IMF Executive Board Concludes 2018 Article IV Consultation with the Republic of Kazakhstan
On September 12, 2018, the Executive Board of the International Monetary Fund (IMF) concluded the 2018 Article IV consultation with the Republic of Kazakhstan, considering and endorsing the staff’s appraisal without meeting.
Growth has strengthened in Kazakhstan supported by higher oil production and increased activity in trade and manufacturing. Robust exports have contributed to an improvement of the external current account. Inflation has declined and remained within the target band of the National Bank of Kazakhstan (NBK). This, along with anchoring of inflationary expectations, has allowed the NBK to undertake several interest rate cuts. While medium-term growth prospects are favorable, there are also domestic and external risks.
Steps have been taken to address weaknesses in the banking sector, including purchase of non-performing assets, capital support, withdrawing licenses of banks that were in violation of prudential regulations and legal changes aimed at strengthening the NBK’s supervisory powers.
With the winding down of fiscal stimulus programs and following the provision of funding to the banking sector in 2017, fiscal consolidation is envisaged. This is underpinned by improvements in tax administration and expenditure reforms, notably in health and education.
The authorities’ structural reform agenda aims at addressing dependence on natural resources, including by making public administration more efficient and the business environment more favorable, addressing governance issues, advancing privatization, fostering greater competition, and investing in infrastructure.
Executive Board Assessment
Recovery is continuing from shocks that began in 2014, with a pick-up of growth in 2017. The authorities’ response of fiscal support, exchange rate flexibility, pursuit of inflation targeting, funding to stabilize the banking sector, and implementation of structural reforms has been instrumental and helped by increased exports of oil and metals..
Growth is expected to remain solid, although there are risks. Overall growth will likely slow as the increase of oil production moderates, but non-oil growth should increase further over the medium term, reflecting structural reforms and financial repair and deepening. Non-oil growth could be higher if far-reaching reforms are implemented decisively. Risks relate to commodity prices, due both to higher prices and prospects for a lower impulse for reforms, and to lower prices, lower export earnings and fiscal revenues, and pressures on the tenge. Policy slippages are another risk, along with slower growth in key trading partners (Russia and China), tighter or volatile global financial conditions, and a deepening of global trade or geopolitical tensions. On the upside, the Belt-Road Initiative (BRI) and reforms in next-door Uzbekistan provide an opportunity for greater integration, trade, investment, and diversification.
Fiscal consolidation is underway, as countercyclical spending has been completed and given the need to restore buffers. Ambitious and complex reforms are underway in health and education, public-private partnerships (PPPs) and outsourcing, and public employment; these should be carefully rolled out. The authorities are considering issuance of a tenge Eurobond; this could attract foreign investors and establish a benchmark.
Further fiscal adjustment is expected in the medium term, with the non-oil deficit reaching levels consistent with long-term sustainability. This is driven by higher revenues, mainly from tax administration gains from the VAT and enhanced technology. This is positive, although projected gains may be ambitious. The authorities’ plan to reduce the personal income tax (PIT) rate for low-income earners is also positive; to further enhance progressivity, a moderate increase of PIT rates for high-income earners could be considered. Review of tax incentives and the tax regime for mining should be undertaken. The level of budgetary capital spending is low by international standards, and additional, high-quality outlays should be considered, in a deficit-neutral way, in tandem with higher non-oil revenues. Finally, efforts to further strengthen fiscal transparency and risk management, including monitoring of state-owned enterprises and PPPs, are needed.
The focus of monetary policy should remain on price stability. Declining inflation and stabilization of expectations have allowed the NBK to undertake interest rate cuts. This has been broadly appropriate, given developments and the outlook, and is consistent with keeping real interest rates close to neutral levels. Going forward, a cautious approach to further accommodation is warranted, given the changing balance of risks. In addition, quasi-fiscal initiatives aimed at providing longer-term financing should be targeted and temporary, incorporate robust risk-sharing and market funding arrangements, and be undertaken by the budget and not the NBK. As the recovery gains momentum, bank balance sheet issues are resolved, and structural reforms advance, credit should pick up more broadly, allowing the large stock of NBK notes to be unwound.
Efforts to improve monetary operations and domestic financial markets should continue. NBK notes have helped manage liquidity and build the short end of the yield curve. Money-market rates have stayed within the NBK’s corridor, close to the lower bound. There is scope for strengthening cooperation between the NBK and the government on liquidity management and market issues, including management of SOE funds. A review and changes to the complex system of reserve requirements are also warranted. The flexible exchange rate regime has served Kazakhstan well by helping to absorb changes in the macro environment and support dedollarization. The NBK would benefit from strengthening transparency and communications with respect to foreign exchange purchases and sales, including on behalf of the NFRK and the national pension fund (UAPF).
Despite extensive and costly financial support to banks, risks and challenges remain. Most importantly, Kazakhstan’s banks need to adopt a strengthened business model, with enhanced governance, management, and operations. The sector continues to experience difficulties from weak credit-risk management and NPLs. Actions are needed, including in asset quality and governance, supervision and regulation, emergency liquidity assistance, credit subsidies, collateral and foreclosure, and disposal of distressed assets. Legal, institutional, and operational constraints affecting the Problem Loan Fund should be addressed. Further strengthening of the resilience of the banking sector will contribute to sound macro-financial linkages and growth, while reducing risks.
Reducing the state’s footprint and advancing governance reforms are also critical. A thriving private sector is needed to realize the authorities’ aspiration of joining the world’s thirty most developed countries by 2050. This calls for decisive steps. While the various reform initiatives are ambitious and comprehensive, the state remains predominant. Progress is being made, but the challenge is to ensure that changes on paper lead to deep and meaningful changes in practice. With recovery now underway, extensive state support risks cementing a culture of reliance on subsidies. The growth impetus should move firmly to the private sector, with the state focusing on facilitating the business environment and enhancing infrastructure, connectivity, and inclusivity. Successful initial public offerings (IPOs) of “blue-chip” SOEs would send a strong signal, along with further efforts to modernize rail and road networks, liberalize trade, enhance domestic competition, and improve land use and agriculture infrastructure. Opportunities to enhance connectivity and diversify under the BRI should be seized. On governance, far-reaching and complex efforts to make the civil service more professional, enhance use of technology in public administration, and strengthen accountability are welcome and should proceed.
The next Article IV consultation is expected to take place on the standard 12-month cycle.
Source: International Monetary Fund
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