## 1. Summarizing Indicators of Macro-Financial Conditions

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---

### Kazakhstan: macro context and objectives
- Quarterly growth (year-on-year) averaged over 10 percent in 2000-08 prior to the global financial crisis.
- Macro-financial data used in the analysis generally cover 1999Q4–2019Q4.
- Since 2015 monetary policy in Kazakhstan has been based on an inflation targeting (IT) regime with a target band of 4–6 percent for headline inflation.
- The NBK aims to achieve full-fledged IT by 2030 and has set a lower inflation target range of 3–4 percent by 2025.
- The paper applies the Growth-at-Risk approach to quantify macro-financial linkages in Kazakhstan and assess downside/upside risks to growth prospects.

### Macro-financial indicators and factor construction
- Four groups of macro-financial variables were summarized by their first principal component:
  - Domestic financial conditions: constructed from monetary variables and price-of-risk indicators; a higher value indicates tighter conditions (higher policy rate, higher deposit/lending rates, elevated sovereign risk premium); reserve money and broad money have negative loadings (e.g., Reserve Money loading -0.30, Broad Money loading -0.32).
  - Domestic credit conditions: positive loadings on level and growth of private credit, negative loading on banks’ capital (e.g., Private Credit, % of GDP loading 0.65; Capital to Risk-Weighted Assets loading -0.63).
  - External financial conditions: captures international funding cost and market volatility (VIX loading 0.72; 6-Month LIBOR loading 0.65; MOVE loading 0.24).
  - External demand: summarizes prospects in trading partners and competitiveness (International Oil Price loading 0.49; Terms of Trade loading 0.55; Growth of EU loading -0.53; Growth of CHN loading -0.42).

### Estimated quantile regression results: one-year horizon
- Domestic financial conditions:
  - Tightening domestic financial conditions signal negative one-year-ahead growth for all percentiles.
  - Estimated coefficients at the 10th and 25th percentiles are about twice the magnitude compared to other percentiles.
- Domestic credit conditions:
  - Favorable domestic credit conditions are positively correlated with good growth outcomes (75th and 90th percentiles).
  - No significant impact of domestic credit conditions on lower percentiles at the one-year horizon.
- External demand:
  - Unfavorable external demand is negatively associated with near-term growth prospects.
  - Estimated coefficients are of comparable sizes across percentiles, indicating country vulnerability to external trade shocks.
- External financial conditions:
  - Estimated coefficients are positive for above-median growth outcomes with borderline statistical significance.
- Statistical notes:
  - Bars in figures denote standardized quantile regression coefficients; solid bars indicate statistical significance at 5 percent (Figure 2) or 10 percent (Figure 3 for multi-year horizons).

### Persistence and multi-year effects
- Over 3–4 years:
  - The positive growth implications of tighter external financial conditions and the negative implications of unfavorable external demand remain statistically significant at 10 percent.
- Over 2–3 years:
  - Loose domestic credit conditions may aggravate bad growth outcomes, even though they may boost good growth outcomes in the near term.
- Domestic financial conditions:
  - Impact is short-lived and dissipates beyond two years.

### Simulated impacts: one-year ahead projected growth (post- vs pre-shock, in percent)
- Policy Rate +200 bps: 10th = -2.2 ; 50th = -2.1 ; 90th = -2.0
- EMBIG +200 bps: 10th = -2.0 ; 50th = -1.9 ; 90th = -1.9
- Private Credit, % of GDP -5 percent of GDP: 10th = -1.2 ; 50th = -1.0 ; 90th = -0.7
- 6-Month LIBOR +200 bps: 10th = 0.2 ; 50th = 0.5 ; 90th = 0.7
- Growth of EU -1 percent: 10th = -0.7 ; 50th = -0.7 ; 90th = -0.7
- Growth of CHN -1 percent: 10th = -0.4 ; 50th = -0.4 ; 90th = -0.4
- International Oil Price +$5: 10th = -2.9 ; 50th = -3.0 ; 90th = -3.0
- Note: Kazakhstan’s status as an oil exporter implies high oil prices strengthen fiscal and external positions, but the Growth-at-Risk analysis focuses on global demand channel and may not capture benefits of strong oil prices.

### Historical episodes and policy tradeoffs
- Two significant historical episodes with sharp deterioration at the lower (10th) percentile of projected growth:
  - Global Financial Crisis (GFC): falling global demand.
  - 2015–16: policy rate hike to counter currency pressures induced by the oil price decline and exchange rate regime shift.
- Policy tradeoff highlighted:
  - Monetary policy tightening can reduce inflationary pressures but poses downside risks to growth.
  - Counter-factual simulations suggest permanent increases in the policy rate or sovereign risk premium, lower credit levels, weaker trading-partner growth, or permanently higher oil prices that dampen global demand reduce near-term projected growth.

### Outlook and policy implications drawn from Growth-at-Risk
- Main risks to growth outlook:
  - Elevated inflation.
  - Uncertain recovery prospects in trading partners.
  - Limited export diversification.
- Policy implications:
  - Further monetary tightening might be necessary if inflation pressure persists, but this could pose downside risks to growth; accommodative fiscal policies can mitigate these risks.
  - In the longer term, further export diversification in products and trading partners will help reduce vulnerability to external shocks and enhance resilience.

### DSGE-based findings on shocks and monetary policy transmission
- Key empirical findings from an estimated DSGE model:
  - Large depreciation can have substantial immediate and persistent impacts on inflation, implying difficult policy tradeoffs.
  - The interest rate channel is working but remains relatively weak due to structural features.
  - US monetary policy shocks so far have an insignificant impact on Kazakhstan.
  - Fiscal dominance could undermine the National Bank of Kazakhstan’s (NBK’s) policy credibility, which is crucial to anchor inflation expectations and improve policy tradeoffs.
- Structural and institutional features constraining transmission:
  - Kazakhstan is an oil-exporting country that imports most of its food and consumer goods; oil price declines tend to weaken the economy and raise inflation via tenge depreciation pass-through.
  - Interest rate transmission is hampered by underdeveloped domestic bond markets, excess bank liquidity, widespread credit subsidies, and elevated deposit dollarization.

---

### 3. This note assesses the effectiveness of monetary policy transmission channels based

### A. A Brief Description of the Model and Estimation
- Model framework and objectives:
  - Based on the IMF’s quantitative IPF framework.
  - Two-country DSGE model estimated for Kazakhstan that includes both nominal rigidities and financial frictions.
  - Purpose: quantify the importance of frictions, magnitude and persistence of shocks, and assess alternative monetary policy responses.
  - Emphasizes anchoring inflation expectations so monetary policy can focus more on output stabilization; anchoring requires strong monetary and fiscal policy credibility.
- Key model features (New Keynesian, small open economy):
  - Incomplete international financial markets leading to volatile real exchange rates.
  - Local currency pricing and incomplete exchange rate pass-through.
  - Sticky nominal wages that can amplify exchange rate shocks.
  - Discounting in IS and Phillips curves to mute potency of future policies.
  - Micro-founded endogenous private and sovereign borrowing spreads.
- Four building blocks:
  - Aggregate demand: domestic demand (endogenous), government spending (exogenous), exports and imports (endogenous); exports depend on foreign demand and relative prices.
  - Aggregate supply: domestic prices follow a Phillips curve; export and import pricing allow for gradual and persistent pass-through of exchange rate movements; wage growth adjusts gradually.
  - Financial block: banks lending and financiers trading currencies; two financial frictions—“agency friction” and balance sheet friction—captured by private borrowing spreads.
  - Policy block: monetary policy reaction function is a modified Taylor rule; central bank can also use FXIs.
- Estimation details:
  - Quarterly data 2003Q1–2020Q3 for Kazakhstan with Bayesian likelihood methods.
  - Uses ten structural shocks plus foreign shocks; foreign economy proxied by a pre-estimated closed U.S. economy model.
  - Observables include de-trended GDP, exports, imports, government spending (HP filter), core inflation, nominal wage growth, policy rate, long-term interest rate (10 years), real exchange rate, and FX reserves.
- FX intervention (FXI) specifications estimated:
  - (1) Baseline without FXIs.
  - (2) Exogenous FXI: AR(1) with an error correction mechanism; change in NBK FX reserves included as observable.
  - (3) Endogenous FXI rule motivated by financial frictions.
  - Estimation outcome: does not support that NBK uses FXIs systematically. FX interventions (changes in NBK’s FX reserves) have modest effects on the exchange rate.
  - Empirical example: an FXI (selling) of 10 percent of GDP would lead to about 1.2 percent appreciation of Tenge.

### B. Impulse Responses Analysis
- Purpose:
  - Use estimated impulse response functions (IRFs) to analyze transmission channels and policy tradeoffs for key shocks: large tenge depreciation, effectiveness of interest rate channel, NBK response to COVID-style shocks.
- Key findings:
  - Exchange rate shocks:
    - More inflationary and persistent in Kazakhstan than most other EMEs.
    - Example: a 10 percent depreciation due to an UIP risk premium shock shows larger inflation, larger policy rate increases, and sharper contractions in domestic demand for Kazakhstan relative to typical EMEs and AEs.
  - External adjustment:
    - A flexible exchange rate facilitates external account adjustments; a 10 percent depreciation improves the real trade balance more than the contraction in domestic demand, leading to an overall expansion in output.
  - Interest rate channel:
    - Relatively weak but still effective; a 100 bp increase in the policy rate reduces domestic demand in Kazakhstan by only about half of the impact observed in a typical EME.
  - Fiscal shocks and policy coordination:
    - A one-time 10 percent front-loaded transient increase in real government spending leads an independent central bank to increase policy rate by almost 200 bsp at the peak and maintain tight policy for 2–3 years.
    - If central bank is constrained by government financing needs, it may not maintain tight policy and price stability—policy credibility could be adversely affected.
  - Global monetary policy shocks:
    - Appear to have modest effects, consistent with Kazakhstan’s relatively low degree of financial integration and small share of foreign investors in domestic markets.
  - COVID-style combination shock:
    - Collapsing oil prices in March–April 2020 led to falling export demand and rising global risk aversion, causing sharp tenge depreciation.
    - NBK response: raised policy rate to 12 percent (from 9.25 percent) and intervened in FX market; later policy rate lowered to 9 percent and interventions ceased by summer 2020.
    - Overall tenge depreciation: 10 percent vis-à-vis the US dollar in 2020.
    - In second half of 2021, NBK raised the policy rate three times by a total of 75 bp as inflation rose above the target range.
    - Given persistent inflationary effects of depreciation, NBK should stand ready to raise policy rate as necessary to keep inflation expectations anchored.

### C. Historical Shock Decomposition
- Output gap:
  - Driven by both domestic and foreign demand shocks.
  - Since 2015 and IT introduction, real exchange rate has gained a more important role.
  - Domestic demand tends to fall with tenge depreciation, declining imports, and rising private borrowing spreads.
- Inflation:
  - Influenced primarily by exchange rate shocks (high pass-through) and global commodity price cycles.
  - Wage inflation has become more important since 2018.
- Policy rate:
  - Reacted mainly to developments in domestic demand, foreign demand, exchange rate fluctuations, and wages.
- Private borrowing spreads:
  - Consistently exerted pressure on output, weakening the interest rate channel of monetary policy.
  - Two plausible explanations:
    - (i) Tenge depreciation could increase deposit dollarization; given restrictions on dollar lending and open FX positions, banks would raise rates on tenge deposits (increasing lending spreads).
    - (ii) Given the 4-6 percent inflation band, banks may assume NBK would target 4 percent through a more aggressive monetary stance, leading to higher lending spreads.

### D. Policy Conclusions (Monetary Policy and NBK)
- Near-term policy stance:
  - NBK responded appropriately to the COVID crisis, but containing inflation may require further monetary tightening in the coming months.
  - Headline inflation is now well above the target range.
  - With recovery underway and the output gap closing, NBK needs to be ready for further tightening to reduce the risk of de-anchored inflation expectations in the medium term.
- Policy tradeoffs and vulnerabilities:
  - Flexible exchange rate helps external adjustment but large depreciation can create persistent inflationary pressures while NBK transitions to fully-fledged IT.
  - Interest rate transmission is working but remains weak due to less developed domestic financial markets and subsidized lending.
  - Changes in global financial conditions (US monetary policy) have had limited impact so far but may affect Kazakhstan more as markets develop and attract foreign investors.
  - Fiscal dominance would undermine NBK’s credibility, crucial to anchor inflation expectations and improve policy tradeoffs.
- Structural reforms and broader strategy:
  - A broad reform approach is needed to address obstacles to effective IT implementation, aligned with NBK’s 2030 strategy.
  - Key areas for reform:
    - Further develop domestic capital markets.
    - Reduce dollarization.
    - Coordinate with fiscal policy.
    - Manage excess bank liquidity.
    - Eliminate non-core mandates and quasi-fiscal activities of the NBK.
  - Operational and communication enhancements:
    - NBK could explore alternative settings of the target band (e.g., emphasize a point inflation objective) to better communicate policy intentions and anchor expectations.
    - Conduct surveys of inflation expectations over horizons longer than one year and with larger coverage than households to better assess de-anchoring risks.

---

### Climate Change and Structural Transformation (selected points)

### High-level challenges and commitments
- Authorities committed to cut emissions by 15 percent relative to the 1990 level and to zero net emissions by 2060.
- Given reliance on fossil fuels and low energy prices, achieving commitments will likely require structural economic transformation and higher energy prices.
- Revenue mobilization from carbon taxation can support adjustment; long-term fiscal impact of reduced global oil demand appears manageable if early policy implementation reduces the non-oil deficit.

### Adaptation and mitigation: projections and vulnerabilities
- Historical and projected temperature changes:
  - Average annual temperatures were 0.3°C to 1.4°C warmer during 1997–2010 than 1971–2000.
  - Average rise of 0.28°C per decade between 1941 and 2011.
  - Long-term projections (end of 21st century relative to 1986–2005): average annual rise ranging from 5.8°C under the highest global emissions scenario to 2.1 °C in the lowest one.
- Precipitation projections less clear; most models predict an increase.
- Result: significant rise in frequency of heatwaves, droughts, and mudflows.
- Vulnerability:
  - Notre Dame ND-GAIN index indicates moderate vulnerabilities and good preparedness.
  - Hydrological changes threaten land degradation and agriculture: wheat yields could drop by up to 50 percent by 2050.
  - Higher frequency of natural disasters could threaten infrastructure and disrupt activity; investment in resilience and support for vulnerable groups is key.
- Emissions profile:
  - Kazakhstan was the 20th largest GHG emitter in 2020 and in the top ten by emissions per capita and relative to GDP.
  - Energy production accounts for 81 percent of total emissions: coal 50 percent, gas 20 percent; renewables contributed 3 percent.

### A. Need to transition: economic and structural context
- The fossil fuels energy sector contributes around 17 percent of GDP to Kazakhstan’s economy.
- The oil sector contributes to about 1/3 of fiscal revenues and about 60 percent of exports of goods.
- In many rural areas, coal is currently the only energy source for heating and electricity; new energy infrastructure will be needed throughout the country.
- Pre-tax energy subsidies are substantial, at 3 percent of GDP, and closer to 20 percent of GDP if the definition of subsidy also incorporates the impact of externalities.

### B. Kazakhstan’s climate policy commitments and announced measures
- Nationally Determined Contribution under the Paris Agreement:
  - Unconditional reduction of GHG emissions by 2030 of 15 percent from 1990 levels.
  - 25 percent reduction conditional on external support.
- Presidential announcement: intention to achieve net zero emissions by 2060.
- Government strategies and laws include Concept Note for the Transition to a Green Economy (2013), Action Plan for 2021–30 (Government Decree No 479 of 2020), preliminary Doctrine for Carbon Neutrality (DCN), and New Environmental Code (implemented mid-2021) envisaging largest 50 companies to replace old technologies by 2025.
- Key announced DCN measures:
  - Abandoning new coal-fired electricity generation projects and phasing out existing plants by 2025.
  - Planting 2 billion trees by 2025.
  - Doubling the share of renewable energy sources in electricity generation by 2030.
  - 100 percent sorting of municipal solid waste by 2040.
  - Sustainable agriculture on 75 percent of arable land by 2045.
  - 100 percent electrification of personal passenger transport by 2045.
  - Developing green hydrogen and eliminating coal-fired energy production from 2050 onwards.
  - Authorities contemplating construction of a nuclear plant for electricity generation within the next decade.
- An update of the DCN, including more detailed actions and assessments of macroeconomic and fiscal implications, is expected by mid-2022.

### C. Carbon pricing: current status and simulated increases
- Existing ETS: in 2020 covered about 40 percent of emissions with an average allowance price of USD 1.10 per t/CO2e.
- Current carbon price in Kazakhstan is low; explicit carbon tax embedded in the ETS is about US$ 1.10 per ton of CO2.
- Global benchmark: a global carbon tax of $75 per ton would reduce emissions to a level consistent with 2 degrees Celsius warming (IMF 2019).
- Simulated carbon tax scenarios for Kazakhstan:
  - Carbon tax of $25 per tCO2 (phased in gradually starting in 2022 and reaching $25 in 2030).
  - Carbon tax of $50 per tCO2.
  - Carbon tax of $75 per tCO2.

### D. Impact of a US$ 25 per tCO2 carbon tax on energy prices (projection for 2030 / 2022 baseline)
- Defined Policy Adjustment — Unit — 2022 — 2030 — 1/% change (projection including a US$ 25 per tCO2 carbon tax)
  - Gasoline — US$ per liter — 0.7 — 0.82 — 20.4
  - Diesel — US$ per liter — 0.7 — 1.05 — 53.6
  - LPG — US$ per liter — 0.6 — 0.61 — 10.7
  - Kerosene — US$ per liter — 0.8 — 0.9 — 11.5
  - Oil — US$ per barrel — 71.0 — 85.8 — 20.9
  - Coal — US$ per gigajoule (GJ) — 2.5 — 7.1 — 186.7
  - Natural gas — US$ per gigajoule (GJ) — 4.2 — 7.0 — 66.0
  - Electricity — US$ per kwh — 0.0 — 0.17 — 72.3

### E. Energy pricing reform implementation lessons
- Three critical building blocks from international experience:
  - Engaging proactively and early with the population and key stakeholders on the need for reform, its cost, mitigation strategies and expected benefits.
  - Depoliticizing the process of adjusting energy prices, notably through automatic formulas (especially to remove pre-tax energy subsidies) and a pre-defined path of tax changes.
  - Strengthening fiscal governance, including transparency, to ensure that funds derived from higher energy taxation are spent rightly.

### F. Fiscal implications: long-term fiscal sustainability and oil revenue
- Proven oil reserves used in projections: 30 billion barrels.
- Assumed long-term oil price (real US$ per barrel): 57 (October 2021 WEO scenario for first 5 years, then constant).
- Under assumptions of constant production, resource depletion is projected in 2056.
- Sustainable non-oil fiscal balance estimates:
  - Fiscal non-oil balance could converge to 2–3 percent of non-oil GDP in the long term (PIH-based anchors).
- Current staff projection: a non-oil primary deficit as a share of non-oil GDP of about 8 percent for the coming years.
- Scenario of global transition shock:
  - Simulated oil revenue decline: 40 percent starting in 2028 relative to baseline projections.
  - Result: permanent reduction of the non-oil primary balance (NOPB) as a share of non-oil GDP of about ½ percentage point per year.
  - Impact mitigants: substantial past oil savings in the NFRK and continued growth of the non-oil sector.
- Long-term anchor choices:
  - Keeping a real annuity per capita constant provides greater fiscal space in the medium term but depletes financial wealth faster than a constant share of non-oil GDP anchor.
  - Need to preserve buffers in liquid financial assets and/or maintain a low level of public debt.

### G. Growth and revenue implications of carbon taxation and revenue use
- Growth impact:
  - Short term: higher carbon tax compresses aggregate demand, lowering GDP growth (ceteris paribus).
  - Long term: if 60 percent of additional revenues are devoted to productive public investment and the rest to social spending, higher investment supports faster growth.
- Revenue potential from a $25 per tCO2 carbon tax (fully implemented):
  - Could generate additional fiscal revenues of 6 percent of GDP, about half from coal.
  - Revenues can strengthen social safety nets and finance infrastructure needed for the green transition.
  - Pace of revenue buildup tied to energy price adjustments; gains will dissipate over time as the economy becomes greener.

### H. Managing the transition: policy recommendations and planning needs
- Energy prices should be increased gradually, but starting as soon as possible, to allow time for the private sector to adjust and invest in energy-efficient technologies.
- Planning should start early to facilitate adjustments and assess cost implications of required public investment; these should be incorporated in the macro-fiscal framework.
- Actions needed:
  - Comprehensive strategy with early and sustained policy implementation.
  - In-depth public policy debate on social and economic objectives, including how to support structural transformation and how to share the country’s wealth with future generations.
  - Strengthen public financial management practices and adopt a medium-term strategy to strengthen non-oil revenue mobilization.
  - Protect the most vulnerable while allowing adequate time for private sector adjustment.

*IMF staff report excerpt (Republic of Kazakhstan) contained in the supplied PDF content.*

### 1. Summarizing Indicators of Macro-Financial Conditions ________________________________ 5

### 1kazea2022004 - 1. Summarizing Indicators of Macro-Financial Conditions

### Kazakhstan: macro context and objectives
- Quarterly growth (year-on-year) averaged over 10 percent in 2000-08 prior to the global financial crisis.
- Macro-financial data used in the analysis generally cover 1999Q4–2019Q4.
- Since 2015 monetary policy in Kazakhstan has been based on an inflation targeting (IT) regime with a target band of 4–6 percent for headline inflation.
- The NBK aims to achieve full-fledged IT by 2030 and has set a lower inflation target range of 3–4 percent by 2025.
- The paper applies the Growth-at-Risk approach to quantify macro-financial linkages in Kazakhstan and assess downside/upside risks to growth prospects.

### Macro-financial indicators and factor construction
- Four groups of macro-financial variables were summarized by their first principal component:
  - Domestic financial conditions: constructed from monetary variables and price-of-risk indicators; a higher value indicates tighter conditions (higher policy rate, higher deposit/lending rates, elevated sovereign risk premium); reserve money and broad money have negative loadings (e.g., Reserve Money loading -0.30, Broad Money loading -0.32).
  - Domestic credit conditions: positive loadings on level and growth of private credit, negative loading on banks’ capital (e.g., Private Credit, % of GDP loading 0.65; Capital to Risk-Weighted Assets loading -0.63).
  - External financial conditions: captures international funding cost and market volatility (VIX loading 0.72; 6-Month LIBOR loading 0.65; MOVE loading 0.24).
  - External demand: summarizes prospects in trading partners and competitiveness (International Oil Price loading 0.49; Terms of Trade loading 0.55; Growth of EU loading -0.53; Growth of CHN loading -0.42).

### Estimated quantile regression results: one-year horizon
- Domestic financial conditions:
  - Tightening domestic financial conditions signal negative one-year-ahead growth for all percentiles.
  - Estimated coefficients at the 10th and 25th percentiles are about twice the magnitude compared to other percentiles.
- Domestic credit conditions:
  - Favorable domestic credit conditions are positively correlated with good growth outcomes (75th and 90th percentiles).
  - No significant impact of domestic credit conditions on lower percentiles at the one-year horizon.
- External demand:
  - Unfavorable external demand is negatively associated with near-term growth prospects.
  - Estimated coefficients are of comparable sizes across percentiles, indicating country vulnerability to external trade shocks.
- External financial conditions:
  - Estimated coefficients are positive for above-median growth outcomes with borderline statistical significance.
- Statistical notes:
  - Bars in figures denote standardized quantile regression coefficients; solid bars indicate statistical significance at 5 percent (Figure 2) or 10 percent (Figure 3 for multi-year horizons).

### Persistence and multi-year effects
- Over 3–4 years:
  - The positive growth implications of tighter external financial conditions and the negative implications of unfavorable external demand remain statistically significant at 10 percent.
- Over 2–3 years:
  - Loose domestic credit conditions may aggravate bad growth outcomes, even though they may boost good growth outcomes in the near term.
- Domestic financial conditions:
  - Impact is short-lived and dissipates beyond two years.

### Simulated impacts: one-year ahead projected growth (post- vs pre-shock, in percent)
- Policy Rate +200 bps: 10th = -2.2 ; 50th = -2.1 ; 90th = -2.0
- EMBIG +200 bps: 10th = -2.0 ; 50th = -1.9 ; 90th = -1.9
- Private Credit, % of GDP -5 percent of GDP: 10th = -1.2 ; 50th = -1.0 ; 90th = -0.7
- 6-Month LIBOR +200 bps: 10th = 0.2 ; 50th = 0.5 ; 90th = 0.7
- Growth of EU -1 percent: 10th = -0.7 ; 50th = -0.7 ; 90th = -0.7
- Growth of CHN -1 percent: 10th = -0.4 ; 50th = -0.4 ; 90th = -0.4
- International Oil Price +$5: 10th = -2.9 ; 50th = -3.0 ; 90th = -3.0
- Note: Kazakhstan’s status as an oil exporter implies high oil prices strengthen fiscal and external positions, but the Growth-at-Risk analysis focuses on global demand channel and may not capture benefits of strong oil prices.

### Historical episodes and policy tradeoffs
- Two significant historical episodes with sharp deterioration at the lower (10th) percentile of projected growth:
  - Global Financial Crisis (GFC): falling global demand.
  - 2015–16: policy rate hike to counter currency pressures induced by the oil price decline and exchange rate regime shift.
- The analysis highlights a policy tradeoff:
  - Monetary policy tightening can reduce inflationary pressures but poses downside risks to growth.
  - Counter-factual simulations suggest permanent increases in the policy rate or sovereign risk premium, lower credit levels, weaker trading-partner growth, or permanently higher oil prices that dampen global demand reduce near-term projected growth.

### Outlook and policy implications drawn from Growth-at-Risk
- Main risks to growth outlook:
  - Elevated inflation.
  - Uncertain recovery prospects in trading partners.
  - Limited export diversification.
- Policy implications:
  - Further monetary tightening might be necessary if inflation pressure persists, but this could pose downside risks to growth; accommodative fiscal policies can mitigate these risks.
  - In the longer term, further export diversification in products and trading partners will help reduce vulnerability to external shocks and enhance resilience.

### DSGE-based findings on shocks and monetary policy transmission
- Key empirical findings from an estimated DSGE model:
  - Large depreciation can have substantial immediate and persistent impacts on inflation, implying difficult policy tradeoffs.
  - The interest rate channel is working but remains relatively weak due to structural features.
  - US monetary policy shocks so far have an insignificant impact on Kazakhstan.
  - Fiscal dominance could undermine the National Bank of Kazakhstan’s (NBK’s) policy credibility, which is crucial to anchor inflation expectations and improve policy tradeoffs.
- Structural and institutional features constraining transmission:
  - Kazakhstan is an oil-exporting country that imports most of its food and consumer goods; oil price declines tend to weaken the economy and raise inflation via tenge depreciation pass-through.
  - Interest rate transmission is hampered by underdeveloped domestic bond markets, excess bank liquidity, widespread credit subsidies, and elevated deposit dollarization.

*Source: IMF staff estimates and analysis as presented in 1kazea2022004 - 1. Summarizing Indicators of Macro-Financial Conditions.*

### 3. This note assesses the effectiveness of monetary  policy transmission channels based

### 1kazea2022004 - 3. This note assesses the effectiveness of monetary  policy transmission channels based

### A. A Brief Description of the Model and Estimation
- Model framework and objectives:
  - Based on the IMF’s quantitative IPF framework.
  - Two-country DSGE model estimated for Kazakhstan that includes both nominal rigidities and financial frictions.
  - Purpose: quantify the importance of frictions, magnitude and persistence of shocks, and assess alternative monetary policy responses.
  - Emphasizes anchoring inflation expectations so monetary policy can focus more on output stabilization; anchoring requires strong monetary and fiscal policy credibility.
  - For countries that recently adopted IT, such as Kazakhstan, building policy credibility takes time and additional policy tools may be necessary in specific cases.

- Key model features (New Keynesian, small open economy):
  - Incomplete international financial markets leading to volatile real exchange rates.
  - Local currency pricing and incomplete exchange rate pass-through.
  - Sticky nominal wages that can amplify exchange rate shocks.
  - Discounting in IS and Phillips curves to mute potency of future policies.
  - Micro-founded endogenous private and sovereign borrowing spreads.

- Four building blocks:
  - Aggregate demand:
    - Domestic demand (endogenous), government spending (exogenous), exports and imports (endogenous).
    - Exports depend on foreign demand and relative prices.
    - Imports disaggregated into consumption and intermediate goods; influenced by domestic consumption and relative prices.
    - Private borrowing spreads (partly endogenous, partly exogenous) enter the forward-looking consumption equation in addition to inflation adjusted policy interest rate.
  - Aggregate supply:
    - Domestic prices follow a Phillips curve.
    - Export and import pricing allow for gradual and persistent pass-through of exchange rate movements.
    - Wage growth adjusts gradually to catch up with long-term consumer price inflation, potentially amplifying exchange rate shocks if inflation expectations are not well anchored.
  - Financial block:
    - Banks lending and financiers trading currencies.
    - Two financial frictions: “agency friction” (financiers’ limited risk-bearing capacity) and balance sheet friction (banks’ occasionally binding collateral constraints), captured by private borrowing spreads.
    - These frictions modify the UIP condition and provide rationale for using FXI in certain cases.
  - Policy block:
    - Monetary policy reaction function: modified Taylor rule for the interest rate.
    - Central bank can also use FXIs.

- Estimation details:
  - Quarterly data 2003Q1–2020Q3 for Kazakhstan with Bayesian likelihood methods.
  - Structural parameters and shock processes estimated with standard priors (Table 1); steady-state ratios calibrated (Figure 1).
  - Uses ten structural shocks plus foreign shocks; foreign economy proxied by a pre-estimated closed U.S. economy model.
  - Observables include de-trended GDP, exports, imports, government spending (HP filter), core inflation, nominal wage growth, policy rate, long-term interest rate (10 years), real exchange rate, and FX reserves.

- FX intervention (FXI) specifications estimated:
  - (1) Baseline without FXIs.
  - (2) Exogenous FXI: AR(1) with an error correction mechanism; change in NBK FX reserves included as observable.
  - (3) Endogenous FXI rule motivated by financial frictions.
  - Estimation outcome: does not support that NBK uses FXIs systematically (see Table 2). FX interventions (changes in NBK’s FX reserves) have modest effects on the exchange rate.
  - Empirical example from staff estimates: an FXI (selling) of 10 percent of GDP would lead to about 1.2 percent appreciation of Tenge (contrast with Adler et al. and Blanchard et al. estimates of 15 percent appreciation for comparable interventions in a group of EMEs and small AEs).

### B. Impulse Responses Analysis
- Purpose:
  - Use estimated impulse response functions (IRFs) to analyze transmission channels and policy tradeoffs for key shocks: large tenge depreciation, effectiveness of interest rate channel, NBK response to COVID-style shocks.
  - Examine initial impact and persistence of domestic and external shocks; IRFs plotted in Figures 2–7.

- Key findings:
  - Exchange rate shocks:
    - More inflationary and persistent in Kazakhstan than most other EMEs.
    - Example: a 10 percent depreciation due to an UIP risk premium shock (Figure 2) shows larger inflation, larger policy rate increases, and sharper contractions in domestic demand for Kazakhstan relative to typical EMEs and AEs.
    - Indicates less well anchored inflation expectations and more difficult policy tradeoffs in EMEs, and even more so for Kazakhstan where exchange rate pass-through is larger and more persistent.
  - External adjustment:
    - A flexible exchange rate facilitates external account adjustments.
    - Example: a 10 percent depreciation improves the real trade balance more than the contraction in domestic demand, leading to an overall expansion in output (Figure 3). Result holds under alternative FXI assumptions.
  - Interest rate channel:
    - Relatively weak but still effective.
    - A 100 bp increase in the policy rate reduces domestic demand in Kazakhstan by only about half of the impact observed in a typical EME (Figure 4).
  - Fiscal shocks and policy coordination:
    - High government spending can crowd out private demand and undermines monetary credibility.
    - Scenario: a one-time 10 percent front-loaded transient increase in real government spending leads an independent central bank to increase policy rate by almost 200 bsp at the peak and maintain tight policy for 2–3 years.
    - If central bank is constrained by government financing needs, it may not maintain tight policy and price stability—policy credibility could be adversely affected.
  - Global monetary policy shocks:
    - Appear to have modest effects (Figure 6), consistent with Kazakhstan’s relatively low degree of financial integration and small share of foreign investors in domestic markets.
  - COVID-style combination shock (Figure 7):
    - Collapsing oil prices in March–April 2020: export demand fell sharply; rising global risk aversion led to sharp tenge depreciation.
    - NBK response: raised policy rate to 12 percent (from 9.25 percent) and intervened in FX market to limit volatility; later policy rate lowered to 9 percent and interventions ceased by summer 2020.
    - Overall tenge depreciation: 10 percent vis-à-vis the US dollar in 2020.
    - In second half of 2021, NBK raised the policy rate three times by a total of 75 bp as inflation rose above the target range.
    - Given persistent inflationary effects of depreciation, NBK should stand ready to raise policy rate as necessary to keep inflation expectations anchored.

### C. Historical Shock Decomposition
- Purpose:
  - Assess combined effects of all structural shocks on macro variables and how relative importance evolves over time (Figures 8–10 show contributions to output gap, inflation, and policy rate).

- Key results:
  - Output gap:
    - Driven by both domestic and foreign demand shocks.
    - Since 2015 and IT introduction, real exchange rate has gained a more important role.
    - Domestic demand tends to fall with tenge depreciation, declining imports, and rising private borrowing spreads.
  - Inflation:
    - Influenced primarily by exchange rate shocks (high pass-through) and global commodity price cycles.
    - Wage inflation has become more important since 2018.
  - Policy rate:
    - Reacted mainly to developments in domestic demand, foreign demand, exchange rate fluctuations, and wages.
  - Private borrowing spreads:
    - Consistently exerted pressure on output, weakening the interest rate channel of monetary policy.
    - Two plausible explanations (requiring further analysis):
      - (i) Tenge depreciation could increase deposit dollarization; given restrictions on dollar lending and open FX positions, banks would raise rates on tenge deposits (increasing lending spreads).
      - (ii) Given the 4-6 percent inflation band, banks may assume NBK would target 4 percent through a more aggressive monetary stance, leading to higher lending spreads.

### D. Policy Conclusions (Monetary Policy and NBK)
- Near-term policy stance:
  - NBK responded appropriately to the COVID crisis, but containing inflation may require further monetary tightening in the coming months.
  - Headline inflation is now well above the target range.
  - With recovery underway and the output gap closing, NBK needs to be ready for further tightening to reduce the risk of de-anchored inflation expectations in the medium term.

- Policy tradeoffs and vulnerabilities:
  - NBK faces difficult tradeoffs:
    - Flexible exchange rate helps external adjustment but large depreciation can create persistent inflationary pressures while NBK transitions to fully-fledged IT.
    - Interest rate transmission is working but remains weak due to less developed domestic financial markets and subsidized lending.
    - Changes in global financial conditions (US monetary policy) have had limited impact so far but may affect Kazakhstan more as markets develop and attract foreign investors.
    - Fiscal dominance would undermine NBK’s credibility, crucial to anchor inflation expectations and improve policy tradeoffs.

- Structural reforms and broader strategy:
  - A broad reform approach is needed to address obstacles to effective IT implementation, aligned with NBK’s 2030 strategy.
  - Key areas for reform:
    - Further develop domestic capital markets.
    - Reduce dollarization.
    - Coordinate with fiscal policy.
    - Manage excess bank liquidity.
    - Eliminate non-core mandates and quasi-fiscal activities of the NBK.
  - Operational and communication enhancements:
    - NBK could explore alternative settings of the target band (e.g., emphasize a point inflation objective) to better communicate policy intentions and anchor expectations.
    - Conduct surveys of inflation expectations over horizons longer than one year and with larger coverage than households to better assess de-anchoring risks.

### Climate Change and Structural Transformation (selected points)
- High-level challenges:
  - Kazakhstan needs to adapt to adverse natural phenomena, reduce carbon emissions from current high levels, and prepare for a low-carbon global economy.
  - Authorities committed to cut emissions by 15 percent relative to the 1990 level and to zero net emissions by 2060.
  - Given reliance on fossil fuels and low energy prices, achieving commitments will likely require structural economic transformation and higher energy prices.
  - Revenue mobilization from carbon taxation can support adjustment; long-term fiscal impact of reduced global oil demand appears manageable if early policy implementation reduces the non-oil deficit.

- Adaptation and mitigation:
  - Climate projections and impacts:
    - Average annual temperatures were 0.3°C to 1.4°C warmer during 1997–2010 than 1971–2000.
    - Average rise of 0.28°C per decade between 1941 and 2011.
    - Long-term projections (end of 21st century relative to 1986–2005): average annual rise ranging from 5.8°C under the highest global emissions scenario to 2.1 °C in the lowest one.
    - Projections for precipitation less clear; most models predict an increase.
    - Result: significant rise in frequency of heatwaves, droughts, and mudflows.
  - Vulnerability and preparedness:
    - Notre Dame ND-GAIN index indicates moderate vulnerabilities and good preparedness.
    - Hydrological changes threaten land degradation and agriculture: wheat yields could drop by up to 50 percent by 2050 (WB and ADB, 2021).
    - Higher frequency of natural disasters could threaten infrastructure and disrupt activity; investment in resilience and support for vulnerable groups is key.
  - Emissions profile:
    - Kazakhstan was the 20th largest GHG emitter in 2020 and in the top ten by emissions per capita and relative to GDP.
    - GHG emissions returned to 1990 level with economic growth since 2000s.
    - Energy production accounts for 81 percent of total emissions: coal 50 percent, gas 20 percent; renewables contributed 3 percent.

*International Monetary Fund.*

### 2020. Coal production generates significant employment, concentrated in few areas, which would be

### 2020. Coal production generates significant employment, concentrated in few areas, which would be

### A. Need to transition: economic and structural context
- The fossil fuels energy sector contributes around 17 percent of GDP to Kazakhstan’s economy.
- The oil sector contributes to about 1/3 of fiscal revenues and about 60 percent of exports of goods.
- In many rural areas, coal is currently the only energy source for heating and electricity; new energy infrastructure will be needed throughout the country.
- Pre-tax energy subsidies are substantial, at 3 percent of GDP, and closer to 20 percent of GDP if the definition of subsidy also incorporates the impact of externalities (e.g., on climate change and air pollution).

### B. Kazakhstan’s climate policy commitments and announced measures
- Nationally Determined Contribution under the Paris Agreement:
  - Unconditional reduction of GHG emissions by 2030 of 15 percent from 1990 levels.
  - 25 percent reduction conditional on external support.
- Presidential announcement: intention to achieve net zero emissions by 2060.
- Government strategies and laws:
  - Concept Note for the Transition of the Republic of Kazakhstan to a Green Economy (2013).
  - Action Plan for the Transition of the Republic of Kazakhstan to a "Green Economy" for 2021–30 (Government Decree No 479 of 2020).
  - Preliminary version of the Doctrine for Carbon Neutrality (DCN).
  - New Environmental Code (implemented mid-2021): envisages that the largest 50 companies (responsible for 80 percent of emissions) will replace old technologies by the best available technologies by 2025.
- Key announced DCN measures:
  - Abandoning new coal-fired electricity generation projects and phasing out existing plants by 2025.
  - Planting 2 billion trees by 2025.
  - Doubling the share of renewable energy sources in electricity generation by 2030.
  - 100 percent sorting of municipal solid waste by 2040.
  - Sustainable agriculture on 75 percent of arable land by 2045.
  - 100 percent electrification of personal passenger transport by 2045.
  - Developing green hydrogen and eliminating coal-fired energy production from 2050 onwards.
  - Authorities contemplating construction of a nuclear plant for electricity generation within the next decade.
- An update of the DCN, including more detailed actions and assessments of macroeconomic and fiscal implications, is expected by mid-2022.

### C. Carbon pricing: current status and simulated increases
- Existing ETS: in 2020 covered about 40 percent of emissions with an average allowance price of USD 1.10 per t/CO2e.
- Current carbon price in Kazakhstan is low; explicit carbon tax embedded in the ETS is about US$ 1.10 per ton of CO2.
- Global benchmark: a global carbon tax of $75 per ton would reduce emissions to a level consistent with 2 degrees Celsius warming (IMF 2019).
- Simulated carbon tax scenarios for Kazakhstan:
  - Carbon tax of $25 per tCO2 (phased in gradually starting in 2022 and reaching $25 in 2030).
  - Carbon tax of $50 per tCO2.
  - Carbon tax of $75 per tCO2.
- Quantitative assessment tool: IMF Carbon Pricing Assessment Tool (CPAT).

### D. Impact of a US$ 25 per tCO2 carbon tax on energy prices (projection for 2030 / 2022 baseline)
Defined Policy Adjustment — Unit — 2022 — 2030 1/% change (projection including a US$ 25 per tCO2 carbon tax)
- Gasoline — US$ per liter — 0.7 — 0.82 — 20.4
- Diesel — US$ per liter — 0.7 — 1.05 — 53.6
- LPG — US$ per liter — 0.6 — 0.61 — 10.7
- Kerosene — US$ per liter — 0.8 — 0.9 — 11.5
- Oil — US$ per barrel — 71.0 — 85.8 — 20.9
- Coal — US$ per gigajoule (GJ) — 2.5 — 7.1 — 186.7
- Natural gas — US$ per gigajoule (GJ) — 4.2 — 7.0 — 66.0
- Electricity — US$ per kwh — 0.0 — 0.17 — 72.3

### E. Energy pricing reform implementation lessons
- Three critical building blocks from international experience:
  - Engaging proactively and early with the population and key stakeholders on the need for reform, its cost, mitigation strategies and expected benefits.
  - Depoliticizing the process of adjusting energy prices, notably through automatic formulas (especially to remove pre-tax energy subsidies) and a pre-defined path of tax changes.
  - Strengthening fiscal governance, including transparency, to ensure that funds derived from higher energy taxation are spent rightly.

### F. Fiscal implications: long-term fiscal sustainability and oil revenue
- Proven oil reserves used in projections: 30 billion barrels.
- Assumed long-term oil price (real US$ per barrel): 57 (October 2021 WEO scenario for first 5 years, then constant).
- Under assumptions of constant production, resource depletion is projected in 2056.
- Sustainable non-oil fiscal balance estimates:
  - Fiscal non-oil balance could converge to 2–3 percent of non-oil GDP in the long term (PIH-based anchors).
- Current staff projection: a non-oil primary deficit as a share of non-oil GDP of about 8 percent for the coming years.
- Scenario of global transition shock:
  - Simulated oil revenue decline: 40 percent starting in 2028 relative to baseline projections.
  - Result: permanent reduction of the non-oil primary balance (NOPB) as a share of non-oil GDP of about ½ percentage point per year.
  - Impact mitigants: substantial past oil savings in the NFRK and continued growth of the non-oil sector.
- Long-term anchor choices:
  - Keeping a real annuity per capita constant provides greater fiscal space in the medium term but depletes financial wealth faster than a constant share of non-oil GDP anchor.
  - Need to preserve buffers in liquid financial assets and/or maintain a low level of public debt.

### G. Growth and revenue implications of carbon taxation and revenue use
- Growth impact:
  - Short term: higher carbon tax compresses aggregate demand, lowering GDP growth (ceteris paribus).
  - Long term: if 60 percent of additional revenues are devoted to productive public investment and the rest to social spending, higher investment supports faster growth.
- Revenue potential from a $25 per tCO2 carbon tax (fully implemented):
  - Could generate additional fiscal revenues of 6 percent of GDP, about half from coal.
  - Revenues can strengthen social safety nets and finance infrastructure needed for the green transition.
  - Pace of revenue buildup tied to energy price adjustments; gains will dissipate over time as the economy becomes greener.

### H. Managing the transition: policy recommendations and planning needs
- Energy prices should be increased gradually, but starting as soon as possible, to allow time for the private sector to adjust and invest in energy-efficient technologies.
- Planning should start early to facilitate adjustments and assess cost implications of required public investment; these should be incorporated in the macro-fiscal framework.
- Actions needed:
  - Comprehensive strategy with early and sustained policy implementation.
  - In-depth public policy debate on social and economic objectives, including how to support structural transformation and how to share the country’s wealth with future generations.
  - Strengthen public financial management practices and adopt a medium-term strategy to strengthen non-oil revenue mobilization.
  - Protect the most vulnerable while allowing adequate time for private sector adjustment.

*Italicized source attribution: IMF staff report excerpt (Republic of Kazakhstan) contained in the supplied PDF content.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1kazea2022004.pdf_