USD/KZT 369.36  -2.5
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 KAZAKHSTAN International Business Magazine №1, 2008
 Financial Sector: Is There Light at the End of the Tunnel?
Financial Sector: Is There Light at the End of the Tunnel?
According to analysts, global markets have stepped into the second phase of the financial crisis caused by the U.S. subprime mortgage crisis. The reason for this conclusion was a sharp fall in the prices of shares traded by the major stock exchanges in late November. Sceptics began to talk about “black days” of the stock market. And, although the dynamics of stock markets and of economies are not always linked to each other directly, it is likely that bear markets from the New World to the Land of the Rising Sun will affect the debt capital markets. For Kazakh banks this means more than an appreciation in external funds. The very opportunity of borrowing abroad and refinancing earlier debts is now questionable. Analysts say that, in this situation, domestic banks can only rely on domestic funds, their own non-core assets and government support.
Government Support Promised
The government’s intention to maintain the liquidity of banks at an “adequate level” was voiced by officials long before 1 January, when the global liquidity crisis was in its first phase. Shortly after the New Year the government, the National Bank and the Financial Supervision Agency (FSA) reiterated these intentions having announced the main directions of the 2008 economic policy. In particular, their joint statement said that “the National Bank will continue to support the banking system by providing it with short-term liquidity using various methods,” which include “repo transactions, currency swaps and lending against pledge of minimum reserves”.
At the same time, the document stated that FSA and the National Bank would welcome banks’ initiatives to raise alternative funds through additional issues of shares and/or convertible bonds and asset securitisation. The regulators believe that “this will definitely help improve the financial standing of banks”. FSA and the National Bank promised, in their turn, to support second-tier banks in implementing these instruments and expressed confidence that this will significantly reduce their dependence on world debt markets.
The country’s central bank details its liquidity maintenance measures for the banking sector in a paper called “Main Directions of the Monetary Policy of the National Bank of the Republic of Kazakhstan for the Years 2008-2009”. It says that “in reaction to changes in the global and domestic economies,” the National Bank will diverge from its tight monetary policy and pay more attention to the role of rates in transactions. Thus, the official refinancing rate will be determined according to the market situation and inflation so that it remains the highest rate at the money market in short-term instruments.
Time will show whether this happens. Today, the National Bank seems to have no optimism: the “main directions” set for this year (as distinct from 2007) provide for two scenarios only – base and pessimistic – with the respective measures for each one.
If the base scenario works (which forecasts the real GDP growth as being within 5%), the National Bank intends to pursue a “moderately tight” monetary policy. This policy is aimed to maintain, on the one hand, the National Bank’s rates at a level, which would be adequate to the existing situation, and, on the other hand, short-term liquidity of banks through the issue of short-term notes, attracting deposits for second-tier banks, and providing loans for refinancing. To maintain the yield curve, the National Bank does not rule out a possibility of issuing new short-term notes with a term not exceeding one year.
In case the pessimistic scenario (which forecasts no GDP growth) happens, the National Bank is ready to follow a “supporting” monetary policy that provides for the possibility of a “significant reduction of the existing minimum reserve requirements”.
The most notable thing is that the National Bank is ready to provide second-tier banks with direct long-term aid (although insignificant in value). In addition, should strong pressure on the tenge occur, the National Bank can admit “its stronger depreciation compared to the base scenario so as to maintain foreign exchange reserves at a level, which is necessary for the country to discharge its international obligations”.
The National Bank’s statement that “the shrinkage of the domestic investment and consumer demand will help correct the foreign balance through the reduction of not only import costs, but also expenditures on foreign debt service” is somewhat doubtful. Before the end of the year, Kazakh banks must repay external liabilities to a tune of $12bn, which is why it is not clear what reduction is meant and how the National Bank intends to realise the same. As distinct from the previous paper, which was based on forecasts of oil prices and inflows of foreign capital, this one is built on a single assumption that this year oil prices will range from $70 to $90 a barrel.
Recently, oil prices fluctuated significantly in reaction to forecasts of possible recession in the U.S. Analysts believe that a fall in oil prices may become a stable trend, since the U.S. recession will slow down GDP growth in other major economies, first of all in China, Japan and the European Union. Should this happen, the National Bank’s pessimistic scenario could turn out to be too optimistic. In particular, it is unclear how Kazakhstan will correct its foreign balance if its incomes from exports of oil and other materials can only go downwards in such case. It is common knowledge that Kazakhstan does not have other export items to make up the deficit in foreign balance.
Because this situation is possible, the National Bank’s document reads that “since foreign currency seriously lacks liquidity and there is a threat of sudden capital outflows from the country, tight measures will be taken, if necessary, to stabilise the domestic foreign exchange market”. To this end, the National Bank is ready to use by far non-market measures “to restrict capital outflows and increase the supply of foreign currency, including temporary currency restrictions (special permits)”.
To be fair, despite the announcement of correction of the foreign balance, the National Bank still expects “a serious deficit on current accounts” (estimated at over $5bn). It also makes a cautious assumption that “banks will not be able to refinance all their liabilities to non-residents, which will mature in 2008-2009, from new foreign borrowings”. In such a situation, we only have to agree with the National Bank that “if there is no access to external resources, the need to service external debt will cause a net outflow of capital from the country” and that “this will exert high pressure on, or depreciate, the tenge”.
The last thing that cannot be omitted is that the government is ready – if necessary – to double allocations through the banking system to secure socioeconomic stability (“on a targeted, repayable and interest-bearing basis”). This was said by Kazakhstan’s Prime Minister Karim Massimov in an interview to the Russian Vedomosti. He also reminded bankers that “this is not only the government’s problem, but also that of the banks’ shareholders”. To overcome the problem, Karim Massimov, on the one hand, advised shareholders to inject additional funds into banks and sell non-core assets and, on the other hand, suggested that “the government will welcome additional issues of shares”.
Experts Warning
While the government, the National Bank and FSA planned how to overcome the current situation, experts expressed their own opinion. Many analysts – although they do not reject the usefulness of the government support – are rather critical of the possibility that the government will allocate, “if necessary”, an extra $4bn to stabilise the situation. For instance, Boris Umanov, chairman of the board of the Eurasia insurance company, said at a press conference: “Increasing government expenses on various projects should be done cautiously. It is like a medicine, a high dose of which can be poisonous. The more money the government lends to banks in order for them to lend to developers, the more risks we’ll accumulate. And we will face serious problems sooner or later. In the current situation, government expenses are not bad, but the lesser they are, the better for the economy”.
The World Bank noted, in a special statement issued in support of measures planned by the Cabinet, the monetary authorities and the regulator, that the “government and National Bank should not cover all of the risks and losses in the financial sector associated with the current difficult situation”. Moreover, the World Bank believes that “if banks and private investors are given the impression that their private risks are insured by the government, they will behave in an excessively risky manner to the detriment of the Kazakhstani economy and financial stability in the medium term”.
Yekaterina Trofimova, analyst of the international rating agency Standard & Poor’s, also approves the government’s “positive and constructive” measures. She said that “Kazakh banks have successfully overcome the first shock associated with the worsened situation in the global financial markets with the support of the National Bank, the national financial regulator and the government”. Yet, there is a fly in this ointment. She said that “neither banks, nor the government have a clear idea of how the banking system will develop in the new reality, which is the very first thing foreign investors want to know”. She also emphasised that “today’s tension signalises the necessity to seriously review business models and banking practices”. Yekaterina Trofimova expressed confidence that the year 2008 should determine the overall dynamics of the development of Kazakhstan’s banking system in the long term.
However, what really produced the “bomb effect” was criticism of the government and the Kazyna Sustainable Development Fund by Zeinulla Kakimzhanov, ex-chairman of the board of the Investment Fund of Kazakhstan, who said to the press: “There is a tendency to shift the banking problem to banks themselves. What are the main problems in the financial sphere that everyone talks about? A large portion of external borrowings, bad structure of loan portfolios, a high portion of mortgages and problems in the construction sector, all of which weigh down the banking sector. Yes, banks could exercise a more balanced and cautious policy. But the banking system moved in set directions, which were proclaimed a priority of the governmental policy: small and medium-sized business, industrial projects, residential construction. The conclusion is that banks were directed by the governmental policy”.
As for future trends, Mr Kakimzhanov was very pessimistic: “In the future we will face aggravation of liquidity and further shrinkages in lending in the construction sector and in the sphere of industrial projects. A serious negative consequence will be a reduction of lending for working capital purposes. As you saw in the recent years, the advancement of enterprises was largely associated with an increase in working capital lending. So, we should expect further decreases in production and GDP growth, a latent payment crisis, and, as an overall result, a reduction in tax incomes”.
Mr Kakimzhanov also criticised the mechanism of supporting the economy through banks. “The mechanism built by Kazyna is nothing more than misunderstanding of the real functioning of the financial and banking systems, a desire to control something that cannot be controlled. This could be resolved by a far simpler scheme – a deposit agreement between banks, the National Bank and the Finance Ministry that could clearly set out the designation of these moneys. And believe me, in these conditions banks would discharge their obligations in good faith”.
The main conclusion made by Mr Kakimzhanov about the government’s actions sounded like a diagnosis: “Today, we have not a problem of banks, but a problem of national economy management”.
While rating agencies and experts voice their far from optimistic evaluations of the current situation and make uninspiring forecasts, banking statistics do not show a significant fall in the quality of second-tier banks’ assets.
FSA reported that, as at 1 December 2007, the portion of loans to businesses was 72.5% of the total loan portfolio of banks or, in absolute terms, 6,388.3 billion tenge. At that, the concentration of banking loans did not change. As earlier, over two thirds of the loan portfolio of second-tier banks falls on three industries: trade (27.6%), construction (26.6%) and non-production sector (23.5%). In other sectors, the figures are significantly lower. Loans to the industrial sector totalled 13% of the banks’ total loan portfolio as at 1 December, agriculture 4.5%, and transport and communications 2.7%.
FSA’s analysts note that the quality of loans to the construction sector remains high. They estimate that the specific weight of standard and doubtful loans in the first category of this sector is about 81.4% and that of bad loans 1.2% only against 1.7% as at the beginning of the previous year. Yet, there are grounds to question these figures, such as idle construction sites, which were frozen in August and the majority of which remain stagnant today, and the worsened quality of assets of the largest banks in the world, especially considering that their risk management is far higher than that of domestic second-tier banks.
It should be noted that FSA prepares its report based on the information provided by banks, which is why there should be no claims to the regulator. On the contrary, FSA has its own concerns about the situation. According to its ex-head Arman Dunayev, “it is impossible that, globally, the quality of loan portfolios goes down and yet in our country it remains at the previous level”. So, it is no surprise that FSA intended to begin checks of major Kazakh banks in the beginning of the year.
If we accept that the quality of bank assets remains high de facto, there arises the justified question as to whether there is a real need for the government support to the economy through banks, which totals $4bn and will be allocated from budget or, in other words, at the expense of taxpayers.
As for the trade and non-production sectors, the consequences of reductions in lending are still to come.
Repaying Debts
This year, the banking sector will need to repay over $12bn in foreign liabilities. Most analysts believe that the main portion of these moneys cannot be refinanced from external borrowings or domestic sources. Representatives of the banking sector itself also acknowledge it. In particular, Darkhan Shadykul, managing director of Tsesnabank, thinks that the domestic capital market is not developed enough to meet this demand: “Besides pension funds, we have no major investors. Unit investment trusts do not play a significant role yet. Today, placing even 1 billion tenge in the domestic market is a real problem. If we talk about billions of dollars – today’s deficit faced by banks – this task is practically unsolvable. It is absolutely unrealistic to consider the domestic market as a means to replace external refinancing of the banks’ debts”.
All these facts cast a lurking concern that, if the situation worsens further, the government would not confine itself to indirect support to the financial sector and the economy, but would step out of the limits of market regulation instruments with the help of the National Fund. Experts believe that the resources of the latter are still taboo for the very simple reason that if the government sacrifices these moneys on the altar of the financial stability, the market would perceive that as a weakness. This would instigate speculative transactions and can provoke a second wave of capital outflows, which, at best, will significantly affect the national currency and forex reserves or, at worst, cause a default. We cannot but hope that this cup will pass from us.

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Stock Market: RFCAsums up Results  Chingiz Kanapyanov 
Stock Indices: Fighting All Winds  Tatyana Kudryavtseva 
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