Republic of Kazakhstan—2010 Article IV Consultation Concluding Statement of the IMF Mission
June 8. IMF
The following statement reflects the views of an International Monetary Fund (IMF) mission, led by Ana Lucia Coronel, that visited Astana and Almaty during May 26-June 8, 2010 to conduct discussions for the 2010 Article IV consultation. The mission reviewed recent economic and financial sector developments and discussed ongoing and envisaged policy responses and economic prospects. The mission met with government, parliament and central bank officials, and representatives of the international, banking and business communities. The mission would like to thank the authorities for the open discussions and fruitful collaboration.
1. Global economic activity has begun to recover, but the pattern of growth is uneven and financial conditions remain fragile. Overall, the rebound in global growth and the improvement in financial conditions have not been enough to compensate for the ground lost during the recession. Macroeconomic policies in most economies are expected to remain supportive of growth and employment, although in some faster growing emerging economies, policies must balance against the risks from rising capital inflows. Advanced countries are faced with the challenge of fiscal consolidation to address rising levels of public debt and the consequent risks to global financial stability. Bank capital constraints, private sector deleveraging, and ongoing regulatory reform will likely continue to limit wide-ranging access to credit, highlighting global financial uncertainties and downside risks to global growth.
2. Against this background, Kazakhstan’s economy is expected to recover. Growth is aided by stronger trade and continued policy stimuli, but remains constrained by banking sector difficulties. Public sector support and externally driven activity in the mining and manufacturing sectors contributed to a strong economic rebound in the last few months of 2009, but credit expansion is subdued despite ample bank liquidity, and activity in key sectors, such as construction and real estate, remains sluggish. IMF staff projects the economy to expand by about 4 percent this year, reflecting developments through the first quarter of 2010. However, weak non-oil activity and continued deleveraging of private sector balance sheets will likely limit the growth of consumer demand. The government’s plans to improve productivity and advance economic diversification could support an increase in growth towards its projected potential of about 6 percent over the next 5 years, but this will require a healthy, adequately capitalized, and well regulated financial system.
3. Despite significant public sector support to banks, the financial sector remains under stress and there is a need to fully address the underlying vulnerabilities. The banking system has been stabilized with large scale capital and liquidity support. The successful external debt restructurings of Alliance Bank and BTA have been key in stabilizing the financial positions of these banks, which are now ready to employ new business models. Nonetheless, the ongoing sharp increase in nonperforming loans (NPLs) across banks and economic sectors reflects banks’ excessive exposure to currency induced credit risk stemming from the combination of a low and dollarized deposit base, the reliance on foreign funding, and risky lending practices. Therefore, actions should be taken to:
• Swiftly design and implement a comprehensive and transparent resolution of NPLs. Given the ongoing deterioration in asset quality, the associated effects on provisioning and capital, and the increasing prospect for higher minimum capital requirements at the international level, it is essential that banks, in conjunction with the Kazakhstani authorities, take more forceful and broad action to reduce NPLs. This would help to effectively rehabilitate the financial system and support a level of credit growth consistent with the necessary deleveraging of the corporate sector. There is no guarantee that higher GDP growth will automatically solve the banks’ bad debt problems, and the maintenance of a high stock of NPLs could act as a significant drag on growth prospects. While the aggregate provisioning level of the banking system is currently high, it has been declining. A full diagnostic assessment of systemically important banks would help to establish whether there is scope for remedial measures at the bank level, or whether there is a need for a more centralized approach to deal with bad assets. Such assessment should also determine any needs for additional capital and a contingent plan for recapitalization.
• Address the vulnerabilities that led to the deterioration of the quality of bank credit portfolios. Given the challenges ahead, the government should continue to strengthen the Financial Supervision Agency’s authority, independence, legal protection, and resources to credibly address weaknesses and risks that became apparent during the crisis. This includes continued action to curb overseas borrowing (especially short term) by banks, raise provisioning requirements on foreign currency loans to insufficiently hedged borrowers, strengthen banks’ governance frameworks, encourage appropriate asset valuation methods, transparency and accountability, and forego regulatory forbearance, especially regarding the banks under state control. The unwinding of public support to the financial sector will need to be carefully calibrated to minimize market impacts. Continued public sector support to promote lending to specific sectors such as SMEs should be well focused to avoid the emergence of future bad credits.
4. Monetary policy will need to find the balance between keeping inflation under control and supporting the financial sector and real economy. In the presence of higher growth, inflationary pressures need to be continuously monitored and real interest rates kept positive to support depositor confidence and prevent inflation from surpassing the projected 6-8 percent range. Once the banking sector difficulties are addressed, the economy would benefit from greater market determination of the exchange rate and lower central bank intervention. This would enhance the effectiveness of monetary policy and the economy’s response to external shocks, such as commodity price movements and exchange rate developments of trading partners. It would also promote better management of exchange rate risk and thus support dedollarization against an improved macroeconomic and financial sector backdrop. Efforts to deepen domestic financial markets—including liquid futures and forward markets in foreign exchange—and promote risk diversification are needed to encourage the demand for holding and transacting in tenge, and ensure that private domestic savings become the primary source of financing of productive activities.
5. The authorities should withdraw fiscal stimulus gradually, while raising the efficiency of public spending. With large international reserves and low debt, the public sector is well positioned for continued support of the economic recovery, albeit at a lower level than in 2008 and 2009. However, the quality of public projects should be consistent with growth objectives, and hard-to-reverse outlays—including subsidies and excessive public sector wage increases—should be avoided. The economy will also benefit from improved tax administration to reduce tax evasion. Once the most pressing difficulties in the banking and real sectors are resolved, the fiscal position should be brought back to a conservative path with a phasing out of the contingent liabilities of the public sector. Importantly, the assessment of fiscal sustainability would benefit from an aggregate approach that comprises all fiscal transactions (including those that are off-budget) within a medium-term framework. This framework should reflect judgments on the optimal combination of savings and use of oil and commodity revenues—perhaps supported by an appropriately defined fiscal rule—to allow for countercyclical fiscal policy, and encourage economic diversification.
6. On the road to sustainable economic growth, Kazakhstan needs to address a dual challenge in the period ahead: addressing the bank weaknesses while reinvigorating economic activity. Restoring banks’ balance sheets and resolving banks’ underlying vulnerabilities is the immediate priority. Public sector support is still critical in the near term, but a strategy to gradually unwind this support—including the phasing out of the contingent liabilities—is needed. These efforts should be supplemented by effective bank supervision and careful medium-term budget planning. The need for removal of public entity deposits from banks, divestment of equity stakes in the system, and withdrawal of the stimulus-oriented budget spending has to be balanced against the need to sustain economic recovery. In parallel, a greater role for the market in the determination of the exchange rate and further development of domestic financial markets are expected to promote dedollarization and support monetary management. These policies and the authorities’ efforts to enhance the business environment, sustain improvements in education, health and infrastructure are expected to boost competitiveness, encourage economic diversification, and strengthen the financial system’s resilience to volatility in commodity prices or shifts in market risk appetite.