Kazakhstan tries to dispel devaluation fears

By bne IntelliNews September 18, 2014

Naubet Bisenov in Almaty -


Kazakhstan's central bank has extended the currency trading corridor to enable the tenge to strengthen up to 8% against the dollar, in a bid to diffuse fears among the populace that the authorities are planning a second devaluation. A wider trading corridor is welcome news for the country's embattled financial sector, which is still recovering from the 2007 housing market crash and 2008 global crisis.

On September 10, the governor of the National Bank of Kazakhstan, Kairat Kelimbetov, announced that the regulator had widened the trading corridor against the dollar from KZT185 plus/minus 3 to KZT185 plus 3/minus 15. Earlier, Kelimbetov speculated that the new corridor would allow the currency to appreciate to KZT179-181 to the dollar, saying it might even strengthen to as high as KZT170.

The National Bank devalued the tenge by 19% in February after spending billions of dollars trying to keep the exchange rate stable when the currency of Kazakhstan's major trading partner Russia collapsed. Russia accounts for around a third of Kazakhstan's total imports.

Since that February devaluation, rumours have been swirling in the country's financial capital, Almaty, about a "second wave" of devaluation, which the regulator has decided to quell by reassuring about the tenge's strength.

Local financial analysts share Kelimbetov's optimism over the tenge, but warn against complacency about the behaviour of the Russian currency, which is continuing to fall in value as more sanctions from the West are imposed. "The more we will integrate with Russia, the more we will depend on the ruble," Sabit Khakimzhanov, head of research at investment bank Halyk Finance, tells bne in an interview.

Kazakhstan, along with Russia and Belarus, is a member of the Customs Union, which will be transformed into the Eurasian Economic Union in 2015. He says the arguments offered by Kelimbetov in support of the tenge are of a fundamental nature whereas the devaluation problems of the tenge are not fundamental. "I agree with him that the tenge still has a cushion and it is undervalued against the ruble," he continues, "but our currency faces pressure because there is no certainty about and trust in the tenge and monetary policy since the fixed-rate regime is always more fragile and inflexible."

Problems in Kazakh banking system

The move by the central bank to extend the currency trading corridor will have knock-on benefits for the country's banks, which are still dealing with last decade's financial crisis.

Kazakhstan's banking system is currently facing two major problems – rising non-performing loans (NPLs) and long-term funding. Kazakh banks suffered badly from the bursting of the property bubble in 2007 because of their dependence on foreign funding, which came to a "sudden stop" as the credit crunch took hold. The banks reacted to this shock by raising interest rates and shifting the burden onto the clients. "When you shift the risks onto the clients, the quality of assets worsens," Khakimzhanov notes.

The already poor quality of commercial banks' loan portfolios worsened further as a result of the global crisis and has recovered only very slowly. Even though the government has been preoccupied with the problem of bad loans in the past few years, the share of NPLs stood at 31.6% for the whole of the banking system as at August 1.

The government has tried to solve this problem in an administrative manner by establishing schemes to buy NPLs from commercial banks and to encourage them to write them off, but these measures have largely failed. The government has now ordered banks to reduce the share of NPLs in their loan portfolios to 15% by 2015 and 10% by 2016. Annette Ess of Standard & Poor's told a conference in Almaty on September 10 that most of the banks ("about three-quarters" of the country's 38 banks) to which S&P's assigns ratings would fulfil the 15% requirement by the end of 2014 or would be close to it.

Ess believes that banks will manage this by writing off debts, increasing the recovery of debts through the sale of security pledged on loans (though this takes time), and setting up special subsidiaries that will continue to deal with bad loans.

Khakimzhanov of Halyk Finance explains that banks will funnel bad loans from their balance sheets, but will keep them as part of consolidated balance sheets. He sees the root cause of the problem in the imperfect legislative basis – the company law, the bankruptcy law and civil laws – which creates a "certain barrier" to making the transfer of property rights easier and freer. In his opinion, Kazakhstan needs to change these laws and regulations, and strengthen the role and independence of the judiciary to solve the problems in the banking sector. "Unlike the OECD countries, Kazakhstan doesn't apply regulatory impact analysis and lacks specialists and analysts because there is no demand," the analyst complains.

Transparency in the financial sector, infrastructure, reporting and corporate governances also remain major issues in the country, where the law prevents banks from holding stakes in non-financial organisations privately; as a result, banks can only acquire shares in such entities on the stock exchange. "This means banks cannot control insolvent debtors and cannot appoint an administrator. A threat of this happening usually disciplines debtor companies. In Kazakhstan, banks cannot do anything with insolvent entities," Khakimzhanov tells bne.

Without creditors exercising their right to sell assets of debtors who fail to fulfil their obligations, the quality of loan portfolios will continue to be a problem in Kazakhstan, he believes. "This means banks will issue loans only to affiliated entities because there is less risk. Only banks with administrative leverages will develop in this situation because it is impossible to establish control over debtors via courts without the trappings of power," he says.

At the moment, Kazakh banks issue loans only on security, usually assets and working capital, Khakimzhanov explains, "otherwise they will not be able to control debtors."

Capital requirements

In order to strengthen the banking system, the National Bank intends to increase minimum capital requirements from the current KZT10bn to KZT100bn in 2019. The banks that fail to meet these requirements will have a cap placed on them over the retail deposits they can attract. The regulator explains the measure by the need to "increase the share of loans in GDP, expand the coverage of consumers with financial services, develop new high-tech services, including mobile banking and internet banking services, and to switch to Basel III standards."

In a commentary published on August 8, S&P said the new capital requirements would strengthen the banking sector "only if there are simultaneous efforts to improve banking regulation, banks' risks management practices, and corporate governance." S&P believes the measures will force smaller and weaker banks to leave the market or merge with larger institutions, while the weaknesses of the sector – "the lenient banking regulation and supervision, banks' aggressive risk management practices, and sometimes deficient corporate governance procedures" – are likely to persist. It will also discourage foreign investors and niche players from entering the market, the rating agency says. Despite this, it doesn't anticipate the measure will affect Kazakh banks' ratings over the next two years.

At the moment, only five banks out of the country's 38 have a market capitalisation of over KZT100bn and six banks have capitalisation of KZT50bn-100bn, according to S&P.

Khakimzhanov of Halyk Finance is critical of the measure and says that Kazakh banking regulations should be liberalised instead of being tightened. "The regulator is now trying to regulate not what should be regulated, but with its regulation and restrictions it is trying to substitute solutions which can be adopted only for a certain financial institution," he laments. "Banks lack resources because all resources are diverted to deal with unproductive activities such as fulfilling regulatory requirements, for example maintaining capital requirements."

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