Protect yourself from inflation — invest money in the economy!

CEO and majority stakeholder in Freedom Holding Corp.
Op-ed by Timur Turlov / Photo: Valery Ayapov

While President Kassym-Jomart Tokayev was delivering his address to the nation, he said that it is necessary to spur corporate lending and justly noted that banks aren’t active enough in contributing to the economic growth of Kazakhstan. Сorporate loans to the GDP ratio has been declining since 2014. As a result, we have already fallen behind our big neighbors in terms of this rate.

Banks have gone through a set of actions aimed at making their balances look perfect. They have written off loads of bad loans they issued to domestic businesses and learned many painful lessons. At the time, the government did a lot to support big banks, requiring high responsibility and more conservative behavior from them in return. This wasn’t something unique to Kazakhstan as banks cut lending throughout the globe while trying to escape from risks with the help of safe assets like central banks’ securities and public bonds. The more successful banks were in reducing risks, the less responsibility they were ready to bear. As a result, many big economies have been hit by recession and unemployment.

What have central banks done to solve the problem? Regulators have tried to make risk-free instruments less attractive. For instance, risk-free interest rates have been decreased upward of nil. (In the E.U. these rates have even become negative.) However, as long as investors have an opportunity to earn yields higher than inflation and do this with no risk, it is impossible to convince the aging and scared population to take a risk. How we can lead managers from the Unified Accumulative Pension Fund to buy something other than public securities if yields of these securities are higher than inflation even in the long term? If someone wants to protect himself from inflation, he should be ready to take bigger risks and invest money in the economy! Of course, we can’t just duplicate the policy of developed countries where people trust their national financial systems, while foreign currency risks are absent. I think it’s safe to say that the comfortable level of yields for deposits nominated in the tenge is 9% to 10%. Historically, people are okay with these rates; during a period when oil prices are on a comfortable level and devaluation expectations are low, this is enough to win the competition with deposits in foreign currency yields which might be restricted by the government at a level less than 1%.

I believe that we need public securities and notes issued by the National Bank to be 1% to 2% less profitable than that level in order to spur corporate lending. When the National Bank is lending to certain sectors of the economy, it can cause a surplus of money at banks. As a result, they may want to sell it back to the regulator, which in turn should buy money at a lower rate, just to give them a lesson not to do this in the future.

What have countries around the globe done to achieve this? They used different QE (quantitative easing) programs. When banks couldn’t sell risk-free money at 10%, they sold it at 8% because this was the point when a central bank was their competitor. In Kazakhstan, this money has no choice within the current regulation because yields on assets nominated in USD are even worse, while inflation is high everywhere. Banks can’t gamble on foreign currency because it’s too risky, while the government covers extra budget spending with transfers from the National Fund. In fact, exporters and the quasi-public sector are the main speculators in our market. Their joint foreign exchange position should be regulated in order to minimize the volatility and prevent some «effective managers» from creating an artificial procyclicality on the market during crises.

What other kinds of actions have global central banks taken, and when and why didn’t it work? Sometimes they intervened in the mortgage securities markets as they were forced to lend to those industries that became unattractive for banks each time after a crisis. In usual conditions, banks rely on mortgage securities yields which are 1% to 2% higher than pubic securities yields. When there is no profit in the segment of public securities, banks rush back to these markets to earn not 8% to 9% but 10% or even 11%. In turn, the presence of the Fed or the ECB on the mortgage debt market helped to ensure that a mortgage loan was available and provided banks with liquidity because they knew that they could sell their mortgage loans to a central bank in the case of panic in the market.

When COVID-19 hit the globe, central banks took things a step further: they weakened prudential standards (and simplified risk evaluation for corporate lending), issued loans for banks on security of credit portfolio and different corporate securities and sometimes even started buying bonds and promissory notes from big businesses with a certain level of credit rating.

Yes, these decisions required heads of central banks to take responsibility, while governments had to support them and create special funds to compensate for potential credit losses. As a result, the biggest economies of the world managed to rebound after global shocks and force financial institutions to do their job. The financial system is a closed system: if you fail to invest money at a high rate, you will invest it at a lower rate. If you can’t avoid risks, you should take a risk.

Regulators always send commercial banks a simple message: If you don’t want to lend money to the key industries, we will do this for you. And this threat works quite well almost everywhere. China, for example, intervenes in the market with the help of massive state-owned banks. Thanks to stable and cheap lending with an effective rate at the level of long-term inflation, China’s GDP has demonstrated a long-term growth of 6% to 10% for more than two decades.

Our country is very young and our people are very savvy. We are all dealing with an amazing historical chance. We have commercial banks with an impressive level of digitalization and operational efficacy. We have a huge deficit of capital expenditures in many spheres and a lot of frustration in the industry. We have a huge demand for lending resources. Businesses in Kazakhstan can obtain yields higher than anywhere else. If we only dare, we can easily reach goals related to economic growth even without institutional reforms that are still pending. We have everything for this: experienced and cynical bankers, cohorts of highly-qualified managers, a rapidly growing population and even a record-high influx of foreign capital to our market. We have to gradually reform the industry and our approach to it by introducing one measure after another when it is necessary and after rigorous analysis of their potential impact on the macroeconomic stability of the country. It’s like doing business: launch a pilot project and expand it if it succeeds. If something doesn’t work, just skip it. Being twice shy even before being once bitten isn’t right. In this case, we won’t achieve the goals our president has told us about.

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