Republic of Kazakhstan-2011 Article IV Consultation Concluding Statement of the IMF Mission
May 6, 2011
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.
The following statement reflects the views of an International Monetary Fund (IMF) mission, led by Ana Lucía Coronel, which visited Astana and Almaty during April 26-May 6, 2011 to conduct discussions for the 2011 Article IV consultation. The mission reviewed economic and financial sector developments and discussed ongoing and envisaged policy responses and economic prospects. The mission met with government and central bank officials, and representatives of the international, banking, and business communities. The mission would like to thank the authorities for the useful discussions.
1. The economic recovery is gaining speed and the external position is strengthening, but inflationary pressures have intensified. Aided by favorable commodity prices and continuing public sector support, real GDP expanded by 7 percent in 2010, and IMF staff projects that it would further expand by 6½ percent this year. Oil, minerals, and related services will continue to be key drivers of growth, but agriculture is also expected to recover from the severe drought and retail trade to benefit from higher incomes. The external current account—which returned to surplus in 2010—will strengthen further. Strong export earnings along with significant foreign exchange inflows will further boost international reserves and assets in the oil fund—which, taken together, are now at a healthy level of over $70 billion. Driven primarily by rising global food and fuel prices, and despite the use of administrative measures, headline inflation has picked up sharply. Staff projects inflation to exceed the official objective range of 6–8 percent this year.
2. The banking and corporate sectors have not fully recovered from the crisis. Forced deleveraging is bringing the size of the banking system to more sustainable levels. Banks’ reported capital adequacy ratios have improved to near pre-crisis levels following the successful restructuring of external liabilities and increased holdings of government securities. However, nonperforming loans (NPLs) remain stubbornly high, and provisioning coverage of overdue loans may be overstated by doubtful recoveries of restructured loans, reinforcing risks to banks’ capital. Supported by an increase in deposits, largely short-term in nature, the aggregate liquidity position has improved, but profitability remains weak and driven mainly by non-interest income. Reflecting heightened risk aversion by banks and enterprises, credit remains subdued and not likely to recover in the immediate future. Corporate sector leverage and investment uncertainty continue to undermine the recovery of problem assets and the pool of potential borrowers.
3. The authorities are appropriately beginning to tighten policies in response to the effects of the increase in commodity prices and related inflows. Public sector support to the economy continues, mainly through bank deposits, subsidized lending, and increasing wages and pensions. Nevertheless, the authorities target a small reduction in the non-oil deficit, and are improving tax administration. In response to increased inflation, the National Bank of Kazakhstan (NBK) raised slightly its policy rate, signaling a reversal in the easing cycle implemented during the crisis. The supervisory authority is also taking measures to limit foreign exchange borrowing.
4. Planned efforts to pursue further regulatory enhancements are welcome. These include raising minimum capital levels, improving the standards of investments included in core capital, increasing the transparency of shareholder structures, and strengthening regulation for related party lending. This would complement the use of macroprudential policies to limit banks' exposure to foreign exchange risk. When implemented, these measures should help to place the financial system on a sounder footing, ensure that domestic private savings become the primary source of financing of productive activities, and facilitate the access of Kazakhstani banks to global capital markets. The recent decision to reintegrate the financial sector supervision into the NBK should be used as an opportunity to improve coordination and communication between monetary and financial sector decision-making and to deepen the financial stability analysis. For this reform to succeed, it is essential that regulatory and supervisory matters are kept independent from monetary policy, and that supervisors have enhanced independence, legal protection, enforcement capabilities, and the budgetary resources to credibly perform their role.
5. Looking forward, restoring the health of the banking and corporate sectors remains the main priority. Targeted subsidized lending has not been successful in unclogging credit channels, and banks have been reluctant to write off bad loans given expectations of economic recovery, difficulties of managing collateral, and tax disincentives. The authorities have recently announced a new conceptual plan to resolve NPLs. While the details are still being defined, the strategy consists of a combination of a centralized fund established and owned by the NBK and enhanced efforts at the individual bank level. The strategy rightly acknowledges the need for the public sector to take the lead in organizing this process, including by removing tax impediments to the recognition of problem assets. Crucially, the asset valuation is to be determined by independent professional appraisers. The plan also calls for improved prudential standards. Nonetheless, the plan represents only a partial solution to the large stock of problem assets as it deals with a subset of these assets and is not fully financed. Furthermore, ownership and partial financing of the fund by the central bank pose risks to the integrity of monetary policy and may create conflicts with NBK’s new supervisory responsibilities. The plan would benefit from a forward–looking diagnostic assessment of systemic banks’ asset quality and—if private sector funds cannot be identified—from the transparent use of budgetary funds instead of central bank resources. At the same time, proper accounting of restructured assets has to be ensured. Efforts to address tax and legal shortcomings, including those related to bankruptcy, foreclosure and insolvency regimes are also crucial.
6. In parallel, to ensure a broad-based recovery and promote medium-term macroeconomic stability there is a need to:
• Monitor inflation closely and continue to withdraw the accommodative bias in monetary policy. Demand-led price pressures appear to be relatively contained, but planned public sector wage and pension increases and the effects from a potential boost in capital inflows pose risks. While evidence of second round inflationary effects is so far limited, the authorities should communicate clearly the causes of and outlook for inflation, and react proactively by tightening policies. The use of administrative measures to limit price increases of staple goods should be phased out in favor of enhanced and well-targeted assistance to all low-income groups, especially in the rural areas.
• Pursue greater exchange rate flexibility and lower central bank intervention. Greater exchange rate flexibility would enhance the economy’s response to external shocks, promote better management of exchange rate risks and allow monetary policy to have greater traction. At the same time, the authorities need to ensure that the pace of reform is consistent with financial stability, including by assessing the likely implications for the balance sheet exposures of banks and corporations.
• Improve the quality of fiscal expenditure. To achieve the deficit targets while ensuring the implementation of the industrialization and business development programs, the authorities should keep expenditures under control, and in particular try to avoid further increases of hard-to-reverse items, such as wages and pensions.
• Formulate fiscal policy within a credible and transparent medium-term framework. The optimal balance between the use of commodity revenues and their accumulation in the national fund should be integrated within a medium-term framework that includes intermediate targets for the non-oil deficit reduction. This would allow additional flexibility in budget financing, and ensure the oil fund’s role in helping the economy to adapt to cyclical macroeconomic fluctuations while safeguarding future generations. The fiscal framework should incorporate the enlarged government, including all off-budget transactions with public and quasi-public enterprises. This would also allow proper assessment of the implications of state-owned enterprises’ debt.
7. The authorities’ medium-term plans rightly focus on diversifying the economy and ensuring that the population benefits from development. To be sustained and inclusive, growth has to be balanced and inequalities need to be addressed. Significant structural reforms have already been implemented, but there is room for improvement in the business climate by removing impediments to trade and investment, ensuring that financial institutions and local financial and capital markets are able to support private sector growth, reducing the role of the state, and building a comprehensive and viable social safety net that targets support to those most in need of it. The challenge is to ensure that the momentum of reform does not flag. Furthermore, as the economy becomes more sophisticated, domestic population and the international community will likely demand improvements in governance, transparency and accountability.