Katya Malofeeva of Renaissance Capital -
In the week of January 19-23, the Kazakh authorities admitted the possibility of managed tenge weakening this year, indicating a potential 10% downward movement.
Given the weak oil price environment, and recent devaluations of the rouble and other oil-exporting countries' currencies, we think the tenge will come under too much pressure for the authorities to resist, and that devaluation is now only a matter of magnitude and timing.
The central bank (NBK) lost reserves over the fourth quarter, following a comparatively upbeat year during which the current account was in surplus, comfortably covering for outflows from the capital and financial accounts. In the last quarter, the NBK lost $2.5bn in reserves, which we attribute to a current account deficit of about $1bn and an outflow of more than $1.5bn from the capital account. At a current oil price of $40 per barrel, we estimate a current account deficit of more than $2.5bn in the first quarter of this year (largely due to the seasonal deceleration of imports).
Fundamentals suggest a weaker tenge
We expect Kazakhstan's current account to deteriorate significantly over 2009, primarily due to low oil prices. Import growth slowed markedly in 2008 (to 15% in the first 11 months of 2008 from 38% in 2008), due to a slowdown in foreign direct investment (FDI) and the credit squeeze. We see further, although limited, scope for imports adjustment, due to the overall economic slowdown and a likely further deceleration of inward FDI. We expect no significant increase in the volume of exports: following completion of the two-stage extension of the Tengiz oil field in 2008, the next sizeable increase in Kazakh oil production will come with the launch of the Kashagan project, as other producing fields cannot currently increase production without very significant investment. Furthermore, we think price dynamics will remain unfavourable for oil and metals, Kazakhstan's key exports. The country's services trade balance is likely to remain in deficit over 2009.
We expect outflows of direct investment dividends - traditionally a major draw on Kazakhstan's current account - to decrease versus 2008, in line with the decline in oil prices, although such outflows will likely remain substantial. This component of the current account softens the impact of lower oil prices, as outflows increase in a high oil price environment and decrease when oil prices are low.
We note that pressure is also mounting on Kazakhstan's capital and financial account, which is influenced by the oil price as the willingness of foreign investors to lend to Kazakhstan largely depends on the visibility of oil revenues.
In the current oil price environment, we think Kazakhstan's ability to raise new debt will be limited at best, and that rolling over outstanding debt will become more challenging. In the third quarter of 2008, when oil prices were still high, Kazakhstan's total foreign debt increased by $4.8bn, most of which was short term. As a result, debt repayment and servicing obligations increased by $1.5bn, to $6.0bn for the first quarter of this year, and $5.4bn for the second.
Arguably, the greatest argument against devaluation stems from the question of the private sector's ability to service foreign debt (as indicated by the graphic below, Kazakhstan's debt-servicing schedule is front-loaded). Half of corporate loans (which represent over one-third of the overall loan book) and 36% of loans to individuals are foreign currency-denominated. Clearly, a devaluation of the tenge reduces the ability of individuals to service and repay debt - an ability already undermined by the ongoing crisis. With regard to loans to corporate borrowers, we note that foreign-currency loans have usually been granted to industries such as construction, trade and services, but not to exporters; therefore, by the very nature of their revenues, these borrowers are also unhedged against devaluation (as their revenues are mostly tenge-based). Although asset quality varies from bank to bank, we note that a 10% devaluation would not, in itself, result in dramatic asset quality deterioration, while a bigger devaluation could pose more serious problems.
The magnitude of adjustment
In our view, the following range of factors could influence the magnitude of any forex adjustment in Kazakhstan:
• The government has traditionally exercised significant control over the economy as a shareholder, and used soft power to reduce the risk of speculative attacks against the tenge from within the country;
• The authorities could attempt to slow imports with a range of administrative measures;
• Changes to the tax regime, effective January 2009 (with the introduction of a new Tax Code) will, in our view, result in a reduction of tax receipts, and therefore a relative increase in oil-related outflows;
• Given the shallowness of local markets, any meaningful speculative attack on the tenge by external players appears out of the question - making a managed devaluation, and avoiding overshooting, easier, in our view.
We think the possible 10% devaluation signalled by the Kazakhstan authorities in January appears reasonable unless the external environment deteriorates sharply (for example, if the oil price declines further). Importantly, the total level of foreign reserves - including NBK reserves (which incorporate the foreign-currency portion of commercial banks' correspondent accounts with the NBK) and the National Oil Fund - stood at over $46.7bn at end-December. Despite repeated government promises last year that state funds would be drawn on to support the economy and the banking system, in reality the government was more conservative, and did not tap the National Oil Fund for additional expenditures. Accordingly, the authorities appear to have some ammunition to ensure any devaluation is managed, and reduce the likelihood of overshooting.
At current oil prices, we think a 10% devaluation is highly likely over next two-to-three months: the weaker the oil price, the greater the pressure on the tenge. We believe the authorities will subsequently choose to return to the dollar peg if oil prices start to recover, in an attempt to build up reserves.
Given the relatively large size of Kazakhstan's reserves (including both NBK reserves and the National Oil Fund), the authorities may resist the pressure to weaken the currency, particularly given the extent of debt repayment requirements in the first quarter, and the likelihood of a negative public reaction to increases in tenge prices for imported goods. We believe the scope for import adjustment in response to devaluation is limited (total imports, given that they are largely represented by investment and intermediary goods for industrial use, are largely a function of the oil price), and that the major beneficiaries of devaluation will be export-oriented industries - particularly those in the metals sector. The timing of any potential pick-up in global demand for metals is an important factor here. In summary, we think Kazakhstan has both the capacity and the rationale to allow tenge weakening later, rather than sooner, but that it will definitely do so by the summer of 2009.
Katya Malofeeva is chief economist at Renaissance Capital
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