Press Release No. 15/367

Press Release: IMF Executive Board Concludes 2015 Article IV Consultation with Kazakhstan

August 5, 2015

On July 31, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Kazakhstan and considered and endorsed the staff appraisal without a meeting.²

Against the backdrop of external shocks, economic growth and inflation have decelerated, financial conditions have tightened, and external imbalances are emerging. Real GDP growth slowed to an annualized 2 percent during the first quarter of 2015, down from around 4 percent in 2014 and 6 percent in 2013. In addition to weaker external demand, slower growth was driven by the impact of lower income and profitability (resulting from lower oil prices) and confidence effects (reflecting regional developments) on private consumption and domestic investment. The external position has deteriorated largely due to the fall in oil prices, with the current account balance turning negative in the second half of 2014, although there has been some improvement in the current account during the first quarter of 2015. At the same time, Kazakhstan’s real effective exchange rate (REER) has appreciated over the past year, mainly reflecting the depreciation of the ruble and sharp appreciation of the U.S. dollar, against which the tenge is managed. In the face of slowing demand and a more stable exchange rate, headline inflation fell from 7.4 percent year-on-year at end-2014 to 3.9 percent year-on-year at end-June, 2015. In mid-July, following the decline in sovereign spreads and reduced currency pressures, the authorities successfully issued a $4 billion sovereign bond and widened the exchange rate band from 170–188 to 170–198 tenge/dollar.

Real GDP growth is projected to decelerate to 2 percent in 2015. Weaker demand from Russia and China, lower oil prices, confidence effects, and continuing delays in the Kashagan oil field are the main factors behind the projected slowdown. Next year, growth is projected to pick up to 3.25 percent, driven by gradual recovery in oil prices and external demand. Still, the medium-term growth outlook is less favorable than projected last year, given the impact of lower oil prices and continued slow growth in Russia on non-oil potential growth in Kazakhstan.

The fiscal stimulus aimed at supporting growth has led to deterioration in the fiscal accounts, with the overall fiscal surplus falling from 5 percent of GDP in 2013 to 1.7 percent of GDP in 2014. Monetary conditions have tightened, which, together with lower economic activity, have slowed lending activity sharply. At the same time, the NBK has made progress in improving its monetary policy framework and operations, while administrative and prudential measures have succeeded in lowering the level of non-performing loans (NPLs). In line with the 2014 FSAP recommendations, the authorities have started to undertake bottom-up stress tests for banks. The NBK has also initiated discussions with bank supervisors in other jurisdictions to strengthen cross-border supervision. The authorities have embarked on an ambitious structural reform program, bolstered by extensive engagement with the Multilateral Development Banks. In June, 2015 Kazakhstan completed negotiations to become a formal member of the WTO.

Executive Board Assessment³

In concluding the 2015 Article IV consultation with Kazakhstan, Executive Directors endorsed staff’s appraisal, as follows:

Amid slower economic growth, tighter financial conditions, and emerging imbalances, policies should balance ensuring sustainability while alleviating the impact of shocks in the near term. In recent years the authorities have successfully harnessed oil resources to bolster economic growth and build buffers. However, economic growth has now decelerated largely as a result of likely long-lasting external shocks and is expected to remain subdued this year and next year. Moreover, the outlook for growth is subject to predominantly downside external risks. In view of weaker growth, the large and likely long-lasting nature of the shocks, and the accumulated buffers, the policy response in the short term should be geared toward supporting the economic recovery. Over the medium term, there is a need to further strengthen macroeconomic policy frameworks, to bolster resilience to shocks and promote durable growth.

To ensure fiscal sustainability, the stimulus must be accompanied by credible medium-term fiscal consolidation and more transparent fiscal policy framework. The stimulus is justified on countercyclical grounds and is appropriately frontloaded and tailored to support growth. However, to ensure a sustainable path for the non-oil deficit, the stimulus must be accompanied by credible medium-term consolidation measures, especially on the revenue side. In particular, there is scope to strengthen the enforcement of tax collection, reduce tax exemptions, including in the Special Economic Zones, and make income tax rates more progressive. Moreover, enhancing the fiscal policy framework is critical to ensuring transparency and medium-term sustainability. Key priorities include expanding the budget coverage to all fiscal activity, in line with GFSM 2001, and integrating fiscal policy into a broader macroeconomic policy framework.

Greater exchange rate flexibility in tandem with the introduction of new monetary policy instruments is needed to enhance the policy architecture and address imbalances. The authorities have taken confidence-building measures to overhaul the monetary policy framework in support of their medium-term goal of adopting inflation targeting, and have widened the exchange rate band. However, with the aim of more effectively managing liquidity and signaling the stance of policy, the authorities should speed up the planned introduction of a new policy interest rate, supported by open market operations. Moreover, strengthening the policy architecture requires further exchange rate flexibility, which will support a more independent interest rate policy and help reduce imbalances. To avoid undermining financial stability, and anchor expectations about policy intentions and operations, the authorities should communicate their plans openly and consistently.

In view of rising vulnerabilities, further actions are needed to bolster financial sector resilience. Efforts underway to reduce the level of NPLs are paying off. However, more needs to be done to bring down the level of NPLs to sustainable levels, while ensuring that the achievement of the 10 percent prudential ceiling by end-2015 does not compromise proper loan classification and provisioning. In this regard, while the recent plans to refocus the NPL resolution framework at the merged KKB-BTA entity is appropriate, weaknesses in the bank should be addressed and an asset quality review be undertaken within a broad strategy to ensure long-term viability. Strengthening financial sector resilience also requires introducing higher risk weights or exposure caps on corporate lending, limiting FX lending to unhedged borrowers, and tightening net open position limits to mitigate credit risk. Further steps in implementing the FSAP recommendations include adopting risk-based assessment tools and supervision and finalizing legislative amendments in insurance, pensions, and the securities market.

The structural reform agenda is appropriately ambitious, but effective implementation is essential to achieving sustainable and inclusive growth. Priority areas include strengthening human capital, building institutions, bolstering the rule of law, enhancing financial intermediation, and improving the business climate. Close collaboration with MDBs in these areas should facilitate greater efficiency in the procurement and implementation process. Moreover, diversification away from the oil sector and the reduction of the state footprint in the economy are necessary conditions to ensuring successful implementation of the broader private-sector-led growth strategy.