IMF Executive Board Concludes 2006 Article IV Consultation with the Republic of KazakhstanPublic Information Notice (PIN) No. 06/70
June 27, 2006
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On June 14, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Kazakhstan.1
Macroeconomic conditions were buoyant in 2005 and early 2006. Real GDP grew 9.4 percent in 2005. While hydrocarbon output decelerated, the income and wealth effects associated with high oil prices lifted non-oil output growth to 11 percent, with construction and financial services output expanding particularly rapidly. The unemployment rate declined further to 8.1 percent. However, inflation picked up to 7.6 percent in 2005 (period average) and jumped to almost 9 percent in February-April 2006 (year-on-year). A 30 percent increase in pensions and public sector salaries contributed to inflationary pressure.
The current account edged into a small deficit in 2005. A sharp increase in oil exports (by $6 billion;10.7 percent of GDP) was more than offset by higher income remittances to foreign direct investors and a sharp increase in goods and services imports, including Foreign Direct Investment (FDI)-financed imports by the oil sector. Banks borrowed heavily from abroad but also increased their holdings of foreign assets and securities, while amortization of FDI liabilities picked up, reflecting the stronger cash position of oil companies. With net outflows increasing, official reserves declined in 2005, albeit by less than the increase in foreign asset accumulation in the National Fund of the Republic of Kazakhstan (NFRK), and the tenge depreciated by 3 percent against the dollar. In early 2006, however, official reserves recovered sharply, including on account of continued rapid bank borrowing abroad, and the tenge appreciated by 8 percent against the dollar. In real effective terms, the tenge has appreciated by 5½ percent since end-2004 and by about 13 percent since end-2003, with little apparent consequence for the non-oil sector's competitiveness.
Monetary policy was accommodative and bank credit boomed, fueled in part by bank borrowing abroad. Money growth remained high and policy interest rates were flat for much of 2005. Credit growth accelerated to over 70 percent (year-on-year) in late 2005 and early 2006 as banks' lending interest rates declined in real terms. Banks funded their lending partly with a surge in external borrowing—banks' external liabilities rose to $15 billion (27 percent of GDP) at end-2005, from $7.7 billion at end-2004. On the fiscal side, policy remained prudent. The overall fiscal surplus rose to 6 percent of GDP, with surging oil revenue permitting a further rapid expansion in public spending (by over 20 percent in real terms).
Executive Board Assessment
Executive Directors commended the authorities' prudent macroeconomic framework, which helped Kazakhstan achieve an impressive economic performance over the past five years, including in the non-oil sectors of the economy. Looking forward, Directors welcomed the continued favorable outlook, but cautioned that mounting inflationary pressures and risks in the banking sector needed to be addressed.
Most Directors encouraged the authorities to tighten the monetary policy stance further. While they welcomed the recently announced broadening of the coverage of reserve requirements, they recommended further increases in policy interest rates. Directors also welcomed the nominal appreciation of the tenge in recent months and supported more exchange rate flexibility to allow greater appreciation of the tenge to help absorb liquidity and curb inflation. They pointed out that tighter monetary conditions would affect the National Bank Kazakhstan's (NBK) balance sheet and recommended an early capital injection into the NBK to send a convincing signal to markets that monetary policy will not be constrained by profit and loss considerations.
Directors welcomed the adoption of a number of prudential regulations over the past year to help contain risks associated with banks' loan portfolios. They urged the authorities to consider further prudential measures, particularly for real estate-related and foreign currency lending, and for investment activities. Directors also considered the need for an early tightening of prudential regulations to contain external bank funding and strongly supported measures recently announced by the authorities, including tougher liquidity requirements and net open position limits. In addition, they urged the authorities to improve monitoring of the maturity structure of banks' external obligations and debt repayment profiles to better assess the rollover risks.
Directors emphasized that regulatory measures would have to be supported by vigorous supervision to ensure banks' compliance. They recommended increased on-site inspections and enhanced supervision of banks' cross-border activities. They also underscored the importance of maintaining the Financial Supervision Agency's independence and stressed that the FSA should deal expeditiously with any violation of prudential regulations.
Directors considered that an adequate monetary tightening would facilitate implementation of the authorities' fiscal plans, which aim at addressing social and infrastructure needs, and helping diversify the economy. They noted that there remains significant room to raise spending and cut taxes without compromising fiscal sustainability. However, in light of the continued rise in government expenditure, Directors underscored the importance of intensified scrutiny over expenditure efficiency. They also cautioned against distortive tax incentives that would erode the tax base.
Directors welcomed the important steps taken by the authorities to improve the investment climate and economic governance. They noted that transparency would be enhanced with the expeditious implementation of the Extractive Industries Transparency Initiative and the new design of the NFRK.
Directors noted that the growth prospects and competitiveness of the non-oil sector would benefit from an acceleration of structural reforms. They pointed in particular to the need for early WTO accession, continued reform of customs administration, and further progress in enhancing regional trade, including by streamlining procedures that lower the cost of cross-border trading. Directors also urged reforms to address weaknesses identified in business climate surveys.
Directors welcomed the authorities' efforts to improve data disaggregation into the oil and non-oil sectors of the economy. In this context, they called for closer cooperation between various agencies involved in compiling and analyzing the relevant data.