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Republic of Kazakhstan - 2008 Article IV Consultation, Preliminary Conclusions of the IMF Mission
April 30, 2008
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 visited Kazakhstan during April 21-30, 2008 to conduct discussions for the annual Article IV consultation. The mission team would like to thank the authorities for the informative and open discussions during its stay, and for their warm hospitality. Against the background of ongoing turbulence in global financial markets, the mission reviewed recent economic developments in Kazakhstan and discussed policy responses with the authorities. The following statement reflects the views of the mission team.
1. Kazakhstan has been significantly affected by the global financial market turmoil that began last summer. Market perceptions of risk on Kazakhstani assets have increased with bank bond and sovereign CDS spreads rising and bank share prices dropping. After borrowing heavily in international markets in 2006 and the first half of 2007, banks now have limited access to external funding. The authorities' prompt policy response helped the economy weather the initial fallout from the turmoil. The downward pressure on the exchange rate experienced last year has eased and the spike in money market interest rates has receded.
2. The "sudden stop" in capital inflows is affecting the economy, and the outlook is for a period of weaker growth. In response to their funding difficulties, banks have curtailed lending activities, and credit growth has stalled since September. Real GDP growth has slowed sharply over the past two quarters, property prices are declining, and nonperforming loans (NPLs) are rising. The mission expects real GDP growth to slow to 5 percent this year, from 8.5 percent in 2007, before recovering modestly to just above 6 percent in 2009. Risks to the outlook are firmly on the downside in our view, particularly if the global economy weakens further or if pressures in the domestic banking sector persist.
3. With the economy slowing and the surge in domestic food prices moderating, inflationary pressures are beginning to ease. Price data for the first quarter have been quite encouraging, and appear consistent with consumer price inflation falling below 10 percent (year-on-year) by end-2008, and then declining further in 2009. The large current account deficit is also projected to narrow as oil and commodity exports continue to do well and import growth slows. Preliminary tax revenue data confirm a sharp slowdown in import growth in 2008.
4. The current situation is difficult, but Kazakhstan has considerable financial resources to help it weather the situation, and medium-term growth prospects remain very favorable. The country's foreign assets (oil fund and international reserves) were US$43.4 billion on April 18, well above the level reached just prior to the onset of market volatility in August 2007. In the short-term, policies should focus on managing risks to the outlook and setting the stage for a resumption of strong and sustained growth, with the different branches of policy—monetary, fiscal, and financial sector supervision—all moving toward achieving these broad objectives. To this end, we believe that further steps are needed to strengthen the banking sector and that macroeconomic policies should be supportive of growth. This focus is not to downplay the importance of tackling high inflation, which is appropriately a central policy objective of the National Bank (NBK) and the government. Rather, it reflects our view, as noted above, that inflationary pressures are already easing.
5. The health of the banking sector is central to the outlook for the economy. Given the slowdown in growth and the tightening of credit availability, NPLs are expected to continue to rise in the coming months. Banks also face further large external debt repayments during the remainder of the year and this will continue to put pressure on their liquidity. In the face of these challenges, a clear picture of the vulnerabilities facing the banks needs to be developed, and steps taken to mitigate risks. Efforts to postpone adjustment, for example by replacing maturing external borrowing with new higher-cost, short-maturity, credits, are likely to increase vulnerabilities in the future. Banks should have in place plans to maintain liquidity, preserve asset quality, and continue to meet solvency standards, including, if necessary, by raising additional capital. For their part, the supervisors need to ensure that banks are realistically assessing their business model, adequately provisioning to cover rising NPLs, taking a conservative approach to collateral valuations in an environment of limited liquidity and falling prices in the property market, and carefully monitoring all risks taken in the form of off-balance sheet transactions.
6. Bank supervision and regulation need to be strengthened. We very much support the recent efforts by the FSA to step up their supervision of banks and conduct more rigorous stress tests of the system. The government's recent commitment to increase the resources available to the agency will help in these endeavors. Efforts are particularly needed to develop offsite supervisory capacities, with a reduced emphasis on form filling, a greater role for analysis, and prompt follow-up, including through additional inspections when issues of concern arise. We also welcome the changes in legislation which would give the FSA more flexibility to react to adverse changes in banks' financial positions, if needed. Regulatory measures to encourage banks to broaden their funding base, particularly by focusing on domestic resources, are also welcome, although in some other areas it is important that overregulation does not distort the market forces of intermediation or stymie the usual risk-taking nature of the banking business.
7. The authorities have made considerable progress in developing their financial safety net framework. The central bank's liquidity support framework has proved effective at providing the necessary support to banks during the recent turbulence. The consideration of further refinements, including the type of securities that can be used as collateral and the maturity of the liquidity provision, is appropriate, although it is important that the strength of the central bank's balance sheet is not compromised by its liquidity operations. The mission strongly supports the Memorandum of Understanding (MoU) on Financial Stability between the government, the NBK and the Agency for Financial Supervision (FSA). The principles of the MoU are sound and help establish a foundation for managing any difficulties that may emerge in the banking system.
8. The mission fully supports the NBK's policy of maintaining a stable exchange rate during this current period of uncertainty. Since last October, the tenge has effectively been pegged to the U.S. dollar. In view of the importance of maintaining the confidence of domestic depositors, the considerable foreign currency exposure of the corporate sector, and the need to keep inflation on a downward path, such exchange rate stability provides considerable benefits at present. In our view, it should remain a central policy objective until conditions in financial markets improve. At such a time, returning to a more flexible exchange rate policy would be desirable. If downward pressures were to resume, a number of steps could be taken to support the exchange rate, including: increasing flexibility in the current framework for converting—within a set period—from tenge to dollars the inflows into the oil fund; encouraging commercial banks to use their own foreign currency assets to meet external debt repayment obligations; and intervening in the foreign exchange market, although under a clear operational rule that limits the amount of reserves committed to defend the exchange rate.
9. Monetary policy needs to walk a fine line between contributing to financial stability, supporting the exchange rate, and ensuring that inflation is on a firm downward path. Given our expectation that growth will remain quite subdued this year and that inflation pressures will continue to ease, the mission sees the NBK's current monetary policy stance as appropriate for now. However, the central bank will need to continue to closely monitor developments as they unfold and adjust the policy stance as needed. In this regard, if liquidity conditions remain relatively tight, the increase in the minimum reserve requirement scheduled for July may need to be reconsidered (for example, "postponed until further notice"). On the other hand, if inflation does not ease as expected, wage pressures accelerate, or the exchange rate comes under significant downward pressure, a monetary tightening would need to be considered.
10. The fiscal position in Kazakhstan is very strong, with a large budget surplus, low public debt, and sizeable public savings. The government therefore has scope to allow the automatic fiscal stabilizers to operate in full, rather than seeking to offset any shortfalls in tax revenue that may occur as a result of the slowing economy. Indeed, measures to increase tax rates or lower expenditures to meet previously set fiscal targets are likely to be counter-productive in the present circumstances, possibly aggravating the slowdown in a procyclical manner. In the event of a sharper-than-expected slowdown in growth, we see scope for a fiscal stimulus package this year, although it is important that this be well-targeted and consistent with development and fiscal reform objectives. For example, if such a package were needed, accelerating spending on transportation infrastructure would provide a short-term stimulus to the economy as well as help to boost productivity in future years.
11. The recent sharp rise in food prices in Kazakhstan, and around the world, is rightly a key policy concern. A well-crafted response is needed to mitigate the negative effect on poorer sections of the population, while encouraging increased production of food products in the future. Given the strong fiscal position, there is scope to introduce well-targeted government subsidies to low income households to help offset the higher cost of food. We believe this would be a better response than measures that seek to influence prices, including trade restrictions or trade bans, as these reduce incentives for higher production. Efforts to boost productivity in agriculture and improve distribution systems will also help alleviate price pressures going forward.
12. Lastly, we would like to highlight two other issues. First, the publication of Kazakhstan's first report under the Extractive Industries Transparency Initiative (EITI) initiative is very welcome and represents an important step in further increasing the transparency of revenues received by the government from companies in the oil sector. Second, a draft bill to bring AML/CFT legislation in to line with international best practice is still pending and we would urge its rapid passage.
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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