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Republic of Kazakhstan -- 2007 Article IV Consultation, Preliminary Conclusions of the IMF Mission
April 24, 2007
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
An IMF mission team visited Kazakhstan during April 16-27, 2007 to conduct the discussions for the annual Article IV consultation. The mission has reviewed macroeconomic developments and changes to the economic outlook since the last consultation. Economic performance remains impressive and the rapid transformation of the economy continues. The key near-term policy challenges are to lower inflation and to mitigate risks in the rapidly expanding banking sector.
1. Kazakhstan's rapid economic growth continues. A favorable external environment and sound economic management set the stage for a seventh consecutive year of impressive performance in 2006. Real GDP grew by 10.6 percent, employment expanded further, and per capita income reached almost five times the 1999 level in dollar terms. High oil prices and impressive gains in tax administration led to buoyant growth in oil and non-oil revenues, permitting a further substantial increase in savings in the National Fund (NFRK) as well as continued sizable expansion in budgetary expenditures. Large foreign exchange inflows—related to buoyant oil and non-oil exports, direct investment, and a sharp acceleration in external borrowing by the banking sector—boosted official reserves to $19 billion at the end of the year, equivalent to 7 months of imports.
2. At the same time, policy challenges to sustaining the strong performance have intensified. Inflation, which had picked up to 9 percent in mid-2006, persists at a relatively high level and may rise again in response to the 30 percent wage increase awarded to public sector employees at the start of the year. Moreover, the banking sector's vulnerability to shocks has risen. Fuelled by the $18 billion external borrowing by banks last year, credit growth has accelerated to almost triple digits, with especially rapid expansion in real estate lending and consumer loans. A reduction in external creditors' appetite for Kazakhstan exposure, or a sharp decline in the quality of loan portfolios were the credit cycle to turn, could disrupt banking activity and carry consequences for the real economy. Thus, policy measures to lower inflation and mitigate banking sector risks are needed to ensure a continued favorable macroeconomic outlook.
3. The National Bank of Kazakhstan (NBK) has taken a number of steps to tighten monetary conditions over the past year. Reserve requirements were broadened and raised in mid-2006, the NBK's deposit rate was increased by 100 basis points, and issuance of NBK notes has been stepped up, reflected in higher yields. The NBK also permitted substantial nominal appreciation of the tenge in the first half of 2006 and again since February of this year. Despite these measures, however, money growth rates are very high.
4. Further monetary policy tightening is needed to curb credit growth and mitigate risks. Higher reserve requirements will soak up banks' liquidity, which will reduce funds available to lend and dampen inflationary pressures. In addition, a larger diffential between requirements relating to external versus domestic liabilities should help curb external borrowing by making external funding less attractive than domestic funding. Increases in policy interest rates—for NBK deposits and notes—will also reduce liquidity. Although higher interest rates could attract greater capital inflows, increased reserve requirements should offset such an effect.
5. A stronger tenge and greater exchange rate flexibility will support monetary tightening in bringing inflation down. Allowing the tenge to appreciate further will facilitate a scaling back of the NBK's intervention in the foreign exchange market, as in recent months, implying slower tenge liquidity growth. A stronger and more flexible exchange rate should also help remove perceptions of a "one-way bet" that may have encouraged capital inflows. Furthermore, exchange rate appreciation will directly translate into lower tenge prices for imports, which will moderate inflation. Conversely, limiting nominal appreciation at the expense of higher inflation will not safeguard competitiveness and will only make the eventual disinflation more difficult.
6. Additional prudential tightening is also needed to contain risks related to the rapid growth in bank credit and external debt. The Financial Supervision Agency (FSA) has appropriately tightened regulations in a number of areas over the past year, including on related-party lending, real estate exposures, cross-border loans, foreign currency liquidity, and external borrowing. Encouragingly, several banks have responded by increasing their capital base, and the FSA's latest stress test results indicate that even sizable interest and exchange rate shocks would not cause major distress in the banking system. However, credit growth remains very high and many banks still have considerable room to continue to borrow externally under the new limits on external debt, as evidenced by their announced borrowing plans. Thus, vulnerabilities are likely to mount further, implying a need for further prudential measures to strengthen the banking system's capacity to weather shocks. Measures could include a tightening of provisioning regulations for overdue loans, more stringent collateral regulations, and higher capital adequacy requirements or risk weights, particularly for consumer loans, foreign currency loans to unhedged borrowers, and property credits with high loan-to-value ratios.
7. Vigorous supervisory effort must accompany the tighter regulations in order to ensure banks' compliance. The mission welcomes the recent legislation that has enhanced the FSA's supervisory powers, as well as the plans to increase the FSA's resources. A substantial share of the new resources should be used to hire bank examiners in order to increase the frequency and depth of on-site inspections, especially unscheduled topic-based inspections, to ensure that banks maintain adequate risk management and internal control systems and comply with prudential regulations. The FSA will need to stand ready to deal with any violations of regulations expeditiously. In this context, the decision to form a committee comprising respresentatives from the FSA, NBK, and relevant ministries to develop early warning indicators and contingency plans to handle the emergence of distress in the banking system is a valuable proactive step.
8. Fiscal policy remains prudent, although the acceleration of public spending will require additional monetary tightening and exchange rate appreciation to keep inflation from rising. In view of Kazakhstan's still substantial social and infrastructure development needs and the high oil revenue saving rate in recent years, the moderate easing of the fiscal stance in the 2007 budget is appropriate, provided adequate monetary and prudential tightening is undertaken expeditiously. With growth in government expenditures picking up to 25 percent this year, the anti-inflation burden on monetary and exchange rate policies has increased and the need to ensure spending quality has intensified. The aim to enhance spending efficiency by reducing the number of budgetary programs and improving budget execution is commendable. A comprehensive public expenditure review, possibly with technical assistance from the World Bank, and evaluation of recent capital projects will help strengthen project selection and execution.
9. While Kazakhstan can clearly afford supplementary spending measures, they would exacerbate inflationary pressures and necessitate even more monetary tightening and tenge appreciation. The mission welcomes the authorities' intention not to undertake supplementary spending until inflation is firmly on a downward path.
10. Intensified structural reforms will help sustain strong economic performance over the medium term. Early WTO accession, customs administration reform, and further progress in enhancing regional trade will help secure productivity gains. The mission welcomes the program underway to privatize state enterprises that are presently run by various ministries. This should facilitate enterprise restructuring and enhance competition policy, areas where Kazakhstan's ranking in international structural reform indicators is relatively weak. The formation of Samruk and Kazyna, with the aim of streamlining operations and enhancing commercialization of large state enterprises and development institutions, should also help in this regard. Plans to boost the development of the securities market, which should also result in enhanced corporate transparency and governance, are commendable and the recent pickup in initial public offerings by Kazakhstani corporates—both domestically and abroad—is encouraging. However, increased availability of financing through development institutions could reduce the corporate sector's demand for funding through the issuance of equity and debt securities, thereby impeding the development of the capital market.
11. Progress has been achieved in enhancing macroeconomic data monitoring, and further steps would be desirable. A recent IMF Statistics Department mission found that Kazakhstan is in observance of the specifications of the Special Data Dissemination Standards and "observes" or "largely observes" all but two of the 132 best practices outlined in the Fund's Data Quality Assessment Framework. Over the past year, notable progress has been made in reconciling external debt data prepared by different agencies, compiling external debt statistics on a remaining maturity basis, and constructing an aggregate debt service profile. These steps will aid in monitoring and assessing vulnerabilities. The assessment of vulnerabilities will also be enhanced by progress in disaggregating imports data across the oil and non-oil sectors of the economy. The mission urges expeditious completion of the project to broaden the concept of public debt to include obligations of state enterprises and development institutions. While this is unlikely to result in a major change in public debt ratios, it will present a more accurate picture of public sector indebtedness. The mission also notes that progress is being made in complying with the Extractive Industries Transparency Initiative and urges expeditious completion and publication of the external audit report. In addition, the mission encourages early passage of AML/CFT legislation.
1 This represents the views of the mission team, not of the IMF, and these views may evolve as the staff assessment presented in the staff report on Kazakhstan is produced.
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