Why base rate increase can cause sharp damage for outlook of Kazakhstan’s economy

Head of Kursiv Research
According to Timur Turlov, CEO of Freedom Holding Corp.

One of the anti-crisis measures Kazakhstan authorities may apply is increasing the base rate of the National Bank. This is a contradictory decision because in the short term this might be an obstacle for the regulator’s policy to keep inflation and exchange rate under control. Timur Turlov, CEO of Freedom Holding Corp. (FRHC) explains why the base rate increase might not be such a good idea at the moment.

Timur Turlov / Photo: Valeriy Ayapov

– Mr. Turlov, how you would describe the current economic situation in Kazakhstan after western sanctions have been imposed on Russia?

– What we’ve seen today is Russia becoming more and more isolated from the rest of the world. The vast majority of assets that belong to the state banks are now either paralyzed or blocked while the biggest Russian banks can’t support transactions with foreign currency. Amid all this, a foreign currency crisis is unfolding right now in Russia. Its very foundation is another crisis – a crisis of trust. Both the collapse of oil prices and the inability to implement the budget aren’t macroeconomic factors. Russia’s central bank has limited access to the gold and foreign currency reserves therefore the regulator has started to manage the exchange market in a manual manner. The only participants of the foreign exchange market in Russia today are exporters who have obtained foreign currency amid high commodity prices.

The situation in Kazakhstan is different. Kazakhstan isn’t a part of the conflict or target for sanctions. Nobody, I mean serious politicians, talk about sanctions against Kazakhstan as the country neither participates in nor supports the conflict. Kazakhstan depends on exports and currently, export prices are high: oil prices reached $110 per barrel and continue to grow while metal prices hit historical highs. The influx of foreign currency to Kazakhstan is still there because of trade with commodities.

However, the import of non-food products is under pressure while a significant share of the food products is imported from Russia. The pressure on this part of import now is minimal. Even despite the devaluation of the national currency tenge (500 tenge per one USD), we can see tenge appreciation against the Russian ruble. This currency channel helps us to extinguish the inflation rate.

At the same time, Kazakhstan is vulnerable to supply shocks: we have already suffered because of closed Chinese borders and now because of closed Russian ones. On the other hand, demand is also low. After the January events, many people have dropped their plans to buy something expensive as they worry about uncertainty around Kazakhstan and now Russia. A huge number of investments have been frozen. Even the quasi-state sector has partially stopped acquiring goods. Even the new cabinet that has worked for two months now isn’t working as fast as it did before.

– What do you think about the devaluation of the tenge. How serious is this danger?

– The National Bank of Kazakhstan hasn’t aggressively intervened in the market after the exchange rate of the tenge reached a bar of 500 tenge per one US dollar. We have not seen much speculation against the tenge. In spite of the events in Russia, we have not seen serious pressure on the exchange rate of tenge recently.

Look at the currencies of developing countries – none of them is devaluating so fast as the Russian ruble. Moreover, we’ve seen that Russian businesses have become more interested in Kazakhstan and perhaps we’ll see an influx of rubles to Kazakhstan. The ruble is going to be devaluated even further but I wouldn’t expect the situation of 2014–2015 because now Russia has no one to trade with. Sanctions imposed on the country work much better than customs borders.

– To cope with the devaluation, the National Bank is going to raise the base rate. Is the percentage channel an effective tool to slow inflation now?

– The efficacy of our percentage channel is far from perfect. However, the National Bank’s approach to base rate management has been well balanced, at least until now.

One of the key problems we met during previous crises is speculative expectations, which had fueled demand for foreign currency. Today, the vast majority of economic actors have a clear understanding that the situation for Russia and Kazakhstan is not the same. Both countries used to deal with a common problem – low oil prices. But now oil prices have hit record heights. Kazakhstan and Russia face different problems and we have to use different tools to solve the problem. There is no liquidity crisis, exchange crisis or trust crisis in Kazakhstan while Russia faces all of them.

Currently, we’ve seen loads of disinflationary factors. For example, devaluation may cause an increase in durable goods prices. On the other hand, low prices for imported food may compensate for the non-food price surge. A non-food goods price increase can’t be stopped by raising the base rate. We must be careful to not devaluate the tenge even deeper but it won’t get more expensive on its own. Also, there is a risk of killing consumer demand.

Last year we saw food inflation increase because food prices surged all over the world. This is imported inflation as well. As the government rolls back its COVID-19 linked supportive programs, the consumer demand decreases as well and the factor of food inflation no longer plays a key role. The pandemic had hit supply chains but now all these problems are fading away. I think we won’t see a 30% surge in the U.S. used car market, one of the main drivers of the price increase.  So far, the forecast for the inflation rate corridor in the mature markets is 2.5% – 3.0%. And there is no correlation with the monetary policy. Even the U.S. and the European Union are weighing right now the possibility of strengthening fiscal policy while the base rate has reached zero or negative points.

In this context, if Kazakhstan decides to raise the base rate, this would cause additional shock for the economy. This would require higher rates of borrowing by the state budget and won’t change the beliefs of economic agents about what foreign currency they should keep their money in.

The activity of big companies has been restricted while individuals have been waiting for a sharp change in the exchange rate and are therefore not so sensitive to the base rate increase.

– Are you talking about the growth of the state budget expenditures because of the high base rate? Is there any example of the Ministry of Finance borrowing costs increasing?

– A few days ago the ministry was able to borrow with an interest rate of 13.5% for 15 years. In a month or two, this rate will be decreased while regular citizens will be forced to pay this debt over 15 years. Who is going to win? If the ministry continues to borrow with this rate, the deposit rates will also soar to the sky, banks’ revenue will surge as they won’t be able to attract funds at 16% and of course will not lend money at less than 25% of interest. Russian banks have stopped providing loan facilities or left the market. Many banks have strengthened credit terms for their new clients. However, the higher base rate will hit banks as well. For example, securities they have issued will be reassessed downwards. This will narrow the range of options they can use to borrow money from the central bank and of course, would limit their capability to provide the economy with loans.

Concerning another factor linked to the budget, look at the very basis of growth of lending facilities in the corporate sector. These are the state programs. About 70% of corporate debt has been subsidized by the government for the past several years. However, even with record-high oil prices, the Ministry of Finance would be forced to pay an incredibly high price for securing credit facilities. On top of it, I just can’t see any objective risk for this.

– Okay, the base rate shouldn’t be raised. What about the monetary policy; what actions must the National Bank take to save the economy?

– It would be reasonable if the committee on the monetary policy of the National Bank revised and slightly decreased the base rate. It would allow normalizing the monetary policy and avoiding new economic shocks. In other words, we must not create imbalance on our own. So far, Kazakhstan’s economy is stable. Even if it starts to worsen the regulator must be very careful when it decides to use monetary policy tools. There is a feeling that the exchange rate of tenge is well-balanced and even slightly growing. We have to realize that tenge is not under attack. We have to let tenge gain ground against the Russian ruble. We have to keep an eye on the economic situation and be prepared to the neutral point of the base rate or as close to inflation as possible. The growth of the economy is one of the key problems in Kazakhstan. There are many disinflationary factors, so we have to take counter-cyclic measures with the future in mind.

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