ING has initiated regular coverage of Kazakhstan. The bank’s chief economist, CIS, Dmitry Dolgin and EM sovereign strategist James Wilson, take a broad look at what the recent geopolitical shift in the CIS region as well as domestic developments mean for the country’s economic activity, fiscal and monetary policy, interest and exchange rates. They also take a snapshot of what the bank sector lending looks like.
Country view: Largest Central Asian economy Kazakhstan is showing solid growth momentum but there are concerns on the fiscal side. The deficit is widening with higher savings in the oil fund, meaning more active borrowing and lower support to the Kazakhstani tenge (KZT), which is pressured by growing imports and the depreciation of trading partners’ currencies. However, with positive real rates, the domestic debt might be attractive to portfolio investors.
Economic overview: Fiscal policy is a key watch factor for the country’s financial market. The budget deficit is widening but, at the same time, the government is building up savings in the sovereign oil fund. This means higher borrowing at generous rates.
On the negative side, it means elevated breakeven Brent at US$115-125/bbl in the coming couple of years as well as growing public debt and interest expense.
Also, in the longer run, lower disbursement of FX out of the oil fund might limit the government’s ability to support the tenge, which is currently under pressure of growing imports and depreciation of trading partners’ currencies.
On the positive side, it is growth-supportive for the medium term, while the growing local debt amid positive real rates could draw the attention of foreign portfolio investors.
Economic activity in Kazakhstan is currently on a recovery path as, after the trough in 3Q22, GDP growth is back to a normal 5.0-5.2% YoY in 1H23. While the non-oil GDP (70% of total) has been largely upbeat the whole time and benefited from Russian immigration in 2022, the oil sector has been volatile. After some disruption in production and exports in 2022, the situation in 2023 appears to be more solid now, with oil extraction showing confidently double-digit growth rates YoY since June this year, contributing to the significant improvement in overall industrial production growth.
We see GDP growth remaining at 5% in 2023 and we raise our expectations to 4.5% for 2024 given the recent signs of renewed easing in the fiscal policy.
Budget policy is leaning towards easing, as expenditures showed a broad-based increase of 1 percentage point of GDP during 8M23. In the meantime, the revenue side is under pressure from lower fuel revenue collection, which is down from US$180m per annum to US$170m per US$1/bbl of Brent because of slightly and temporarily lower production and export volumes.
Despite this, the deficit widened by 0.9ppt of GDP to 2.2% of GDP in 8M23. We expect a consolidated deficit at 2.7% of GDP for FY23, with some moderation in 2024. Meanwhile, the announced tightening of the fiscal rule means a higher preference to save fuel revenues in the sovereign fund (NFRK) rather than use them to finance current expenditures of the republican budget.
This leads to higher borrowing requirements. We see the 2023-24 republican budget deficit at 3-4% of GDP (KZT4.5-5.0tr) per annum and already, as of August 2023, the domestic public debt securities market is growing at a pace of KZT4.2tr YoY amid elevated rates, leading to higher interest expense. In the case of a wider deficit, some additional external borrowing might be required.
Inflation and monetary policy: CPI and the key rate are on a cautious downward path, but risks remain. Having peaked at 21.3% YoY in February 2023, CPI has crawled down to 13.1% YoY currently amid normalisation of the global food prices and other commodities as well adjustment to the newly arrived Russian immigrants.
This enabled the NBK to make a first cautious 25bp cut in August to 16.50%, while indicating that the fiscal easing and elevated domestic inflationary expectations may be clouding the outlook. We expect CPI to continue decelerating to 10.0% YoY at year-end 2023 and to 7.5% YoY at year-end 2024, allowing the central bank to cut the rate to 15.50% and 11.50%, respectively.
That said, the recent tenge depreciation may create an upside risk to this path.
Balance of payments and exchange rate: Following the geopolitically driven collapse of 1H22, the tenge has been on a gradual recovery path for four quarters. The abrupt end to this recovery in 3Q23 despite the strength in Brent prices may seem surprising even considering lower support to KZT from the state-owned enterprises. However, the evolution of balance of payments sheds some light on the issue.
Looking at the foreign trade evolution, it appears that the FX market is losing the temporary support of the current account, which showed a brief surplus in 2022 amid elevated oil prices and is now coming back to its usual deficit state. While Kazakhstan’s oil-heavy exports (55-60% of total) are stable in physical terms and slightly down in dollar terms, imports are growing rapidly at 30% YoY, primarily from China, reflecting the country’s growing investment needs amid recovery in industrial output and efforts to diversify oil exports away from the Russia-related CPC pipeline (80% of oil exports).
We expect the current account to slide into a 1.6% GDP deficit in 2023 and remain in a 1-2% range in the subsequent couple of years.
Looking more broadly at the balance of payments, it could be argued that the weakness in the current account should not be a big problem for the tenge because it seems to be offset by the capital inflow. Indeed, as of mid-2023, the current account deficit of US$2.4bn (4Q rolling sum) appears to be overwhelmed by the net private (banks, companies and households) capital inflow of US$13bn.
However, we see two major issues with that inflow. First, the quality and sustainability of the inflow are under question, as two-thirds of this inflow is ‘errors and omissions’, which became large and positive in 3Q22 following the Russia-related geopolitical turmoil. The transparent and sustainable capital inflows are much more modest, providing much smaller support to the local FX market.
The second issue is that the private capital inflows are actively sterilised by the accumulation of FX assets by the central bank and NFRK, the state oil fund. The FX interventions by the sovereign fund – which must convert a portion of its FX oil revenues into KZT to finance the current spending of the budget – is a game changer for the exchange rate.
Looking at the past 12 months, the period of deepest KZT weakness corresponds to a decline in the NFRK FX sales. Although the overall transfers from the NFRK to the republican budget remained roughly unchanged at US$10bn in 2022, the share of conversion into KZT dropped materially from 90% in 2021 to 44% (US$4.3bn) in 2022, reducing support to the tenge.
In 2023, the situation improved, as with the planned decline in the annual transfer by KZT1tr to c.US$8bn, the intensity of FX conversion recovered, suggesting an increase in the annual FX sales from NFRK this year and guiding for some support to tenge by this year-end. At the same time, the planned reduction of NFRK transfers by KZT200bn (c.US$0.6bn per year) in 2024-26 suggests lower support to tenge in the longer run.
To sum up, the recent round of KZT weakness in 3Q23, which may have been amplified by the weaker RUB and CNY, the currencies of Kazakhstan’s major trade partners, may pause in the coming quarter assuming the expected normalisation in the global risk mood, continued private capital inflows to Kazakhstan and potential interest of portfolio investors (who can no longer invest into Russia) to Kazakhstan’s public debt against a backdrop of positive real rates, as well as more active FX conversion out of the NFRK.
However, the weakening trend may resume in 2024 with a continued deterioration of the trade balance, evaporation of the Russia-related capital inflows, and an expected lower participation of NFRK in support to the domestic FX market.
Banking sector snapshot, lending chartbook