4 percent of GDP this year. The improvement reflects higher oil revenues, as well as lower core spending via streamlining initiatives. This reflects, in turn, a scaling up of public-private partnerships (PPPs) and a new “capitation” approach for health and education spending to provide funding for services delivered by private providers. The authorities are also reviewing public sector jobs, aligning wages to private-sector indicators, and improving performance management. The non-oil deficit is expected to be reduced to 6.1 percent of GDP, from 8.6 percent in 2017 (excluding bank support), mostly through lower capital and current spending. The authorities are considering issuance of a tenge-denominated Eurobond to attract foreign investors and establish a new benchmark.

7. Tax policy changes were introduced last year, mainly in natural resource taxation to encourage exploration. For oil and gas, a key change was introduction of an optional, “alternative” tax, aimed at promoting exploration in high-cost, deep-water areas of the Caspian Sea and replacing production- and sector-specific profit-based instruments. Revisions also eliminated a discovery bonus and introduced more favorable treatment of exploration expenses. A licensing round for deep-water areas is planned later this year. For mining, changes included removal of an excess profits tax and increased reliance on (regressive) ad valorem royalties.

8. The authorities have taken major—and costly—steps to secure the stability of the financial sector, although risks remain. Many banks experienced significant trouble caused by deleveraging and depreciation of the exchange rate in 2015. Besides state support for the Halyk-KKB merger, five large banks received the equivalent of US$2 billion worth of capital support from the NBK via long-term (15 years), low-interest-rate subordinated loans (4 percent), which were used to purchase NBK securities carrying the interest yield of around 8 percent. Legal changes to enhance the NBK’s regulatory powers, particularly on use of supervisory judgment, were adopted by parliament in June. Still, NPLs remain elevated, and risks remain. The NBK withdrew or suspended licenses of several medium-sized and small banks that were in violation of prudential requirements. Long-term funding remains limited, and a number of initiatives are being rolled out, including NBK support for mortgage lending and purchase of bank bonds by the pension fund (UAPF).

9. Private sector credit has resumed, largely consumer lending. High NPLs and large volatility of deposits affected lending, and in 2017, private sector credit was flat. After the Halyk-KKB merger and NBK actions on smaller banks, there are signs that lending is picking up. While the May 2018 stock of private sector credit was only slightly higher than a year ago, this reflected write-offs, loan portfolio restructuring, and banks whose licenses were revoked. Taking these developments into account, credit growth stood at 11.5 percent, with the main driver being consumer loans to households. Insufficient demand by creditworthy borrowers, along with limited availability of long-term funding, are key constraints to a faster corporate credit growth.

10. Progress is being made on flagship structural reform initiatives to improve the business climate and governance. In 2015, the “100 Concrete Steps” initiative was launched, with reforms to modernize the civil service, strengthen rule of law, increase transparency and accountability, support diversification, industrialization, and growth, and boost nation-building. More than half of the 100 Steps were completed by June, and implementation of the remaining items is proceeding. However, some stakeholders suggested that the reforms may be moving more on paper than in practice. Small-scale privatization is advancing, and IPOs for the first group of “blue-chip” SOEs—in telecoms, aviation, and nuclear materials—are expected later this year or in 2019. The Astana International Financial Center (AIFC) was launched in July, with the aim of becoming a regional hub.

11. New reform initiatives have also been launched. Last November, the government adopted the “Kazakhstan 2025” strategic development plan, which gives a roadmap for a new, private-sector-led growth model and actions to increase productivity, human-capital development, competition, and investment. Quantitative indicators guide and measure progress. A program to advance Kazakhstan’s ranking in the World Economic Forum’s Global Competitiveness Index is underway, with over 200 specific measures being taken. In March, President Nazarbayev launched a “5 Social Initiatives” plan comprising: (i) the “7–20-25” mortgage program—7 percent interest rate, 20 percent down payment, 25 years repayment—to be implemented by the NBK4; (ii) reduction of the effective personal income tax (PIT) rate from 10 to 1 percent for low-income earners from 2019; (iii) improved higher education accessibility and quality; (iv) expanded microcredits; and (v) construction of a gas pipeline from south Kazakhstan to Astana/Karaganda to supply 2.7 million people, and ideally, to reduce reliance on coal-fired power plants.

Outlook and Risks

12. Non-oil growth is projected to strengthen and inflation to decline. Non-oil growth is expected to increase further this year and reach 4 percent over the medium term, reflecting a better business climate and progress in public administration reforms, privatization, and bank repair. Overall growth is expected to slow in the next few years, as oil production gains moderate; a further large increase of production is expected in 2022–23 due to planned expansion of the big Tengiz field. On the demand side, consumption is projected to recover with a rebound of real wages and higher social payments. If reform implementation is decisive and the external environment is favorable, medium-term non-oil growth could be higher. The external current account is projected to improve in 2018 due to strong exports and remain close to balance over the medium term. In the absence of major shocks, inflation should decline gradually in line with the NBK’s targets. 5

13. Risks are mainly related to commodity prices and slower growth in Russia and China (Annex II). Lower commodity prices would affect exports, fiscal revenues, the tenge, and confidence; sustained high prices may reduce the reform impetus. Tightening global financial conditions could lead to capital outflows, pressure on the tenge, and risks to inflation. Although risks from market turbulence are tempered by high oil prices and buffers, if developments in Russia are adverse, Kazakhstan would be affected. Uncertainties and spillovers from geopolitical and trade tensions, including sanctions against countries in the region, are another risk. Domestically, there are risks that in the absence of tangible tax revenue gains, fiscal consolidation may not proceed as planned, while lower social and capital spending may weaken economic prospects. Monetary policy loosening—possibly in response to accommodation pressures—could result in higher inflation. On the upside, the Belt-and-Road Initiative (BRI) provides an opportunity to deepen integration and boost transport, services, and processing. Further reforms in neighboring Uzbekistan are likely to open additional opportunities for trade and investment. The next presidential elections are due in 2020.

Authorities’ views

14. The authorities broadly concurred with staff’s views. The government sees potential for higher non-oil growth than in staff’s baseline, especially over the medium term, due to continued efforts to support the economy, investment in mining and manufacturing, higher credit growth, emergence of AIFC, and structural reforms. Risks are seen mainly from the outside—commodity prices, geopolitical uncertainty, monetary tightening in advanced economies, and global trade tensions. The authorities reiterated their determination to pursue sound macro policies and a robust reform agenda to realize the aspiration of joining the world’s 30 most advanced economies by 2050.

Policy Discussions

The authorities are transitioning from significant state support to the economy and banks. Although there is substantial fiscal space, there is also a strong case to consolidate, restore buffers, reduce the state’s footprint, and foster a dynamic, competitive, and globally-integrated private sector. Public administration should be more transparent and efficient. While state support is difficult to turn off at once, there are risks of cementing reliance on government/NBK support after several years of stimulus and with the recovery of oil prices. Discussions focused on the 2018 fiscal stance, medium-term fiscal consolidation, the monetary framework and operations, actions to strengthen the financial sector, and structural reforms. Staff’s views are that fiscal consolidation is warranted, that medium-term fiscal adjustment should incorporate higher non-oil revenues (to increase social and capital outlays), that support programs should be phased out, that monetary accommodation should be resisted, that further efforts are needed to strengthen the financial sector, and that key reforms should proceed without delay.

A. Fiscal Policy

15. Adjustment in the 2018 budget is in line with staff’s advice and reflects ambitious spending reforms. The 2018 non-oil deficit is in line with staff’s advice from last year’s consultation and with the deficit reduction path outlined in the authorities’ medium-term fiscal plan.6 Reforms to health and education spending, public employment, and the wage bill offer prospects for greater efficiency and flexibility, but are complex and should be carefully planned and executed. The “5 Social Initiatives” are generally well-targeted, linked to long-term growth and social objectives, and incorporate risk-sharing or commercial elements, although staff noted that the 7–20-25 mortgage program should be undertaken not by the NBK, but by the government. In addition, following the conclusion of Nurly Zhol and other major projects (e.g., Astana Expo) budgetary capital spending will be low by international standards. While sizeable capital expenditures are undertaken by public enterprises—and in the future, via PPPs—high-quality budgetary investment outlays should be increased in a deficit-neutral manner to support medium-term growth. Staff sees merit in the authorities’ planned issuance of a tenge-denominated Eurobond to deepen the market and set a benchmark for other issuers.

16. Further, gradual medium-term consolidation is planned. The non-oil deficit is expected to decline gradually to around 5 percent of GDP, in line with staff estimates of the sustainable long-term non-oil deficit.7 The path is consistent with a gradual increase in net financial assets, which would help the authorities weather renewed oil price shocks or a materialization of contingent liabilities or other fiscal risks, and also increase intergenerational equity. The authorities noted that medium-term fiscal adjustment will be supported by measures to improve non-oil revenue administration, especially simplification and clarification of ambiguities, reducing taxpayer compliance burden, improving dispute resolution, and advancing digital initiatives (invoicing, tax filing, and compliance enforcement). Staff welcomed the planned adjustment, noting that it would help rebuild buffers. While expressing support for the authorities’ revenue administration plans, staff noted that the projected gains—by 6 percent of GDP through 2025, to 25 percent of GDP—seem ambitious. Accordingly, staff encouraged the authorities to review and phase out tax holidays and exemptions, to consider a moderate increase in the PIT rate for higher-income earners (along with universal income declaration requirements), and to consider a lower VAT threshold and a moderate VAT rate increase once administrative gains have been secured. Finally, while recent revisions to the extractive industries fiscal regime are generally positive, further gains in the investment and regulatory environment are likely needed to secure major new investment, and as prospects for increased mining activity appear to be particularly favorable, a comprehensive tax regime review should be considered (Selected Issues Papers).

17. Kazakhstan has substantial fiscal space, which is expected to increase over the medium-term. With fiscal adjustment and higher oil prices and production, NFRK balances are expected to increase from just below US$60 billion at end-2017 to over US$80 billion in 2023. Government debt is projected to decline from 21 percent of GDP in 2017 to 15 percent in 2023 (Annex III), while public external debt will drop from 8 to 2 percent of GDP. However, external SOE debt is higher— 17.3 percent of GDP at end-2017—and bears continued close monitoring.

18. Further improvements in fiscal transparency and risk management practices are needed, in line with international best practice. The authorities have made significant steps in strengthening planning, accounting, and reporting, especially in accrual budgeting. Further improvements should include: fully adopting IMF GFS methodology to formulate, evaluate, and inform the public and markets about fiscal policy; enhancing risk management by analyzing and reporting on both macroeconomic and specific risks (e.g., SOE finances and debt), including through a detailed risk statement (Selected Issues Papers); and introducing a more elaborated medium-term fiscal framework to support the consolidation and anchor expectations, including in the context of scaling up of investment under the BRI. The authorities and investors are also encouraged to increase transparency around contractual arrangements in the natural resources area.

Authorities’ views

19. The authorities reaffirmed their commitment to restoring buffers and rebuilding NFRK balances, now that shocks have receded. They agreed that non-oil revenues should be raised over the medium term, expressing confidence that efforts to improve compliance and efficiency via digital/IT enhancements would pay off. They noted that PIT and VAT rate increases would require more study, given possible adverse impacts. They also expressed interest in enhancing fiscal risk management to mitigate adverse effects of future volatility and shocks.

B. Monetary and Exchange Rate Policy

20. The NBK remains focused on price stability and improving transmission, although there are continuing calls for accommodation and funding support. Staff noted that the NBK should keep its commitment to policy neutrality, amidst calls for accommodation and continuing support to the economy. Staff shared the NBK’s assessment that the balance of risks and current ample liquidity warrants a cautious approach to further easing. Moreover, given relatively stable inflationary expectations—recently at around 6 percent, it may prove difficult to converge to the medium-term objective of 4 percent if policy rate cuts continue. Some tightening may be needed if risks become more pronounced, or if fiscal policy is looser than envisaged. Staff also noted that efforts should be targeted at improving monetary transmission by reducing dollarization, phasing out subsidized lending, and deregulating deposit rates. While there are concerns with low corporate lending, unlocking such financing is best achieved through a dynamic private sector and stronger banks. Staff noted that quasi-fiscal activities (including bank recapitalization) should be undertaken by the budget and that conflicts may arise with the central bank’s primary goal of maintaining price stability. Efforts to enhance long-term funding are unlikely to be fully effective given still-limited credit demand and bank balance-sheet issues. That said, measures under consideration such as the 7–20-25 mortgage program, sale by banks of a portion of the securities obtained through state support, and UAPF purchase of bank bonds could bring some benefits, provided that they remain targeted and temporary, and there are robust risk-sharing and market funding arrangements.8

21. The NBK is considering ways to further strengthen the monetary policy framework and operations. The NBK has made progress in enhancing its inflation targeting framework, analytical capacity and policy-relevant research, and communications with markets and the public. Staff and the NBK agreed that efforts should continue to enhance the efficiency and transparency of monetary policy, including through development and application of additional tools to help guide monetary policy (Selected Issues Papers). In addition:

  • Liquidity management. With limited availability of government securities, NBK notes have continued to play the key role in mopping up surplus liquidity. In April, the NBK introduced a new tool for liquidity provision and withdrawal—a one-day FX swap—with the goal of reducing volatility of the interest rate in the swap market. Staff suggested that FX could be added as a collateral for open-market operations. Also, in view of banking-system liquidity, a review of reserve requirements (RRs) is warranted. In staff’s view, there is a case to unify RRs for residents and non-residents and eliminate residency discrimination in line with the IMF’s Institutional View on capital flows, increase RR rates from current levels, and introduce remuneration of RRs.9 Keeping differentiated RR rates for FX and tenge deposits is advisable, as is gradual elimination of cash from eligible RR assets (Selected Issues Papers).10

  • Securities market development. The securities market remains underdeveloped, and work is continuing to deepen the local market. A project between the NBK and Clearstream is welcome, as it will allow settlement of tenge-denominated government and NBK securities through the Clearstream platform, facilitating foreign investor access. There is scope for strengthening cooperation between the NBK and government on market and liquidity management issues, including management of treasury and SOE deposits.

  • Exchange rate (ER) policy. Staff noted that the flexible ER is serving Kazakhstan well by helping to absorb changes in the macro environment and support dedollarization. ER changes have reflected fundamental factors, including oil prices and Russian ruble dynamics. The NBK would benefit from strengthening transparency and communications with respect to FX purchases and sales, including on behalf of the NFRK and UAPF.

  • Asset management. The NBK is continuing to diversify investment portfolios of the NFRK and UAPF. For the NFRK, the process was delayed by a highly-publicized asset freeze involving an oil sector investment dispute.11 For UAPF, the NBK is moving to increase the share of allocation to foreign assets. External managers have been hired for emerging market debt, and selection of managers for global equities is underway. Staff supported the engagement of private asset managers, with allocations based on risk-return considerations, to safeguard old-age savings and reduce potential conflicts of interest involving NBK management of the UAPF.

uA01fig04

Key Exchange Rates

Citation: IMF Staff Country Reports 2018, 277; 10.5089/9781484376881.002.A001

Authorities’ views

22. The authorities broadly shared staff’s assessment. They reconfirmed their commitment to inflation targeting, ER flexibility, and enhancements in analytics and communications. While noting limits of supply-side funding initiatives, they consider that banks and borrowers continue to need state support to secure less-expensive long-term funding, while actions are being taken to address structural issues. They consider that measures to share risks with the private sector—e.g., a requirement that banks secure market funding equivalent to UAPF bond purchases and provisions to keep the risk under the 7–20-25 mortgage program in originating banks—will limit the exposure of the state. In contrast to staff’s views on the need for the budget to finance such measures, the government considers that the NBK should be in the lead, given its role in financial sector oversight. The NBK is considering changes to the system of reserve requirements, but noted concern with including FX among eligible collateral for open market operations which they perceive as going against the objective of de-dollarization.

C. Financial Stability

23. Although the authorities’ actions have helped preserve systemic stability, state support has been costly, and important risks and challenges remain. The sector continues to experience difficulties from weak credit risk assessment and management and needs to adopt a substantially stronger business model, with enhanced governance, management, operations, and profitability. Further strengthening the resilience of the sector would contribute to sound macro-financial linkages, improve resource allocation, and limit risks of another round of state support (Selected Issues Papers). Stock market prices have increased significantly in recent years (Figure 4) but due to the relatively—limited investor base, staff does not foresee significant macro-financial implications, although developments warrant close monitoring.

Figure 1.
Figure 1.

Kazakhstan: Economic Developments

Citation: IMF Staff Country Reports 2018, 277; 10.5089/9781484376881.002.A001

Source: Kazakhstani authorities and IMF staff estimates.
Figure 2.
Figure 2.

Kazakhstan: Banking Sector Developments

Citation: IMF Staff Country Reports 2018, 277; 10.5089/9781484376881.002.A001

Source: Kazakhstani authorities and IMF staff estimates.
Figure 3.
Figure 3.

Kazakhstan: Key Financial Soundness Indicators, Cross-Country Comparison 1/

Citation: IMF Staff Country Reports 2018, 277; 10.5089/9781484376881.002.A001

Source: Kazakhstani authorities and IMF staff estimates.1/ Official data. Uzbekistan data from Q2 2017.
Figure 4.
Figure 4.

Kazakhstan: Capital Markets Indicators

Citation: IMF Staff Country Reports 2018, 277; 10.5089/9781484376881.002.A001

Source: Bloomberg, KASE, and IMF staff estimates

24. Staff urged that policy actions be taken in several areas:

  • Large banks—including those that received state support and NBK subordinated loans—should undergo a thorough balance sheet evaluation. A comprehensive asset quality review—ideally by an external party—would help define the magnitude of remaining potential problem loans. Further capital support should come from shareholders or new private investors.

  • Banks that received state support and those with continuing constraints on portfolios and profitability should undertake operational restructuring to ensure sound governance and proper risk assessment. This would address moral hazard concerns.

  • Recent amendments to the Law on the NBK and the Law on Banks and Banking Activity aim at reflecting international good practices in bank supervision and resolution. In particular, the amendments address a critical flaw in the regulatory framework—insufficient powers of the NBK to make supervisory judgments. However, the banks have expressed concern with how these new powers will be used. Accordingly, the NBK should prepare regulations to formalize its use of broader powers. Transparent identification and application of principles underlying supervisory judgment is key to ensuring trust. Another weakness relates to capital regulations, which allow banks to shift NPLs to non-bank subsidiaries that are not subject to consolidated capital requirements. This should be addressed.

  • The framework for emergency liquidity assistance (ELA) to banks also needs attention. ELA should be provided only to institutions that are assessed as viable and should be adequately collateralized or provided under government guarantee.

  • State-supported initiatives to stimulate bank lending—including the 7–20-25 mortgage program and other programs to provide support to SMEs and agriculture—should be targeted, transparent, and temporary and should not compromise credit assessment by banks. They should be rigorously evaluated for cost effectiveness. Where possible, existing agencies should be used—rather than creating new entities. The NBK should refrain from involvement in quasi-fiscal activities, and with economic recovery now underway, state support should be phased out.

  • Further financial infrastructure improvements are needed, including in collateral valuation and foreclosure and disposal of distressed assets. Legal, institutional, and operational constraints impeding the operations of the Problem Loan Fund (PLF) should be addressed, so that the PLF can begin to make progress in resolving bad assets acquired as part of the Halyk-KKB merger and set an example for broader management and liquidation of bad assets.

Authorities’ views

25. The authorities shared staff’s views on the importance of preserving systemic stability. They agreed on the need to ensure sound governance in banks, and regard recent legal amendments to broaden the NBK’s powers as particularly important to promptly and decisively address banking weaknesses. While recognizing the importance of ensuring that financial support initiatives do not generate fiscal risks, the government questioned staff’s advice to limit the role of the NBK. The government also raised concern with staff’s call for ELA to be provided under government guarantee, noting that it is the responsibility of NBK to ensure a stable and well-capitalized banking sector.

D. Structural Reforms and Governance

26. Achieving Kazakhstan’s development goals focuses on reducing the state’s footprint and boosting the private sector. “Kazakhstan 2050” calls for wide-ranging economic and administrative reforms that would place Kazakhstan among the world’s 30 most developed countries in 30 years. Staff noted that while progress is being made, it is critical that changes on paper are translated into meaningful changes on the ground. An increased role of the private sector will be critical to raising productivity, reducing dependence on natural resources and the state, and making growth more inclusive. The authorities should foster a dynamic and competitive private sector by ensuring a favorable business environment, a strong financial sector, and modern infrastructure. The recovery provides an opportunity to move decisively with reforms, and efforts should focus on completing privatization—including successful IPOs and building a robust and diverse export sector through enhancing domestic competition, addressing governance and corruption, investing in health and education, and putting in place a strong regime for land that provides incentives to develop the enormous potential in agriculture (Selected Issues Papers). Reducing dependence on natural resources is key for increasing the economy’s resilience to shocks. The BRI provides an important opportunity to modernize and upgrade infrastructure, increase connectivity, and diversify. Actions in all of these areas would help make growth less volatile and more durable and inclusive.

Astana International Financial Center

The Astana International Financial Center (AIFC) opened officially in July and is intended to serve as a financial hub for the Eurasia region, bridging financial markets in Europe, China and East Asia, and the Middle East. The center will use English as its official language and will operate under a special constitutional and legal regime based on English common law, which will regulate disputes.

AIFC is intended to develop around six main activities: (i) capital markets, with a focus on a new exchange platform (AIX), created in partnership with the Shanghai Stock Exchange and NASDAQ; (ii) asset management; (iii) Islamic finance; (iv) Fintech startups; (v) private banking, oriented to the needs of high net-worth individuals, and (vi) “green” finance.

AIFC presents an opportunity and platform for Kazakhstan and the region to develop and deepen capital markets and attract foreign interest and investment. A transparent and market-friendly regulatory framework, modern infrastructure, and international-caliber human capital would help AIFC to achieve its goals and set an example of innovation, high-quality service provision and good governance for the Eurasia region. However, there are also challenges, including difficulties posed by past and current financial sector weaknesses in Kazakhstan and other countries in the region, the need to build a reputation for excellence, including for AML/CFT, and generate strong and sustained demand for AIFC’s services given competition from already-established financial centers in the Middle East and Asia, headwinds from geopolitical tensions and sanctions, and dependence of the region on oil and other commodities.

27. Numerous initiatives target improved transparency, governance, and public administration efficiency. The authorities have incorporated anticorruption and governance measures into their reform plans under “Kazakhstan 2050,” “100 Concrete Steps,” and “Third Modernization.” These include far-reaching and complex efforts to make the civil service more professional (recruitment, salary, performance, training), strengthen rule of law (judicial qualifications and accountability, police transparency, appeal processes), enhance use of technology in public administration (e-filing of tax statements, permits), improve competition (antimonopoly and ombudsman activities), and strengthen accountability (audit and assessment of programs, online access, devolution of decision-making to local governments). The authorities are also working to improve fiscal transparency to strengthen the AML/CFT framework and ensure its effective implementation. Staff noted that improved coordination among agencies, regular reporting on implementation, and comprehensive evaluation of results would enhance credibility of the reform agenda.

Authorities’ views

28. The authorities attach great importance to their structural reform agenda. They underscored the key role of “Kazakhstan 2025” and its associated benchmarks and accountability framework. They agreed that the private sector should be the driver of growth and pointed to recent amendments to the entrepreneurial code aimed at streamlining regulations and liberalizing activity. They view industrialization and digitalization initiatives as important for diversification, and noted that significant attention and resources are being devoted to human capital development, especially in education, in order to strengthen inclusivity of growth. The authorities noted that the BRI links up well with their own push on road, rail, and port development under the 2015–17 “Nurly Zhol” initiative. The launch of a large PPP to build a new ring road around Almaty was also cited as a key milestone and pilot, and the authorities expect AIFC to provide a platform for financial services and innovation for the Eurasia region (Box 1).

Staff Appraisal

29. Recovery is continuing from shocks that began in 2014. After two years of subdued activity, growth picked up in 2017. The authorities’ response—fiscal support through Nurly Zhol and other initiatives, allowing exchange rate flexibility, pursuing inflation targeting, providing funding to stabilize the banking sector, and implementing structural reforms—was instrumental, although the resumption of growth has been driven by strong exports of oil and metals. The current account deficit is lower, and inflation has come down and remained within the target band; expectations have stabilized.

30. Growth is expected to remain solid, but there are risks. While overall growth will likely slow as the increase of oil production moderates, non-oil growth should increase further over the medium term, reflecting the impact of structural reforms and financial repair and deepening. Non-oil growth could be higher if far-reaching and ambitious reforms are implemented decisively. Risks relate to commodity prices—both high prices and the prospects for a lower impulse for reforms and lower prices and correspondingly lower export earnings and fiscal revenues, and pressures on the tenge. Slower growth in key trading partners—Russia and China—is another risk, along with tighter or volatile global financial conditions, a deepening of global trade or geopolitical tensions, and policy slippages. On the upside, the BRI and reforms in next-door Uzbekistan provides an opportunity for greater integration, trade, investment, and diversification.

31. Fiscal consolidation is underway. With the winding down of fiscal support and the more favorable environment, further adjustment is envisaged this year. Consolidation is warranted after countercyclical spending has been completed and by the need to restore buffers. Ambitious and complex reforms are underway in health and education, PPPs and outsourcing, and public employment; these should be carefully planned and rolled out. Issuance of a tenge Eurobond would help attract foreign investors and establish a new benchmark.

32. Further medium-term adjustment is expected, with the non-oil deficit reaching levels consistent with long-term sustainability. Adjustment is warranted and driven by higher revenues, mainly from tax administration gains in VAT and from enhanced technology. These are positive measures, although projected gains may be ambitious. Reduction of the PIT for low-income earners is also positive; to further enhance progressivity, a moderate increase of PIT rates for high-income earners could be considered. Review of tax incentives and the tax regime for mining should be undertaken. The level of budgetary capital spending is low by international standards, and additional, high-quality outlays should be considered, in a deficit-neutral way, in tandem with higher non-oil revenues. Efforts to further strengthen fiscal transparency and risk management, including monitoring of SOEs and PPPs, are needed.

33. The focus of monetary policy should remain on price stability. Declining inflation and stabilization of inflation expectations has allowed the NBK to undertake interest rate cuts, most recently in June. This has been broadly appropriate, given developments and the outlook and consistent with keeping real interest rates close to neutral levels. Going forward, the NBK should resist calls for accommodation, as the changing balance of risks warrants a cautious approach to further easing. Quasi-fiscal initiatives aimed at providing longer-term financing should be targeted and temporary, incorporate robust risk-sharing and market funding arrangements, and should be undertaken by the budget and not the NBK. As the recovery gains momentum, bank balance-sheet issues are resolved, and structural reforms advance, credit should pick up more broadly, allowing the large stock of NBK notes to be unwound.

34. Efforts to improve monetary operations and domestic financial markets should continue. NBK notes have helped manage liquidity and build the short end of the yield curve. Money-market rates have stayed within the NBK’s corridor, close to the lower bound. There is scope for strengthening cooperation between the NBK and the government on liquidity management and market issues, including management of SOE deposits/funds. A review and changes to the complex system of reserve requirements are also warranted. The flexible exchange rate regime has served Kazakhstan well by helping to absorb changes in the macro environment and support dedollarization. The NBK would benefit from strengthening transparency and communications with respect to foreign exchange purchases and sales, including on behalf of the NFRK and the UAPF.

35. Despite extensive and costly financial support to banks, risks and challenges remain. Most importantly, Kazakhstan’s banks need to adopt a strengthened business model, with enhanced governance, management, and operations. The sector continues to experience difficulties from weak credit-risk management and NPLs. Actions are needed, including in asset quality and governance, supervision and regulation, emergency liquidity assistance, credit subsidies, collateral and foreclosure, and disposal of distressed assets. Legal, institutional, and operational constraints affecting the Problem Loan Fund should be addressed. Further strengthening of the resilience of the banking sector will contribute to sound macro-financial linkages and growth, while reducing risks.

36. Reducing the state’s footprint and advancing governance reforms are also critical. A thriving private sector is needed to realize the aspiration of joining the 30 most developed countries by 2050. This calls for decisive steps to foster private activity. While the various reform initiatives are ambitious and comprehensive, the state remains predominant. Progress is being made, but the challenge is to ensure that changes on paper lead to deep and meaningful changes in practice. With recovery now underway, extensive state support risks cementing a culture of reliance on subsidies. The growth impetus should move firmly to the private sector, with the state focusing on facilitating the business environment and enhancing infrastructure, connectivity, and inclusivity. Successful “blue-chip” IPOs would send a strong signal, along with further efforts to modernize rail and road networks, liberalize trade, enhance domestic competition, and improve land use and agriculture infrastructure. Opportunities to enhance connectivity and diversify under the BRI should be seized. On governance, far-reaching and complex efforts to make the civil service more professional, enhance use of technology in public administration, and strengthen accountability are welcome and should proceed.

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

Figure 5.
Figure 5.

Kazakhstan: Monetary and External Sector Developments

Citation: IMF Staff Country Reports 2018, 277; 10.5089/9781484376881.002.A001

Source: Kazakhstani authorities, Bloomberg, and IMF staff estimates.1/ NBK policy rate is refinancing rate through September 2015, then base rate
Figure: 6.
Figure: 6.

Kazakhstan: Fiscal Developments and Outlooks

Citation: IMF Staff Country Reports 2018, 277; 10.5089/9781484376881.002.A001

Source: Kazakhstani authorities and IMF staff estimates.
Table 1.

Kazakhstan: Selected Economic Indicators, 2014–23

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Sources: Kazakhstan! authorities and Fund staff estimates and projections.

For 2015 it includes a transfer of USD 4–5 billion (2.4 percent of GDP) to KazMunaiGaz to make external debt payments. For 2017 it includes the support of the banking sector of about $6.4 (4 percent GDP) billion.

The presentation of monetary accounts has been revised based on Standardized Report Form (SRF). Transactions carried out by the NBK on behalf of the government; in particular, custodian transactions related to the NFRK management are excluded. Credit to the private sector comprises credit to non-financial private enterprises and other resident sectors (mainly households).

Refinancing rate through 2014 and base interest rate of the NBK from 2015.

Gross debt, including arrears and other short-term debt.

Based on a conversion factor of 7.6 barrels of oil per ton.

Table 2.

Kazakhstan: Balance of Payments, 2014–23

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Sources: Kazakhstani authorities and Fund staff estimates and projections.

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

Table 3.

Kazakhstan: Financial Soundness Indicators of the Banking Sector, 2014–17

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Source: IMF Financial Soundness Indicators (FSI) database, National Bank of Kazakhstan
Table 4.

Kazakhstan: Monetary Accounts, 2014–23

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Sources: Kazakhstani authorities and Fund staff estimates.

Private sector includes nonfinancial private enterprises and other resident sectors (mainly households).

Does not include oil fund resources.

Table 5a.

Kazakhstan: General Government Fiscal Operations, 2014–23 1/

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Sources: Kazakhstani authorities and Fund staff estimates and projections.

General government includes republican and local budgets plus the NFRK.

Oil revenues include items such as royalties, export duties on oil, and corporate income and social taxes levied on oil companies.

Non-tax revenues include items such as income from business activities and properties as well as the interest earned by the NFRK

Includes expenses related to business trips, education and social expenses, as well as the 2015 transfer to KazMunaiGas and the 2017 support to the banking

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

For 2015 it excludes a transfer of USD 4.5 billion (2.4 percent of GDP) to KazMunaiGaz to make external debt payments. For 2017 it excludes the support to the banking sector of about $6.4 billion (4 percent GDP) .

General government, including republican and local budgets.