## 1kazea2024002

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---

### Overview and key facts
- Inflation peaked in early 2023 and ended the year at 9.8 percent.
- Headline inflation rose from 8.5 to 21 percent between January of 2022 and February of 2023.
- The NBK’s target band of 4-5 percent for 2023 was modified in July to a point target of 5 percent (also in effect for the medium term).
- Prepared by Alejandro Hajdenberg.

### Major drivers and recent quantitative context
- External shocks:
  - COVID-related supply chain disruptions, surge in commodity prices (mainly energy and food), and the war in Ukraine.
  - Russia accounted for over 40 percent of Kazakhstan’s imports prior to the war in Ukraine.
- Domestic factors:
  - Large fiscal stimulus during COVID (government package estimated at around 9 percent of GDP).
  - Accommodative monetary policy through 2021; NBK’s most significant policy adjustment was a 700 basis points increase in 2022.
  - Strong real wage gains in 2021–22, tight labor market (unemployment has stayed below 5 percent), sustained growth in bank consumer lending.
  - Regulated tariffs/energy prices affecting pass-through.
- CPI composition and key food items:
  - Food products represent about 40 percent of the CPI basket and were the main driver of the 2022 inflation surge.
  - Some key food items (bread, sugar, milk, eggs, vegetables) experienced particularly large price spikes.
- Government administrative responses implemented:
  - Temporary export bans, export quotas, customs duties on some goods, price caps/markup limits on “socially significant” food products and fuels, suspension of fuel price adjustments, utility tariff freezes, expanded agricultural subsidies, measures to increase import substitution and limit monopolistic behavior.

### External drivers — PCA decomposition (method and findings)
- Method:
  - PCA on monthly headline inflation for G20 and CCA countries, January 2017–September 2023, separating a global factor, a regional factor (CCA and Russia), and a country-specific component for Kazakhstan.
- Global factor:
  - Contributed to moderate inflation until early 2021 in a low world inflation context.
  - Started making a positive contribution in May 2021, increased until February 2023, then declined rapidly.
- Regional factor:
  - Did not play a significant role until 2021.
  - Contributed negatively from March 2021 until September 2022.
  - Since September 2022 has made a positive contribution, offsetting the smaller global factor (likely capturing Russia’s influence).
- Domestic (idiosyncratic) component:
  - Has been above the NBK’s target range during the whole period.
  - Smaller than the global factor but significant during the 2022 inflation rise.
  - Contributed to recent inflation moderation as well.

### Phillips Curve (augmented panel) — specification and key estimates
- Model specification:
  - Inflation regressed on lagged inflation, expected inflation, output gap (HP-filter based short-term indicator trend), annual change in NEER, and external factors (Brent oil, FAO food price index, average foreign inflation for G20), with country fixed effects.
- Data and estimation:
  - Monthly data for January 2016–July 2023, least squares with robust standard errors.
- Main empirical findings:
  - Inflation is highly persistent: lag coefficients between 0.48 and 0.67 in monthly-inflation specification.
  - Inflation expectations significant in standard model but lose significance when global variables are added.
  - Exchange rate depreciation is significant and associated with higher inflation (exchange rate pass-through present).
  - Foreign inflation is significant with a large coefficient.
  - Brent oil and FAO food prices do not play a major direct role for Kazakhstan (oil likely muted by tariff regulation; food effect largely captured by foreign inflation).
  - Economic slack (output gap) is not significant.

### VAR model — methodology and pass-through magnitudes
- Model specification and identification:
  - VAR with five endogenous variables: foreign inflation, NEER, imports price inflation, Kazakhstan’s STI, and domestic inflation.
  - Sample: monthly data January 2010–July 2023.
  - Unit root tests indicate series likely I(1); model estimated in differences of log values.
  - Results computed with 4 lags; identification via Cholesky ordering: foreign inflation, NEER, imports price inflation, STI, domestic inflation.
- Cumulative IRF findings for a one percent shock:
  - A 1 percent shock to foreign inflation translates into a 0.5 percentage point increase in domestic inflation almost immediately, with the effect building up over time.
  - A 1 percent depreciation leads to almost 0.25 percentage point increase in domestic prices, with:
    - a small initial impact,
    - an almost 0.2 percentage point impact after 3 months,
    - effect stabilizes after 6 months.
  - Result is almost identical to the 0.27 percent pass-through estimated by the 2017 SIP.
- Other variables:
  - IRFs for the STI and for imports prices are not statistically significant.
- Caveat:
  - Estimates become less precise as the time horizon extends; longer-term effects should be interpreted with caution.

### Implications from empirical analysis (inflation drivers)
- External factors (global and regional) accounted for a large share of the recent inflation surge; domestic factors were important and persistent.
- Exchange rate developments and foreign inflation are key transmission channels to domestic inflation.
- Given high persistence and unanchored expectations, monetary tightening until clear disinflation and re-anchoring of expectations is warranted.
- Administrative controls and price freezes risk undermining market signals; reliance on structural and macroeconomic policies and strengthening of the inflation-targeting framework is recommended.

### Policy guidance (near-term and medium-term)
- Near-term monetary policy:
  - Monetary policy should not be relaxed prematurely given inflation still above target, unanchored inflation expectations, and global uncertainty.
  - Premature monetary policy loosening should be avoided; adjustments should be consistent with a policy stance remaining contractionary.
- Medium-term monetary policy framework:
  - Continue strengthening the monetary policy framework to moderate inflation volatility and reach the inflation target.
  - Addressable issues: high exchange rate pass-through, strong inflation persistence, and unanchored inflation expectations.
  - NBK should continue implementing the “Monetary Policy Strategy 2030” to consolidate the inflation targeting regime, strengthen transmission, and improve policy transparency.
- Fiscal policy role:
  - Fiscal policy should remain supportive of price stability, preserve NBK credibility and independence, avoid political pressure, and support NBK policies.
  - Fiscal authorities should be countercyclical, allow automatic stabilizers to operate, provide stimulus during downturns, and build savings during upswings.
  - Kazakhstan's substantial fiscal buffers provide ample policy space.
- Administrative measures:
  - Administrative measures to control inflation (caps on energy and utility prices, limits on markups, trade restrictions) are costly, ineffective, and counterproductive.
  - Recommended focus: improve business environment, eliminate monopolistic behaviors, and strengthen social safety nets.

### The Kazakhstan Digital Tenge Project — status, design, and macro assessments
- Timeline and expectations:
  - NBK has explored a digital tenge (DT) since 2021; an initial launch occurred on November 15, 2023, with off-line and cross border transactions planned by 2025.
  - Full implementation expected by 2025.
  - Authorities expect a take up of the DT of about 5-10 percent of GDP.
- Design and operational model:
  - DT tested as a retail, token-based currency operating on distributed ledger technology and distributed in a two-tiered, hybrid operational model.
  - NBK issues tokens to STBs in exchange for reserves, monitors security, ensures participant connection, maintains the distributed ledger, and can halt, transfer balances, and restart the payment system if needed.
  - STBs distribute DT through digital account wallets and implement AML/CFT measures including customer due diligence.
- Uncertainties and design choices:
  - Feasibility of safe and unlimited off-line transactions unproven; quantitative limits for offline transactions may be needed to limit fraud risks.
  - Feasibility of unlimited low-cost payments unestablished; periodic reissuance of tokens may be required.
  - Design choices on anonymity, privacy, and consumer protection still under consideration.
  - Several laws will need amendments (banking activities, AML/CFT, data protection, taxation, Criminal Code).
- NBK macro assessments:
  - DT demand limited and estimated at about 10-25 percent of customers’ liquid assets.
  - A nonremunerated DT would reduce demand to 5–6 percent of GDP.
  - DT introduction would not increase the monetary base but would change the money supply structure.
  - Potential crowding out of bank deposits can be mitigated through quantitative restrictions on conversions or price measures.
  - The interest channel of monetary policy transmission would be strengthened due to complementarity of DT and cash.
- Further analysis needed:
  - Macro-financial implications likely to become evident over time; additional user demand scenarios should be considered under steady-state and stress conditions (e.g., confidence shocks triggering flight to safety).

### Economic impact of oil export disruptions — facts and scenario assessments
- Kazakhstan context:
  - Land-locked oil-exporting country servicing about 1.2 percent of global oil demand.
  - Exports about 66 million tons of crude per year (about 50 percent of the value of exports of goods, or 15 percent of GDP).
  - The Caspian Pipeline Consortium (CPC) carries about 80 percent of the country’s total oil exports.
- FSGM scenarios modeled:
  - M1 (Decline in oil production):
    - Two-year temporary decline in domestic oil production and exports.
    - Shock calibrated at 100 percent of annual oil real exports through the CPC pipeline with an immediate redirection of 10 percent of oil exports.
    - Assumptions: no storage capacity for non-exported oil; no permanent impact on oil production capacity; no exogenous changes in risk premia; continued market access; orderly functioning of all sectors; exogenous drop in private investment in oil sector.
  - M2 (Additional exchange rate pressures):
    - Builds on M1 and incorporates additional exchange rate pressures due to agents switching from tenge to dollar assets.
- Key simulation results:
  - Output:
    - GDP decreases initially by about 11 percent relative to the baseline in response to the two-year large decline in oil production.
    - In the third year, full oil export capacity is regained and growth is above trend, reconverging back to trend in the fourth year.
  - Exports:
    - Nominal oil exports through the CPC pipeline amount to about 82 percent of total oil exports.
    - In period one, real oil exports decrease by about 75 percent implying a decrease in total real exports by about 45 percent.
    - Real exports remain depressed at this level until converging back to trend in period three.
  - Consumption:
    - Real consumption remains above the baseline by about 1 percent in M1 despite the large fall in output.
    - In M2, consumption falls below the baseline because of a larger negative wealth effect from a significant increase in the real interest rate.
  - Investment:
    - Real investment decreases by about 10 percent relative to the baseline in the short term.
  - Current account and exchange rate:
    - Current account balance deteriorates by about 4 percentage points of GDP relative to the baseline.
    - Real imports decline by about 13 percent.
    - Real effective exchange rate depreciates by 4–5 percent each year.
  - Inflation and monetary policy:
    - In M1, inflation decreases by about 1½ percentage points below the baseline due to the negative output gap and tighter monetary policy.
    - In M2, monetary policy tightens to contain exchange rate volatility and capital outflows.
  - Fiscal effects:
    - Overall fiscal balance decreases by about 9 percentage points of GDP per year during the recession in M1, and by about 10 percentage points in M2.
    - Additional requirements are financed by issuing debt.
- Buffer adequacy and financing:
  - General government gross debt is about 23 percent of GDP.
  - NFRK foreign assets are about 26 percent of GDP (or slightly less than twice the financing needs in the two scenarios).
  - A full closure of the CPC pipeline for two years with immediate redirection of 10 percent of CPC capacity is estimated to generate additional financing needs of about 8-  9 percent of GDP per year.
  - Under baseline assumptions (orderly functioning and continued market access), buffers are sufficiently large to absorb the shock and sustain demand.
- Risks to baseline:
  - Losing market access would drastically reduce the government’s ability to fill additional gross financing needs by issuing debt.
  - Disorderly behavioral responses and capital flight would greatly aggravate the magnitude and domestic impact of the shock and reduce the effectiveness of available buffers.
- Additional model assumptions and sensitivities:
  - Simulations assume flaring of oil that cannot be exported to maintain drilling infrastructure; no permanent impact on production capacity.
  - With spare storage capacity, production could continue until storage is exhausted, smoothing the impact and lowering gross financing needs.
  - Consumption smoothing depends on LIQ and OLG consumer shares: LIQ consumers assumed 60 percent of consumers (comparator: US and other advanced economies calibration uses 35 percent).
  - A lower share of LIQ consumers would increase consumption smoothing and make the recession less pronounced.

*Prepared by Keiko Honjo, Gregorio Impavido, Nadia Mounir; IMF staff report content provided in content unit 1kazea2024002.*

### 1. Inflation in Kazakhstan and the CCA  _________________________________________________ 4

### 1. Inflation in Kazakhstan and the CCA

### Overview and key facts
- Inflation peaked in early 2023 and ended the year at 9.8 percent.
- Headline inflation rose from 8.5 to 21 percent between January of 2022 and February of 2023.
- The NBK’s target band of 4-5 percent for 2023 was modified in July to a point target of 5 percent (also in effect for the medium term).
- Prepared by Alejandro Hajdenberg.

### Major drivers (summary)
- External shocks: COVID-related supply chain disruptions, surge in commodity prices (mainly energy and food), and the war in Ukraine.
- Domestic factors: large fiscal stimulus during COVID, accommodative monetary policy through 2021, strong real wage gains in 2021–22, tight labor market, sustained growth in bank consumer lending, and regulated tariffs/energy prices affecting pass-through.
- Government response included temporary export bans, export quotas, customs duties on some goods, price caps/markup limits on “socially significant” food products and fuels, suspension of fuel price adjustments, utility tariff freezes, expanded agricultural subsidies, and measures to increase import substitution and limit monopolistic behavior.

### Policy guidance (from the paper)
- Monetary policy should not be relaxed prematurely given inflation still above target, unanchored inflation expectations, and global uncertainty.
- Other macroeconomic policies should support the disinflation process.
- Administrative measures to control inflation should be avoided.
- Continue efforts to strengthen Kazakhstan’s inflation targeting framework to reduce inflation volatility.

---

### Recent developments and quantitative context
- Russia accounted for over 40 percent of Kazakhstan’s imports prior to the war in Ukraine.
- The government implemented a package of (on and off-budget) measures estimated at around 9 percent of GDP to support the economy during the pandemic.
- The NBK’s most significant policy adjustment was a 700 basis points increase in 2022.
- Unemployment has stayed below 5 percent.
- Food products represent about 40 percent of the CPI basket and were the main driver of the 2022 inflation surge.
- Some key food items (bread, sugar, milk, eggs, vegetables) experienced particularly large price spikes.

---

### External Drivers of Inflation (PCA decomposition)
- Method: Principal component analysis (PCA) on monthly headline inflation for G20 and CCA countries, January 2017–September 2023, separating a global factor, a regional factor (CCA and Russia), and a country-specific component for Kazakhstan.
- Global factor:
  - Contributed to moderate inflation until early 2021 in a low world inflation context.
  - Started making a positive contribution in May 2021, increased until February 2023, then declined rapidly.
- Regional factor:
  - Did not play a significant role until 2021.
  - Contributed negatively from March 2021 until September 2022.
  - Since September 2022 has made a positive contribution, offsetting the smaller global factor (likely capturing Russia’s influence).
- Domestic (idiosyncratic) component:
  - Has been above the NBK’s target range during the whole period.
  - Smaller than the global factor but significant during the 2022 inflation rise.
  - Contributed to recent inflation moderation as well.

---

### Phillips Curve estimation and role of persistence, expectations, and external variables
- Model specification (panel cross-country augmented PC): inflation regressed on lagged inflation, expected inflation, output gap (HP-filter based short-term indicator trend), annual change in NEER, and external factors (Brent oil, FAO food price index, average foreign inflation for G20), with country fixed effects.
- Estimation sample and method: monthly data for January 2016–July 2023, least squares with robust standard errors.
- Main empirical findings:
  - Inflation is highly persistent (large coefficients on lagged annual inflation). Monthly-inflation specification produced lag coefficients between 0.48 and 0.67, still indicating high persistence.
  - Inflation expectations are significant in the standard model but lose significance when global variables are added.
  - Exchange rate: depreciation is significant and associated with higher inflation (exchange rate pass-through present).
  - Foreign inflation: significant with a large coefficient.
  - Brent oil and FAO food prices: do not play a major direct role in the augmented PC for Kazakhstan (oil likely muted by tariff regulation; food effect largely captured by foreign inflation).
  - Economic slack (output gap): not significant, consistent with prior regional findings.

---

### Implications for policy and further analysis
- External factors (global and regional) accounted for a large share of the recent inflation surge; domestic factors were important and persistent.
- Exchange rate developments and foreign inflation are key transmission channels to domestic inflation.
- Given high persistence and unanchored expectations, monetary tightening until clear disinflation and re-anchoring of expectations is warranted.
- Administrative controls and price freezes risk undermining market signals; reliance on structural and macroeconomic policies and strengthening of the inflation-targeting framework is recommended.

*Source: Prepared by Alejandro Hajdenberg; IMF staff calculations and analysis.*

### 13.      A vector autoregression (VAR) model provides insights into the dynamic relationship

### 13.      A vector autoregression (VAR) model provides insights into the dynamic relationship among inflation drivers

### VAR methodology and model specification
- VAR methodology helps assess causality and duration of different shocks and circumvents endogeneity problems present in single equation PC approaches.
- Advantage: explicit measures of inflation expectations are not needed if included variables approximately span agents’ information set.
- Model estimated with five endogenous variables: foreign inflation, NEER, imports price inflation, Kazakhstan’s short-term economic indicator (STI) and domestic inflation.
- Unit root tests:
  - Variables in levels (foreign prices, imports prices, domestic prices, STI, and NEER) are non-stationary, the NEER at a lower level of significance.
  - First differences strongly reject the null, indicating all series are likely integrated of order 1.
- Model estimated in differences of the log values.
- Formal lag selection criteria: likelihood ratio method suggests 6 lags, Akaike Information Criteria suggests 2, Bayesian Information Criteria suggests 1.
- Results presented computed with 4 lags; results do not vary significantly with other lag lengths.
- Sample: monthly data for the period January 2010-July 2023.
- Identification for orthogonalized impulse response functions (IRFs) via Cholesky decomposition with ordering: foreign inflation, NEER, imports price inflation, STI, domestic inflation.

### Estimation findings: drivers and pass-through magnitudes
- Exchange rate pass-through and foreign prices are key inflation drivers.
- Cumulative IRFs for a one percent shock:
  - A 1 percent shock to foreign inflation translates into a 0.5 percentage point increase in domestic inflation almost immediately, with the effect building up over time.
  - A 1 percent depreciation leads to almost 0.25 percentage point increase in domestic prices, with:
    - a small initial impact,
    - an almost 0.2 percentage point impact after 3 months,
    - the effect stabilizes after 6 months.
  - This result is almost identical to the 0.27 percent pass-through estimated by the 2017 SIP.
- IRFs for the STI and for imports prices are not statistically significant.
- Note: estimates become less precise as the time horizon extends and longer-term effects must be interpreted with caution.

### Data and estimation diagnostics (selected)
- Variables: five endogenous variables (foreign inflation, NEER, imports price inflation, STI, domestic inflation).
- Sample period: January 2010-July 2023 (monthly).
- Lag length used for results: 4 lags (alternative lag selections: 6, 2, 1).
- Series likely integrated of order 1; model estimated in differences of log values.
- Identification: Cholesky decomposition with specified ordering.

### Conclusions and policy implications (inflation)
- External vs domestic drivers:
  - Kazakhstan’s inflation surge after the Covid-19 pandemic largely reflected inflation imported from the rest of the world due to higher commodity prices, value chain disruptions, and currency depreciation, amplified by the war in Ukraine.
  - Domestic contributors included expansionary fiscal policy to mitigate the Covid-19 shock, delayed monetary policy tightening, rapid wage and credit growth, and strong persistence.
  - Ongoing disinflation mirrors the global trend and tighter fiscal and monetary policies, but transmission has been partially offset by regional inflation related to the war in Ukraine and a decoupling of Russia’s economy from the rest of the world.
- Looking ahead:
  - Key external drivers and sources of uncertainty: the evolution of the war in Ukraine, the pace of global disinflation, and developments in China.
  - Geopolitical fragmentation and supply chain disruption continue to pose risks.
  - Domestically, the expected reduction of energy and utility subsidies will be an important factor in the coming years.
- Near-term monetary policy guidance:
  - Premature monetary policy loosening should be avoided given the volatile external environment, strong inflation persistence, and stubbornly high inflation expectations.
  - This does not imply the policy rate should not be reduced, but adjustments should be consistent with a policy stance remaining contractionary.
- Medium-term monetary policy framework:
  - Continue strengthening the monetary policy framework to moderate inflation volatility and reach the inflation target.
  - Addressable issues include high exchange rate pass-through, strong inflation persistence, and unanchored inflation expectations.
  - The NBK should continue implementing the “Monetary Policy Strategy 2030” to consolidate the inflation targeting regime, strengthen transmission, and improve policy transparency.
- Fiscal policy role:
  - Fiscal policy should remain supportive of price stability, preserve NBK credibility and independence, avoid political pressure, and support NBK policies.
  - Fiscal authorities should be countercyclical, allow automatic stabilizers to operate, provide stimulus during downturns, and build savings during upswings.
  - Kazakhstan's substantial fiscal buffers provide ample policy space.
- Administrative policies:
  - Administrative measures to control inflation (caps on energy and utility prices, limits on markups, trade restrictions) are costly, ineffective, and counterproductive.
  - Such measures can be fiscally costly, distortionary, discourage production, stimulate demand, and have international spillovers.
  - Recommended focus: improve business environment, eliminate monopolistic behaviors, and strengthen social safety nets.

### The Kazakhstan Digital Tenge Project (summary of findings and status)
- NBK has explored a digital tenge (DT) since 2021; an initial launch occurred on November 15, 2023, with off-line and cross border transactions planned by 2025.
- Design and testing:
  - The 2021 project tested DT as a retail, token-based currency operating on distributed ledger technology and distributed in a two-tiered, hybrid operational model.
  - In the model, NBK issues tokens to STBs in exchange for reserves, monitors security, ensures participant connection, maintains the distributed ledger, and can halt, transfer balances, and restart the payment system if needed.
  - STBs distribute DT through digital account wallets and implement AML/CFT measures including customer due diligence.
- Expected implementation and take-up:
  - Full implementation expected by 2025.
  - Initial launch on November 15, 2023, in Almaty for online-only transactions by residents.
  - Off-line and cross-border transactions planned by 2025.
  - Authorities expect a take up of the DT of about 5-10 percent of GDP.
- Uncertainties and design choices:
  - Feasibility of safe and unlimited off-line transactions unproven; quantitative limits for offline transactions may be needed to limit fraud risks.
  - Feasibility of unlimited low-cost payments unestablished; periodic reissuance of tokens may be required.
  - Design choices on anonymity, privacy, and consumer protection still under consideration.
  - Several laws will need amendments (banking activities, AML/CFT, data protection, taxation, Criminal Code).
- NBK macro assessments indicate:
  - DT demand limited and estimated at about 10-25 percent of customers’ liquid assets.
  - A nonremunerated DT would reduce demand to 5–6 percent of GDP.
  - DT introduction would not increase the monetary base but would change the money supply structure.
  - Potential crowding out of bank deposits can be mitigated through quantitative restrictions on conversions or price measures.
  - The interest channel of monetary policy transmission would be strengthened due to complementarity of DT and cash.
- Further analysis needed:
  - Macro-financial implications likely to become evident over time; additional user demand scenarios should be considered under steady-state and stress conditions (e.g., confidence shocks triggering flight to safety).

### Economic impact of oil export disruptions (introductory findings)
- Kazakhstan context:
  - Land-locked oil-exporting country servicing about 1.2 percent of global oil demand.
  - Exports about 66 million tons of crude per year (about 50 percent of the value of exports of goods, or 15 percent of GDP).
  - The Caspian Pipeline Consortium (CPC) carries about 80 percent of the country’s total oil exports.
- Scenario assessment:
  - Kazakhstan may withstand a two-year closure of the CPC pipeline under an orderly scenario with continued market access.
  - In such an orderly scenario, additional external and fiscal financing needs of about 8-  9 percent of GDP per year could be filled by issuing debt or drawing down on NFRK assets.
  - Under a disorderly scenario (including sudden capital outflows and widespread flight from tenge into dollar assets), available buffers would be depleted more rapidly.

*Italic: Source — IMF staff report content provided in content unit 1kazea2024002.*

### 2.      We use the IMF’s Flexible System of Global Models (FSGM) to assess the impact of

### 2. We use the IMF’s Flexible System of Global Models (FSGM) to assess the impact of such a disruption.

### Model description
- The FSGM is an annual, multi-region general equilibrium model of the global economy used at the IMF to analyze risk scenarios and policies with implications for growth, inflation, and public and external accounts.
- The model is semi-structural: some elements (private consumption and investment) have micro-foundations; other elements (trade, labor supply, inflation) have reduced-form representations.
- The Middle East and Central Asia Department Module (MCDMOD) of the FSGM is used to simulate an oil production shock in Kazakhstan, with oil treated as one of three commodities in the model (the other two being food and metals).

### Scenarios modeled
- Decline in oil production (M1):
  - Two-year temporary decline in domestic oil production and exports.
  - Shock calibrated at 100 percent of annual oil real exports through the CPC pipeline with an immediate redirection of 10 percent of oil exports.
  - Assumptions for M1: no storage capacity for non-exported oil; no permanent impact on oil production capacity; no exogenous changes in risk premia; continued market access; orderly functioning of all sectors; an exogenous drop in private investment reflecting foreign investors’ unwillingness to invest in the oil sector until exports resume.
- Additional exchange rate pressures (M2):
  - Builds on M1 and incorporates additional exchange rate pressures due to agents switching from tenge to dollar assets as observed in past episodes of severe exchange rate volatility.

### Simulation results — macroeconomic impacts
- Output:
  - GDP decreases initially by about 11 percent relative to the baseline in response to the two-year large decline in oil production.
  - Decline in output driven by falling exports, decrease in investment and private consumption (notably in M2), partially limited by a decrease in imports and the fiscal response.
  - In the third year, full oil export capacity is regained and growth is above trend, reconverging back to trend in the fourth year.
- Exports:
  - Nominal oil exports through the CPC pipeline amount to about 82 percent of total oil exports.
  - In period one, real oil exports decrease by about 75 percent implying a decrease in total real exports by about 45 percent.
  - Real exports remain depressed at this level until converging back to trend in period three.
- Consumption:
  - Real consumption remains above the baseline by about 1 percent despite the large fall in output in M1.
  - Support for consumption comes from an increase in government expenditure in excess of revenue shortfall via fiscal transfers to liquidity constrained (LIQ) households, overlapping generations (OLG) consumers’ expectations about future tax liabilities, and the temporary nature of the shock.
  - In M2, consumption falls below the baseline because of a larger negative wealth effect from a significant increase in the real interest rate affecting OLG consumers.
- Investment:
  - Real investment decreases by about 10 percent relative to the baseline in the short term.
  - Demand falling below supply potential opens a negative output gap, putting downward pressure on inflation and raising real interest rates.
  - Higher real corporate rates reduce private investment and firm profitability.
  - Public investment is exogenous and does not change; in the longer term, real investment is temporarily above baseline driven by lower corporate real interest rate supporting a positive output gap.
- Current account balance:
  - The current account balance deteriorates by about 4 percentage points of GDP relative to the baseline.
  - Nominal exports decrease more than nominal imports.
  - Real imports decline by about 13 percent in response to the negative output gap.
  - The real effective exchange rate depreciates by 4–5 percent each year, helping contain the current account deterioration.
- Monetary response and inflation:
  - In M1, inflation decreases by about 1½ percentage points below the baseline due to the negative output gap and tighter monetary policy.
  - Policy stance responds to inflation deviations from target and the output gap; it is forward-looking and anchored somewhat to the exchange rate.
  - The model calibration reflects high dollarization in Kazakhstan and authorities’ sensitivity to exchange rate volatility.
  - In M2, an exogenous exchange rate pressure capturing conversion of savings into dollars leads monetary policy to tighten to contain exchange rate volatility and capital outflows.
- Fiscal response, budget deficit, and net debt:
  - The shock reduces oil and non-oil public revenues and, to limit unemployment and support consumption, the government increases public expenditure in excess of the revenue loss.
  - The overall fiscal balance decreases by about 9 percentage points of GDP per year during the recession in M1, and by about 10 percentage points in M2.
  - Additional requirements are financed by issuing debt.

### Additional assumptions and sensitivity
- Financing options:
  - General government gross debt is about 23 percent of GDP.
  - NFRK foreign assets are about 26 percent of GDP (or slightly less than twice the financing needs in the two scenarios).
  - Additional gross financing needs are assumed filled by new debt in baseline simulations; alternatively, drawing down NFRK assets is possible and would not increase interest payments and would likely imply a smaller exchange rate depreciation.
- Impact on oil production capacity:
  - Simulations assume flaring of oil that cannot be exported to maintain drilling infrastructure; no permanent impact on production capacity.
  - A permanent negative impact on production capacity would lower trend GDP, alter convergence to the steady state, reduce relative fiscal buffers, and likely exacerbate the positive output gap in period 3 unless policy is recalibrated.
- Storage capacity:
  - With spare storage capacity, production could continue until storage is exhausted, smoothing the impact on real GDP; shallower recession would lower gross financing needs and make fiscal buffers relatively larger.
- Consumption smoothing and household types:
  - The model includes LIQ (liquidity constrained) and OLG consumers.
  - LIQ consumers (assumed 60 percent of consumers) do not save and cannot smooth consumption, drastically curtailing consumption when the shock hits.
  - OLG consumers are non-Ricardian, treat government debt as wealth, expect tax liabilities to fall on future generations, access financial markets, and smooth consumption—supporting private consumption during the recession.
  - The share of LIQ consumers is 60 percent (comparator: US and other advanced economies model calibration uses 35 percent).
  - A lower share of LIQ consumers would increase consumption smoothing, make the recession less pronounced, and make fiscal buffers relatively larger.
- Temporary shock and expectations:
  - OLG consumers know the shock is temporary and continue to consume; higher uncertainty about duration would reduce consumption smoothing, deepen the recession, and reduce the relative size of fiscal buffers.

### Conclusions and policy implications
- Buffer adequacy under baseline assumptions:
  - A full closure of the CPC pipeline for a known period of two years, with immediate redirection of exports of 10 percent of CPC capacity, is estimated to generate additional financing needs of about 8–9 percent of GDP per year.
  - With general government debt at about 23 percent of GDP and NFRK foreign assets of about 26 percent of GDP, buffers are sufficiently large to absorb the shock and sustain demand under assumptions of orderly functioning of all sectors and continued market access.
- Risks to baseline conclusions:
  - Losing market access would drastically reduce the government’s ability to fill additional gross financing needs by issuing debt.
  - Disorderly behavioral responses and capital flight would greatly aggravate the magnitude and domestic impact of the shock and reduce the effectiveness of available buffers.

*Prepared by Keiko Honjo, Gregorio Impavido, and Nadia Mounir.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1kazea2024002.pdf_