Kazakhstan: Country Outlook

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By SRI ⋅ May 10, 2008 ⋅

FROM THE ECONOMIST INTELLIGENCE UNIT

The president, Nursultan Nazarbayev, will stay in power in 2008-09, having consolidated his hold on Kazakhstan’s political structures, but could face growing dissatisfaction among businesses owing to the slow pace of reforms. Rising inflation and liquidity problems in the banking sector will be among the government’s main policy challenges in 2008-09. The National Bank of Kazakhstan (NBK, the central bank) might be forced to raise the refinancing rate from 11% if inflation remains higher than targeted. The Economist Intelligence Unit forecasts real GDP growth of 6.7% in 2008, rising to 7.1% in 2009. This is much slower than in recent years, and reflects the dampening effect of the global credit squeeze on Kazakhstan’s growth. High food prices and a loosening fiscal policy will exert upward pressure on consumer prices, pushing average annual inflation upwards to over 17% in 2008, from 10.8% in 2007. Disinflation should take hold in 2009. The possibility of more sustained downward pressure on the currency has risen, and greater volatility than in recent years is likely. The current-account deficit should narrow in 2008 because of higher oil prices, but it will widen again from 2009 owing to rising invisibles debits.

DOMESTIC POLITICS: Mr Nazarbayev is expected to remain in power over the 2008-09 forecast period, although he will need to demonstrate considerable adeptness to ensure that a combination of tension among the elite and slowing economic growth does not weaken his control of the political scene. Moreover, double-digit consumer price inflation is causing public discontent and threatens to damage Mr Nazarbayev’s economic record. Recent personnel reshuffles demonstrate the president’s desire to ensure that he is surrounded by loyal and trusted supporters. Although speculation concerning an imminent cabinet reshuffle has died down, if measures to stabilise the economy prove ineffective Mr Nazarbayev could still opt to change his government, blaming ministers for the economic turbulence. The president’s longer-term aim is to shore up his position, with a view to ensuring a successful bid for re-election in 2012. The coming two years could prove crucial in this respect, as Mr Nazarbayev will seek to entrench his position and lessen the risk of challenges from disgruntled members of the elite.

INTERNATIONAL RELATIONS: Kazakhstan will continue to balance its relations with Russia and China, with co-operation in the energy sector driving bilateral ties. The country will also step up diplomatic activity with the Organisation for Security and Co-operation in Europe (OSCE), in preparation for its chairmanship of the body in 2010–the first former Soviet state to hold the position. The OSCE had postponed a decision on awarding Kazakhstan the chair in 2006, owing to doubts among some member states about the Kazakh authorities’ commitment to upholding democratic standards. The fact that most Western leaders favour the maintenance of cordial relations with Kazakhstan–particularly in the context of growing unease about energy dependence on Russia–appears to have influenced the decision to grant Kazakhstan the chair (although this will happen one year later than originally envisaged), and outweighed concerns at the lack of progress in political reforms.

POLICY TRENDS: Accelerating inflation and liquidity problems in the banking sector are among the principal challenges facing Kazakhstan’s policymakers. The two are partly linked, in that rapid growth in bank lending has contributed to strong growth in monetary aggregates, which in turn has put upward pressure on prices. The government intervened quickly to stabilise the banking sector when banking entities faced difficulty in refinancing loans in late 2007, and we expect further such intervention, should it prove necessary, in the coming months–the authorities have allocated at least US$3bn over the next year to support sectors such as construction, which is highly dependent on bank lending. An anticipated slowdown in credit growth in 2008-09 should start to have a positive effect on prices from late 2008, bringing inflation down from its recent seven-year high. However, there is a notable risk that tighter lending policies will dampen growth in the non-oil economy, thereby jeopardising the government’s diversification targets.

INTERNATIONAL ASSUMPTIONS: We have made a large upward revision to our forecast for the average price of dated Brent Blend crude oil in 2008, from US$79.5/barrel to US$91.3/b, and prices are expected to average US$85/b in 2009. Despite the slowdown in global growth, continued strong demand for energy products and an aggressive OPEC policy are keeping prices high. Moreover, a host of geopolitical risk factors present mainly upside risks to our oil price forecast. Slowing world GDP growth will nevertheless dampen demand for industrial raw materials over the forecast period, leading to a modest downturn in prices, including for metals–one of Kazakhstan’s main sources of export revenue.

ECONOMIC GROWTH: Kazakhstan’s GDP grew by 8.5% in real terms in 2007. The year-on-year slowdown was partly attributable to a deceleration in industrial output growth (to around 4.5%), but also reflects liquidity problems in the financial sector. The Kazakh authorities’ forecast for 2008 is for a further deceleration, to between 5% and 7%. Although we also expect growth to weaken, we believe that it will remain at the upper end of this range, given our expectation of continued high global oil prices, as well as the level of state investment planned in 2008. Moreover, spillover effects from the development of the oil sector should continue to benefit services sectors such as communications and retail trade. We therefore anticipate real GDP growth of around 6.7% in 2008, rising to 7.1% in 2009 as investment strengthens in the run-up to the coming on stream of the giant Kashagan oilfield.

INFLATION: Kazakhstan recorded average annual consumer price inflation of 10.8% in 2007 and a year-end rate of 18.8%–the highest rates since 2000. Rising food prices, in conjunction with rapid growth in monetary aggregates, were the main factors behind the acceleration in inflation. We anticipate a further pick-up in inflation in 2008, to an annual average rate of over 17%, owing to a combination of demand-side pressures such as public-sector wage increases and rises in social expenditure, and the continued impact of high food prices. Tighter monetary and credit policies should nevertheless encourage disinflation from late 2008, reducing average inflation in 2009 to around 11%.

EXCHANGE RATES: The NBK drew down its reserves to stabilise the tenge in the second half of 2007, when concerns over liquidity problems in the banking sector sparked higher local demand for foreign currency. In the final months of the year and into 2008 the currency was trading at around Tenge120.6:US$1, up by around 1% year on year in nominal terms in early April 2008. Given our expectation of continued large-scale foreign-exchange inflows, on balance the underlying pressure on the tenge will remain one of appreciation. Nevertheless, the possibility of more sustained downward pressure on the currency–particularly if liquidity problems in the financial sector become more acute, or if the current-account deficit were to widen–has risen, and the tenge is likely to be much more volatile than in recent years.

EXTERNAL SECTOR : The NBK has reported a current-account deficit of US$7.2bn in 2007, equivalent to 6.9% of GDP, a more than threefold year-on-year increase. Factors driving the deficit upwards in 2007–high services debits (for example, on transport and construction services), and large payments by Kazakh banks–will persist in 2008, although higher oil prices will push the trade surplus upwards. This will result in a slight fall in the current-account deficit in 2008, to US$6.3bn, before a weaker oil price in 2009 results in slower growth in export revenue and hence a larger current-account deficit. The risks to macroeconomic stability posed by the deficit have risen over the past year, but we expect Kazakhstan to meet its financing obligations relatively comfortably, owing to continued large-scale inflows of foreign direct investment (FDI). With the Kashagan oilfield coming on stream towards the end of 2011, and several other large projects under development, annual FDI inflows are likely to average around US$7.75bn in 2008-09.