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Vyacheslav Dodonov. The financial sector of Kazakhstan in the period of low oil prices – the state and the key issues

The fall in global commodity prices has significantly complicated the situation in the financial sector of Kazakhstan at all levels – from the deterioration of the financial state of enterprises to aggregative macroeconomic indicators. The manifestation of problems began in 2014, at the end of which there was a drop in oil prices, and gained its momentum in 2015, during which oil prices continued to fall, which was reflected first on macroeconomic indicators, and by the end of the year, reached the micro-level (businesses and households).

In 2015 the volume of export from Kazakhstan has almost halved relative to the maximum level of 2012 – by $40.5 billion, amounting to $46.3 billion against $86.9 billion. The fall of export has caused a number of negative consequences, directly or indirectly connected with financial and investment processes. In particular, since 2013 volumes of gross inflow of foreign direct investments have constantly decreased, and by 2015 this reduction was already very significant – annual inflow dropped below $15 billion, almost halve the peak of 2012, when it amounted to $29 billion. Pure inflow of FDI in Kazakhstan decreased even more – in 2015 it amounted to only $4 billion against $13.3 billion in 2012, $10.3 billion in 2013 and $8.5 billion in 2014.

Along with the reduction of gross inflow investments, gross outflow has increased – from $3 billion in 2012 to $7 billion in 2015. As a result of a simultaneous increase of two negative tendencies – decrease of inflow of FDI and increase of outflow – in 2015 for the first time the decrease in the total amount of the accumulated foreign direct investment in Kazakhstan was recorded – their gross volume has decreased to $119.8 billion, falling below the level of 2012, in comparison with $132.7 billion in 2014, $125.2 billion in 2013 and $119.9 billion in 2012. Also for the first time the amount of net FDI index (the difference between the accumulated FDI to Kazakhstan and from Kazakhstan) decreased – to $96 billion from $107.2 billion in 2014.

The gross foreign direct investment index shows not only new investments but also other articles, including reinvested earnings: the share of foreign direct investors in an undistributed profit (loss) of the Kazakhstan enterprises. Precisely by this factor a significant decrease in gross FDI inflow in 2015 is explained – a reduction of revenue in primary industries because of the fall of prices meant also the reduction of the foreign investors’ share, which greatly reduced the general indicator of gross inflow of FDI. That is, the massive decline of FDI is explained not only and not just by the lack of new foreign investments, but also and primarily by a sharp drop in revenues of enterprises with the foreign participation concentrated mainly in mining industry.

This same reduction in income has led to a negative financial result of the large and medium-sized enterprises, which in the third and fourth quarters of 2015 received a loss for the first time since the mid-2000s, at a rate of 1973 billion and 747 billion tenge respectively. Activities of national companies in 2015 were also unprofitable– due to the high level of losses in the third quarter. For the whole year the negative result amounted to 449 billion tenge.

The sharp rise in business losses has caused a rapid increase in enterprises’ debts in 2014-2015 – during the period from 4th quarter of 2013 to the 4th quarter of 2015 the volume debt on obligations of large and medium-sized enterprises has grown by half – from 30 to 45 trillion tenge, having exceeded the amount of  Kazakhstan’s GDP. In many respects, such a rapid increase in debt was caused by the devaluation of tenge because the largest part of the debt of large and medium-sized enterprises belongs to large companies, including those with foreign participation, who have great substantial obligations to foreign parent companies (the so-called “inter-company debt”). Accordingly, dramatically decreased rate of tenge resulted in a restatement of the currency debt in a tenge equivalent and in an increased debt load, expressed in tenge. Nonetheless, growth of the debt burden became one of the strongest negative factors of the economic development of Kazakhstan in the period of low oil prices.

The debt burden has increased not only among large and medium-sized enterprises, and not only because of the exchange rate factor, caused by the devaluation of tenge. During the period of 2013-2015 the debt load significantly increased in virtually all sectors of the Kazakhstan economy. Thus, from the first quarter of 2013 to the fourth quarter of 2015 the volume of debt growth was as follows:

– in the banking sector (the first quarter of 2016) – 2 times – from 11.3 to 21.2 trillion tenge;

– internal government debt – denominated in the national currency of securities (on the first quarter of 2016) – 1.9 times – from 3.1 to 5.8 trillion tenge;

– public external debt –2.2 times – from 5.5 to 12.2 billion;

– at non-bank finance corporations –1.6 times – from 4.7 to 7.4 trillion tenge;

– at non-financial corporations– by 1.6 times – from 28.5 to 45.1 trillion tenge;

– in households –1.4 times – from 3.2 to 4.5 trillion tenge.

As a result of a debt increase during 2013-15 the annual volume of only non- government debt of three main sectors of economy (finance, non-financial corporations and households) by the end of 2015 reached nearly 200% of Kazakhstan’s GDP – the value that was previously observed in 2009 – during the last crisis when debt growth was also influenced by the devaluation of tenge.

The factor of devaluation and even more so the instability that followed the devaluation in the currency market, caused by contradictory and inconsistent policy of National bank, became the main reason behind the problems of financial sector of Kazakhstan in 2014-16. Key processes of financial sector, primarily in the credit market, became dependent on the unstable exchange rate of tenge. And it was not only market processes that became depended, but also policy of the National bank – a regulator designed to provide anticipatory impact on the situation and negative development of events.

The devaluation factor has begun to strongly impact the destabilization of Kazakhstan’s financial sector since August 2015 when the new round of tenge depreciation has started in an uncontrollable manner. In August-September tenge depreciated by 1.5 times, which led, among other things, to a sharp rise in money market interest rates – for example, the KazPrime indicator (3-month interbank deposits) increased from 9% to 13.5%, and only after that the National bank raised its key interest rate from 12% to 16% (on October 2). This trend remained – at first there was another depreciation of tenge on which monetary market indicators instantly reacted – rates on interbank loan and deposits increased, followed by the increase of retail lending rates, and then, with a certain delay, the National bank raised its key interest rate.

After the stabilization of the exchange rate of tenge and its corrective strengthening, which began in February 2016, the situation has changed on 180 degrees, but the sequence of events has remained – at first there were fluctuations in the exchange rate, almost immediately followed by the change in interbank market rates, and only after that National Bank reacted by reducing its key interest rate – from 17% to 15% on the first decrease on May 5, 2016 after tenge appreciated by approximately 15% in relation to the peak levels in the beginning of the year and interbank market rates decreased from 22% to 17% on the KazPrime indicator.

Thus, regulator’s actions were not proactive, but followed after the change in the situation by the participants of the currency and credit markets. Market’s instability itself was largely caused by the amorphous and inconsistent currency rate policy of the National bank, which resulted in the speculative factor gaining too much influence on the market conditions.

Attempts to stabilize the foreign exchange market, including an increase of interest rates by the National bank and the increase of interest rates on deposits (with a simultaneous increase in volume of guaranteed deposits in tenge) aimed to stimulate the transfer of funds from foreign currency into tenge, had mixed results and led to the opposite imbalance in the foreign exchange market in the first half of 2016. If in 2015 the exchange rate of tenge was excessively undervalued, largely because of dilated, due to the disengagement of the National Bank, capabilities of speculators, in 2016 the situation began to reverse. Overvalued to 380 tenge, the dollar exchange rate in Kazakhstan began to decline rapidly with the growth in oil prices and high rates on tenge financial instruments in the background. However, in this situation National bank ceased to adhere to the stated policy of freely floating exchange rate and started to conduct interventions for the support of dollar exchange rate, not allowing it to fall too much in relation to tenge.

Interventions aimed to support the dollar exchange rate have begun by National bank since February and are continued to this date; interventions are provided in very high volumes and are increasing in the process of the exchange rate decline. In February, during which the tenge strengthened from 375 to 348 per dollar, the amount of interventions of the National bank amounted to $474 million, in March, during the strengthening of tenge to the rate of 340 per dollar, interventions amounted to $1236 million. In April and May when strengthening tenge reached the rate of 330 in certain days, the volume of dollars bought by the National bank amounted to $831 and $728 million.

This is a very significant extent of the regulator’s participation in the transactions in the foreign exchange market, and in some months it amounted to 25-30% of the total volume of foreign exchange trading. Such amount of interventions means that we are talking about a targeted support of dollar exchange rate by the National bank at the level of 330 tenge per dollar, below which tenge interventions of the National bank do not allow dollar to fall, and that the regulator violates the stated policy of a free exchange rate. Proceeding from a ratio of amounts of interventions and dynamics of a rate of tenge, it is possible to assume that in the absence of these interventions, dollar exchange rate would fall to the level of 300 tenge in spring, perhaps lower.

Meanwhile, the instability in the foreign exchange market defines, in the last year or two, the instability of the entire financial sector and, in particular, the stagnation in the credit market, which became a slowdown factor of the economic growth and deterioration of social well-being of the population. Extremely high interest rates on loans, which developed due to the depreciation of tenge, have led to a sharp decline in the volume of issued loans because at rates of 20-25% loans are impossible for bank clients due to the high rates of those loans and for the banks themselves, which doubt the ability of customers to return such expensive loans and therefore fold some of their loan divisions.

In January 2016 maximum rates on loans in tenge for legal entities were achieved, reaching 23.8%, while lending interest rates for individuals continued to grow further, reaching another new maximum at 19.1% in April. As a result of the growth in rates, the volume of issued credits significantly reduced – if in 2014 amount of loans issued to economy was equal to 10.6 trillion tenge, in 2015 – to 9.3 trillion. In 2016 arrears on loans began to rise again – from December 2015 to April 2016 their volume increased by 78 billion tenge or by 8.5%.

Loan volumes in separated and socially sensitive areas are also declining – thus, volumes of the mortgage lending in 2015 amounted to 216 billion tenge against 249 billion tenge in 2014, and in 2016 that decline accelerated – in four months 36 billion tenge of mortgage loans were issued against 73 billion in the same period in 2015, which means that there was almost a twofold reduction. There was an even more reduction in the volumes of consumer lending issued to the population– from 2260 billion tenge in 2014 to 1765 billion tenge in 2015 with further reductions in January-April 2016 amounting to 15% compared to the same months of 2015.

As a result of the recession in the most loan-dependent industries of the Kazakhstan economy, including the financial sector, there was a strong slowdown in the growth rate. If in 2014 growth rates of a financial industry accounted to 8.1%, in 2015 they slowed down to 2.9%, and in the first quarter of 2016 – to zero. In trade, the growth rates during the same periods slowed down from 8.1% to 1.2% and demonstrated a decline of 6% in the first quarter of 2016. In real estate transactions growth slowed down from 4.4% in 2014 to 2.8% in 2015 and to 1.6% in the first quarter of 2016.

These three activities form a considerable part of Kazakhstan’s GDP – they account for 26 – 27% of GDP, which means that the reduction in the growth rate of these sectors in these scales led to the shortfall in GDP growth by about 1.5-2 percentage points. The reduction of crediting played the significant role in the delay of growth of the Kazakhstan economy following the results of 2015 and its recession in the first quarter of 2016. In other words, a sharp deceleration of growth of Kazakhstan’s economy, based on the results of 2015 and its recession in the first quarter of 2016, was mainly caused by the reduction in lending, which was primarily the result of the exchange rate jumps, to which the lending market rates were tied.

 

The most pressing issues of the financial sector today

In our opinion, there are three main problems in the financial sector of the Kazakhstan economy that currently are most pressing – the uncertainty of a situation in the foreign exchange market; stagnation in lending activity; high and increasing debt load on the main sectors of the economy.

The uncertainty of the situation in the foreign exchange market is determined by the fact that the currency rate of tenge is still non-market because to a large extent the rate is formed by National bank interventions. Accordingly, participants of the market have no basis for predicting the currency rate and therefore the course of their business as well – if today the National bank supports an overvalued dollar exchange rate, then there are no guarantees that it will continue to do so tomorrow as there are no reference points to determine to what extent this support will be continued, what levels are considered valid by the regulator, and if there the same support to be provided for tenge, and etc. It is also clear that the free formation of the exchange rate declared by the National bank is not implemented, and that the regulator directly and strongly influences the corresponding processes.

All these questions leave participants of the foreign exchange market in the uncertainty about the causes of the change in exchange rates, scales of possible change, and etc. Therefore it is not possible to plan the business processes that depend on the currency fluctuations, to build long-term financial schemes with foreign partners, and to estimate risks of the credit operations, which is especially important, considering the high level of foreign currency obligations of a large Kazakhstan business – both financial and non-financial. At the end of 2015 pure open position of corporations in the foreign currency amounted to minus 12.2 trillion tenge in balance sheets, meaning that the currency obligations of non-financial companies exceeded their currency assets on the equivalent of that sum in tenge.

This is a very large amount, corresponding to almost half of the equity of these companies, and it carries significant risks to their financial stability. The increase in the dollar rate means the increase of that indicator and the growth of the financial stability risk. In other words, the ones that suffer the most from the devaluation of tenge in the current circumstances are non-financial corporations because of the significant amount of foreign currency debt that they have (it is precisely due to this factor the sharp increase of debt in the period of devaluation was caused) and as the rate of tenge continues to depreciate, its maintenance becomes more and more complicated because more and more funds for the payments of currency debts are needed.

 

The banking system after the devaluation, on the other hand, has a positive difference between assets and liabilities in foreign currency (currency net position). That difference grew after the devaluation in August-September 2015 (from 188 to 280 tenge) more than twice – from 36.5 in the second quarter of 2015 to 84.5 billion tenge in the third quarter. Meaning that the weak status of tenge is not an issue for banks as their currency assets exceed their liabilities. But even for banks the instability of the currency rate is in general problematic as it seriously slows down lending activities due to the high rates, increases the amount of non-performing loans, and creates additional risks both for tenge and currency liabilities due to the unpredictability of the tenge exchange rate.

Another pressing issue is the increase of debt by the majority of Kazakhstan’s economy sectors. It is partly caused by the devaluation of the currency and conversion of the debt’s part into a tenge equivalent, but also there is a chance that the increase in debt was caused by other reasons. The total amount of debt in Kazakhstan has already exceeded 220% of GDP and it is a large amount. The problem mainly lies not in the build-up of a debt, but in the subsequent increase in debt servicing costs – interest payments that “eat” most of the income received by companies, and also an increase in the principal amount of debt, repayment of which becomes very burdensome. As a result, debtors who have stepped a certain threshold are not able to pay the debts from their profits and therefore begin to refinance them, meaning that they, in fact, are paying old debts, making new ones, and this chain soon results either in bankruptcy or restructuration (meaning loss of money by the creditors), or in need for an allocation of the state aid.

Such scenario could become a reality for many large companies of Kazakhstan, as during 2014-15 the burden of debt servicing increased significantly. If in the first quarter of 2014 payments on debt service of non-financial corporations amounted to 865 billion tenge at the capacity of profit of 1316 billion, in the fourth quarter of 2015 the amount of debt payments doubled – to 1675 billion tenge at the volume of profit reduced to 267 billion. Thus, the debt payments become too large for enterprises, particularly in comparison with their profits, income, net worth, which creates preconditions for the collapse in the basic industries of the Kazakhstan economy, associated with the inability to service its debts. The absolute amount of payments for debt obligations is also large – in the fourth quarter of 2015 it reached a historical maximum and that also is a sign of extremely intense financial situation in a manufacturing sector of the Kazakhstan economy.

The third key issue is the reduction in lending by banks to both legal entities and individuals. The decrease in lending, fixated in tenge considering the double devaluation of the national currency, is continuing for the last three years and is a strong negative factor for the Kazakhstan economy as it slows down the growth or even leads to a decrease in production of goods and services in some important sectors. Decrease in mortgage lending became a major factor in the decline in residential property prices, which reached nearly twice the level in currency calculation.

Trade, which is the largest type of activity after industry, forming 15% of Kazakhstan’s GDP, in the first quarter of 2016 showed a decline of 6% – the largest decline among all activities, this decline was caused not only by the decrease in purchasing power and an increase in prices for imported goods due to devaluation, but also mainly by a sharp decline in consumer lending in 2015-16.

The growth in lending rates not only froze the issuance of new loans, but also complicated the maintenance of previously issued ones. Furthermore, increased rates affected the reduction of long-term industry loans, which greatly complicated the implementation of programs aimed to diversify and modernize economy.

 

Conclusions

 

– the most pressing issues of the financial sector of Kazakhstan are currently the following: instability in the foreign exchange market caused by a lack of clear reference points for altering the currency exchange rate of tenge and inconsistent policy of the National bank; rapid increase in the debt burden by all sectors of the economy – from state to households; gradual decline in lending to the economy by banks;

– the core element of the observed issues is the instability of the currency rate, due to which the lending activity stagnates and corporate sector’s debts, most of which are represented by liabilities in foreign currency, increase;

– the currency rate of tenge in recent months was lowered, which is confirmed by a very high activity of the National bank in exchange operations for buying dollars, the volume of which amounted on average to about 0.8 billion per month;

– National bank’s activity on the replenishment of its currency reserves goes against the interests of many economic entities of Kazakhstan that are interested in a higher rate of tenge – from households whose purchasing power and disposable incomes were undermined by increased prices on imports, to the largest enterprises of the industrial sector whose amount of debt denominated in foreign currency and payments for the service of that debt increased because of the elevated dollar exchange rate;

– decline in lending activity caused by unacceptably high rates negatively affects a number of industries that depend on loans (trade, real estate operations, finance, construction), which form a significant part of GDP, and thus greatly slows the economic growth up to the recession that began in the first quarter of 2016.

Vyacheslav Dodonov