• During the years 2000-2007 the Kazakhstan economy enjoyed an extended period of very rapid growth, with real GDP growth averaging 10 percent annually. The expansion was underpinned by the development of the oil sector, prudent macroeconomic policies, structural reforms, and increased access to global financial markets. As a result, real per capita incomes have doubled since 2000 and social indicators have generally improved.
• The global financial turmoil that began last summer had a significant impact on the Kazakhstan economy. Market perceptions of risk on Kazakhstan's assets rose sharply last September and remain relatively elevated.
• Economic growth is expected to drop back significantly in the wake of the financial shock, but is still likely to sustain significant growth. The IMF are forecasting GDP growth of 5 percent in 2008 and a modest recovery to 6.25 percent in 2009.
• Consumer price inflation is still running at very high levels (20% in both June and July) but the month on month figures have begun to ease and it is realistic to expect a decline to single digit rates by year-end.
• The current account is projected to move into surplus in 2008 following the large deficit last year, due to higher oil and commodity prices and much slower import growth.
Country Outlook
Kazakhstan, officially known as the Republic of Kazakhstan, lies in both Central Asia and Europe. Ranked as the ninth largest country in the world by size, it is also the world's largest landlocked country, with a territory of some 2,727,300 km² (greater than the whole of Western Europe). It is bordered by Russia, Kyrgyzstan, Turkmenistan, Uzbekistan and China. On the other hand, and despite its enormous size, Kazakhstan has a comparatively small population. No one actually has an exact idea of the current size of the Kazakhstan population (not to mention the thorny issue of just how many foreign migrants live and work there), but the US Census Bureau International Database lists Kazakhstan’s population as 16.763 million. Whatever the exact figure Kazakhstan’s population level, after falling substantially in the early 1990s as ethnic Russians and the Volga Germans left, has now stabilised, and is virtually stationary. This stagnant population is, in fact, a significant obstacle to the full development of the massive resource base Kazakhstan has at its disposal – it is not much of an exaggeration to desribe Kazakhstan as a country which is sitting above some 95% of component items in the periodic table of elements. The development of a comprehensive and inter-cultural approach to inward migration is likely to be one of the major challenges to the Kazakh authorities moving forward.
Kazakhstan Central Asia’s largest energy producer and its $100 billion economy has largely grown at the 10 percent a year rate since 2000 on the back of the revenue accruing from these resources (see chart below). As the years past and the momentum developed this rapid GDP growth sparked in its wake a substantial construction boom, and it was the bursting of this boom in the autumn of 2007 - on the back of the seize-up in global wholesale money markets which followed August's financial turmoil in the USA - which lies at the heart of Kazakhstan's current growth slowdown. In fact the pace of Kazakhstan's economic expansion dropped back to a 5.3 percent rate in the first quarter of 2008 - only half what was achieved in the same period a year earlier, following a dramatic curtailment in bank lending. If Kazakhstan is able, despite all the problems, to maintain some sort of growth momentum at the present time then this is undoubtedly the result its ability to leverage oil and other commodity resources, and indeed the country increased crude production by an annual 6.3 percent in the first four months of the year, according to recent government data.
Kazakhstan's industrial output growth has, however, steadily lost momentum in 2008 as the slowdown in the building industry lead to a slump in cement and other materials production. Cement production was down 26 percent year on year in January, while copper and rolled iron output declined an annual 13 percent, and output from refineries and manufacturers decreased an annual 2.9 percent. Thus there is thus plenty of evidence for a very sharp shock having hit the local economy in the last quarter of 2007. However some sort of slight recovery is already underway, and industrial production rose 3.8 percent in the January-June period when compared with a year earlier, according to the most recent data from Astana-based State Statistics Agency.
In addition, since the country is so rich in resources, and since the first half of 2008 saw a very significant global commodities boom, there were other economic sectors for the country to fall back on, and mining production was up 6 percent from a year earlier in the first quarter, bolstered by an increase in natural gas and coal output, which climbed 15 percent and 11 percent respectively.
Apart from oil and gas Kazakhstan has a huge array of potential resource reserves just waiting to be tapped. Among these there is copper. London-listed Kazakhmys accounts for the bulk of Kazakh copper output - and this was down 17.5 percent year-on-year in January-April. Industrial output in Karaganda region, home to Kazakhmys and Arcelor Mittal mines and smelters, declined 5.5 percent year-on-year in January-April.
Kazakhmys said first-quarter output fell 9.9 percent on ``severe winter weather'' and repairs at its Balkhash smelter.Production of finished copper plates, or cathodes, from the company's ore fell to 75,500 metric tons, from 83,800 tons a year earlier. So these drops in output are, in many cases not directly associated with the credit crunch, but may indicate a lack of experience in adequately deploying the new technologies the inward investment is making available (skilled labour scarcity?), and they do give some idea of the challenging environment in which the mining and extraction industries work in Kazakhstan. Realistically speaking, however, it seems quite likely that output in these sectors will return to more normal levels during the second-half of 2008, and in any event rebounding significantly from the low point reached in the first-quarter.
Credit Downgrades
Kasakhstan is primarily suffering from the effect of a construction slump following the imposition of a credit crunch. Concern about the rate of expansion in domestic credit in the country goes back to an IMF report in October 2006 which said the pace of credit growth and external borrowing in Kazakhstan was making lenders more vulnerable to external shocks such as a reduction in the availability of financing.
But the crunch itself only came following the forecast reduction in the availability of financing following the August 2007 financial turmoil produced by the US sub-prime crisis. Some of the Central Asian nation's banks, struggling to borrow from overseas financial institutions after the collapse of the U.S. subprime mortgage market, almost completely ceased lending to homebuyers and builders in September 2007.
And when the stop came, it came abruptly. Kazakhstan bank sales of Eurobonds and syndicated loans, which had totaled $8.63 billion during the first eight months of 2007, suddenly plummeted to an estimated $300 million in the three months from October to December. Hence it is possible to talk about Kazakhstan having experienced a "sudden stop".
Essentially the local banks had been financing lending by borrowing in the global wholesale money markets, and the doors to these were pretty much shut in their faces (just like they were shut in the faces of the Spanish banks, the only other global case of similar magnitude) in September 2007.
This evolving situation lead to an ongoing series of "reappraisals" of Kazakh bank creditworthiness on the part of the credit ratings agencies, with Standard and Poor's downgrading the country's foreign currency-denominated debt rating one level to BBB- in October and revising its outlook on Kazakh banks to negative in December. Fitch Ratings also changed its outlook on Kazakhstan's long-term issuer default ratings to negative in December. Even Kazahstan's sovereign rating outlook was revised to negative by S&P in late April.
Credit-default swaps shot up, and those on Kazkommertsbank, for example, surged in June to 694 basis points from an earlier 225 basis points, according to CMA DataVision. CDS contracts, which are used to speculate on a company or country's ability to repay debt, increase when perceptions of credit quality worsen. Contracts on the country's debt cost148 basis points at the end of 2007, compared with 34 basis points at the end of May. The current level is twice that of Russia's debt, which generally has similar credit ratings.
External indebtedness shot up, with Kazakhstan banks' foreign liabilities rising 490 percent in dollar terms between 2004 and the start of 2008 - to $13.5 billion - as they leveraged their investment-grade ratings to borrow abroad and lend to consumers and real-estate developers. This debt has now become impossibly difficult to refinance because of investor wariness about all but the highest-rated debt. Kazakhstan's central bank holds about $20 billion of reserves and the country's oil fund has around a further $15 billion, so if push comes to shove they should be able to ensure Kazakh banks have sufficient funds to meet their obligations.
As well as the banks, Kazakh homebuyers also found themselves suddenly left out in the cold by the global credit shortage. In Almaty, Kazakhstan's biggest city, about 30 people were to be seen on March 18 peering into a hole in the ground which was all that was to be found where they expected to see their new apartments rising. Work had stopped on the project after builder AO Corporation Kuat declared it was unable to get the additional funding it needed to continue.
About 29,000 people are estimated to have had prepaid for apartments which were uncompleted when the September squeeze arrived. More than 140 housing projects were halted in Almaty alone, forcing the government to say it was going to provide $4 billion of emergency funding to get contractors working again. Kazakh construction companies had sold 280 billion tenge ($2.32 billion) of unfinished apartments by September, including 170 billion tenge financed by mortgages, according to government statistics.
Homebuyers have in fact been receiving some help from the government, which in March 13 voted to provide $500 million to help banks finance loans to builders in Almaty, although many are still vociferous in their protests the money has not been arriving as promised to the actual building work on their flats. The governments announced $4 billion emergency investment program also includes funds to purchase 6,000 uncompleted apartments in Astana alone. Prices for residential property soared by 30.2 percent in 2007, reaching a record average high of 161,300 tenge ($1,338) per square meter, up from 123,900 tenge in 2006.
The rate of increase of new property prices has been declining steadily since last autumn (see chart above), and indeed prices in the large cities like Almaty and Astana are now falling substantially.
Inflation and the central bank response
Kazakh inflation accelerated in July, reaching an annual rate of 20 percent, the highest level since March 2000. Food prices, which as elsewhere are one of the key drivers of the inflation, were up by a monthly 1.8 percent in June and by 8.1% since the end of December 2007.
The recent surge in inflation is all the more significant since inflation had been kept pretty tightly under control since the start of the recent growth spurt in 2000. Despite the weakening internal demand, Kazakhstan's central bank left its benchmark interest rate unchanged at 11 percent until the July meeting, following a 2% rate increase in December.
The authorities place a high priority on reducing inflation, hence the absence of interest rate cuts, but they did recently cut the reserve requirement on foreign liabilities (to 6 percent from 8 percent) to help bank liquidity in the face of the crisis. The current policy stance is an attempt to balance a number of policy goals—preserving financial stability, cushioning downside risks to growth, and ensuring that inflation is on a firm downward path. The government have introduced a ban on wheat and vegetable oil exports until September and October, respectively, in an effort to contain food prices and ensure sufficient reserves for domestic consumption (wheat exports to the Kyrgyz Republic are exempt). The NBK take the view that weaker growth will likely help reduce inflation pressures in the coming months, but emphasized that it will be closely monitoring developments and is prepared to adjust its policy stance as needed. The NBK sees changes in its policy interest rate as an increasingly effective monetary policy instrument, although they also stress that exchange rate management remains a very important tool for influencing macro performance, and the IMF in their latest Article IV Consultation by and large accepted this view.
The IMF take the view that a well-crafted response is needed mitigate the negative effect of higher food prices on poorer sections of the population, while encouraging increased production of food products in the future. Given the strong fiscal position, they feel there is scope to introduce well-targeted government subsidies to low income households to help offset the higher cost of food. This, in their view, would be a better response than measures that seek to influence prices, including trade restrictions, as these reduce incentives for higher production. They are also undoubtedly right in pointing out that efforts to boost agricultural production and improve distribution systems would offer additional help to alleviate price pressures going forward.
The Financial Sector
Banks dominate Kazakhstan’s financial system, and account for 80 percent of total assets. These banks are mostly locally and privately owned, although foreign participation has increased recently. The system is highly concentrated, with the largest five banks accounting for 78 percent of market share. Banks are very reliant on external financing, with external liabilities making up about 45 percent of the aggregate balance sheet. Easy access to external funding fueled very rapid domestic credit growth, which expanded at an annual average rate of 70 percent from end-2004 to August 2007, bringing bank credit to around 75 percent of GDP by end-2007. Lending was mainly to households, and to the trade and construction sectors (the oil sector is not reliant on domestic banks for its financing).
Then came the "sudden stop" and confidence in Kazakhstan's banks plumetted, with the consequence that household deposits contracted sharply during the August–October period and nonresidents sold about $4 billion worth of tenge assets — mostly held in central bank notes — putting in the process significant downward pressure on the value of the tenge.
Kazakhstan has, however, large financial resources with which to confront the current situation. Official foreign currency assets totaled $46 billion in early June, comprising NBK reserves of $21 billion and oil fund (NFRK) assets of $25 billion. Commercial banks also have foreign assets of which about $3.5 billion are thought to be liquid. Total foreign assets broadly match foreign liabilities when the intracompany debt of the oil sector is excluded, while liquid foreign currency assets comfortably cover potential short-term foreign currency drains.
The NBK has established a framework for liquidity support for “financial stability purposes” and in addition to the NBK’s refinance window, banks that have signed a “Memorandum of Cooperation and Interaction on Financial Stability” have access to exceptional liquidity support from the NBK. The NBK has also expanded the list of collateral it accepts at its refinance window, and has increased the capital of the deposit insurance fund, although it acknowledges that the fund would only be sufficient to cover deposits in the event of small banks failing. The limit on individual deposit insurance is currently T 700,000 ($5,800 or about 85 percent of per capita income), a level that covers about 90 percent of household depositors. To help manage financial difficulties at a bank, changes in the banking law are also being considered.
These changes would increase the authorities’ ability to react quickly to adverse developments in a bank’s financial position, including through public capital injections (under the current legislation, the government can only inject capital into a bank when its capital ratio is below zero).
NFRK assets consist of a stabilization portfolio of about $5 billion (invested in short-term debt securities) and an investment portfolio (invested in longer-term debt and equity securities). While the NFRK fulfils both a stabilization and savings role, at present the government has no intention to use the Fund’s assets to help cushion the downturn. Indeed, the government spent only 86 percent of the guaranteed transfer from the NFRK last year, and expects the mandated transfer to be adequate to meet spending needs this year.
Exchange rate stability is a central policy objective of the NBK. At present, exchange rate stability is viewed as essential for maintaining depositor confidence, limiting the risks from the large foreign currency exposure of the corporate sector, and helping reduce inflation.
After substantial nominal appreciation of the tenge in the first half of 2006, the NBK stepped up intervention in the second half and the exchange rate depreciated. On average, the tenge appreciated during 2006 by 7½ percent and 4 percent in real and nominal effective terms, respectively. The tenge resumed its upward trend in 2007, appreciating by about 6 percent against the dollar during January– April.
Following the credit crunch in September and the massive outflow in deposits, the tenge came under considerable pressure, but the NBK managed to put a stop to the bloodletting by October.
Downward pressures on the exchange rate has abated since the turn of the year, and foreign currency reserves have been rising, in part due to the decision to delay the automatic conversion of oil fund revenues into foreign currency assets. The country’s official foreign assets (NBK reserves and NFRK assets) are now well above the level reached prior to the onset of market volatility in August 2007. Intervention in the foreign exchange market has been substantially scaled back (as a share of total transactions) in recent months, although the NBK stands ready to intervene in the market if downward pressures on the exchange rate re-emerge. The authorities continue to view the exchange rate regime as a “managed float with no predetermined path for the exchange rate.”
Current Account Issues
Following deficits in 2006 and 2007 (2.4% and 6.6% GDP respectively) the current account is projected to move into surplus in 2008 largely due due to higher oil and commodity prices and much slower import growth. Total goods and commodity exports (including oil) are projected to rise from 48.3 billion USD in 2007 to 71.5 billion dollars in 2008 (a 47.8% increase), while imports will only grow from 33.2 billion USD in 2007 to 35.8 billion USD in 2008 (a 7.8% increase), largely due to weakening domestic demand (imports were up 37.7% in 2007, IMF data and estimates). This improvement in the trade surplus is one of the factors currently supporting headline GDP growth.
The income balance will continue to deteriorate, as will the capital and financial account, largely due to a decline in FDI and a withdrawal of funds from equities.
The Fiscal Dimension
The fiscal position in Kazakhstan is very strong, with a large budget surplus and low public debt. The nonoil fiscal deficit this year is expected to remain below the level staff estimate to be consistent with maintaining per capita oil wealth constant in real terms. The government therefore has room to allow the automatic fiscal stabilizers to operate, rather than seeking to offset any shortfalls in tax revenue that may occur as a result of the slowing economy. Indeed, measures to increase tax rates or lower expenditures to meet previously set fiscal targets could aggravate the slowdown or lead to an inefficient allocation of resources where export taxes keep domestic prices artificially low.
Outlook on Key indicators
• Looking forward, growth is expected to remain relatively subdued. Assuming limited bank access to external financing and only modest deposit growth, credit to the economy is likely to decline in real terms. Nonoil GDP growth is forecast by the IMF at 4.7 percent this year, down from 9.2 percent in 2007, with spillovers from the oil sector partly mitigating the impact of the credit crunch. Oil output should support somewhat stronger overall growth of close to 5 percent in 2008. A strengthening in growth to 6.25 percent is projected next year assuming global financial conditions improve and pressures on bank balance sheets are reduced.
• With banks repaying debt, the external debt/GDP ratio is projected to fall sharply this year, and appears to be on a sustainable path under a range of scenarios. After surging late last year, CPI inflation has eased on a month-to-month basis this year, and in the absence of further oil or food price shocks, is expected to fall below 10 percent by year-end, from the present 20 percent. Despite a weakening in nonoil tax revenues, the overall budget surplus is projected to increase to 6.75 percent of GDP in 2008 due to strong oil revenue growth.
• Risks are on the downside and a significantly weaker growth outturn than in the baseline forecast cannot be ruled out. A prolonged period of tight conditions in global financial markets, a substantial drop in oil prices, and/or a domestic event that triggered a loss of confidence in the banks would adversely affect the economy. In such cases, real credit wou decline sharply, growth would weaken further, NPLs would jump, and bank capita ratios would decline. NPLs would increase more if the exchange rate depreciated given unhedged foreign currency exposure in the nonoil corporate sector.
• The current economic climate is challenging, but Kazakhstan has considerable financial resources to help it weather the situation, and medium-term growth prospects remain favorable. The policy response of the authorities to the drying-up of external financing has so far been broadly appropriate, and policies should continue to focus on managing risks to the outlook and setting the stage for a resumption of strong and sustained growth.
• Delaying adjustment, for example by replacing maturing external borrowing with new higher-cost, short-maturity funding, is likely to increase vulnerabilities in the future. Banks should have in place plans to maintain liquidity, preserve asset quality, and continue to meet solvency standards, including, if necessary, by raising additional capital.
• If downward pressures on the exchange rate were to resume, a number of steps could be taken to support the tenge, including: continuing to delay conversion of the oil fund receipts into dollars; encouraging commercial banks to use their own foreign currency assets to meet external debt repayment obligations; and intervening in the foreign exchange market, although under a clear operational rule that limits the amount of reserves committed to defend the exchange rate. When conditions in financialmarkets improve, a return to a more flexible exchange rate policy would be desirable.
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