Kazakhstan’s Economy. Curve, Here Is Another Curve!
The main consequences of the problems that have emerged in the financial and construction sectors for the Kazakh economy may turn out to be a significant reduction in GDP growth rates. The result of the August events is obvious – a recession in Kazakhstan’s economic system, which seems to be gaining an impetus.
From Growth to Recession
Despite the widespread opinion that the oil and gas industry has been the locomotive of our economy for the past few years, even a superficial analysis of statistical data draws an absolutely different conclusion.
The oil sector had been making the main contribution to GDP growth since 1999, whereas since 2004 the main contributors have been the banking and construction sectors. In the first half of 2007, they contributed 65% of GDP growth, whereas other sectors accounted only for 35% of GDP growth.
Moreover, the growth in the banking and construction sectors was several times the growth in GDP. For example, GDP has been growing by 10% on average between 2004 and 2007, whereas the financial and construction sectors have been growing by 37.5% and 44.2% a year on average respectively. In the first six months of this year (up until the US subprime mortgage crisis), the financial sector grew by an annual 60%.
This would not have been a problem, if these growth rates had been ensured by domestic sources of funding. However, a number of Kazakh major banks had been actively attracting foreign loans because they cost less than those from the domestic market. For example, the National Bank of Kazakhstan’s refinancing rate was higher than interest rates set on Western markets. As a result, local banking institutions increased their foreign borrowings from $800m in the first quarter of 2005 to $4.8bn in the first quarter of 2007. It is precisely this factor (along with high growth rates of foreign investment in the country) that has become the main reason why Kazakhstan’s economic growth has stood at 10% over the past three years.
However, interest rates on foreign loans have gone up after the August events. For Kazakh banks this meant an increase in the risk of failing to refinance loans, a drop in liquidity and the toughening of loan policy, and for the economy in general a reduction in financial injections from the banking sector and a slowdown in GDP growth rates.
The situation was complicated by the fact that most of funds attracted by local banks on the Western capital markets had been channelled into the construction sector and issuing mortgages. In total, Kazakh five major banks (which hold over 70% of banking assets) had increased loans issued to construction companies by 550% from $1.6bn in late 2004 to $10.4bn in mid-2007. Therefore, 20-25% of these five banks’ loan portfolios without mortgages are made up by loans issued to construction companies. This figure will reach 35-40% with mortgages.
That is why it is natural that after banks tightened up conditions for issuing loans to construction companies and mortgages to the population (increasing interest rates, cutting terms and increasing the size of an initial payment) the share of these segments in the loan portfolios of Kazakh commercial banks is expected to fall significantly. This means that the growth rate of the construction sector and related industries will slow down further, strengthening recession trends in the economy.
To Be Continued
It is possible that the recession will be somewhat eased by measures the government intends to take to buy out mortgages issued by commercial banks through the Kazakh Mortgage Company and loan construction companies to enable them to complete projects in which people fund their future housing. However, these anti-crisis measures, in essence, for a number of reasons will not be able to have a considerable impact on preserving previous growth rates in the construction sector.
Firstly, it is still not clear how much money from an anti-crisis fund which has recently been set up (from taxpayers’ money) the government is ready to allocate for supporting the construction sector. One thing is clear that all of this $4bn will be spent on supporting builders.
Secondly, another factor that is having a negative impact on both the construction sector and growth rates in the banking system is the uncertainty on foreign capital markets. Investors are still expecting that the US subprime mortgage crisis will worsen and are calculating the losses inflicted by its first wave. Therefore, we should not expect interest rates on loans for Kazakh banks to fall in the near future. This is increasing their risk of refinancing their debts, as well as reducing their growth rates, opportunities to obtain new loans and their share in GDP.
In this situation, the National Bank’s statement that Kazakh commercial banks have recovered their ability to obtain funds on foreign markets is premature. Despite the fact that our bankers had managed to attract over $4.2bn on Western markets between August and November and paid off (at indirect support from the central bank) sizeable sums on their foreign liabilities, all this points not as much to “recovery of Kazakh banking institutions’ ability to obtain funds”, but to their ability to stay afloat thanks to the National Bank’s financial “braces”. However, the crux of the issue is as how long this can continue because forex reserves and taxpayers’ money are not unlimited. To tell the truth, there are still the funds of the National Fund and the private pension schemes to draw on, however, the government says “there cannot even be talk of” using them to support liquidity in the banking system.
Thirdly, the KazPrime index, which reflects the average interest rate on interbank deposits on the domestic market, has exceeded 12% for the first time, whereas it had never even reached 4% before the August events. This explicitly points to domestic banks’ continuing problems with liquidity coupled with mounting inflationary pressures. As a result, they are unlikely to agree to cut loan interest rates, leading to further cuts in loans for the economy.
These three factors alone are sufficient to draw conclusion that recession in the domestic economy has all chances of growing from a short-term trend into a medium-term problem. However, it is premature to talk now about a large-scale financial crisis, because the National Bank is still capable of supporting the liquidity of leading Kazakh commercial banks.
Meanwhile, foreign creditors’ scepticism about our banks (this is proven by the continuing fall in share prices of leading Kazakh banks on the LSE) is growing, “heated up” by the downgrading of international forecasts and ratings. We can only guess as to what interest rates Kazakh banks had managed to obtain foreign borrowings on between August and October. Although bankers themselves are not inclined to publicise this, we can assume that they were higher than before the US subprime mortgage crisis, because higher risks mean higher costs.
In this situation, some analysts draw parallels with the Russian default in 1998, which was directly linked to the extremely high concentration of funds of financial institutions on the government bond market. In fact, this was a lawful financial pyramid built on sky-high interest rates set by the Russian government. And as soon as the government failed to fulfil its “paper” obligations before local and foreign investors the pyramid collapsed, causing a wave of bankruptcies and the budget’s default on foreign borrowings.
Of course, the current situation in Kazakhstan is considerably different from the events in Russia in 1998. Moreover, the government is not directly linked to liquidity problems in the banking sector. However, we should not deny the extreme concentration of bank loans in the construction sector and on the property market. On the one hand, banks were the source of increasing the total supply of housing through funding the construction sector; on the other hand, they prompted a growth in total demand for property through issuing mortgages. As soon as Western investors turned off the tap of relatively cheap financial flows, both the construction sector and the mortgage market were frozen. That is why it is, at least, naive to expect a thaw to take place soon.
Who Knows What Tomorrow Holds?
When asked whether they expected a slump in GDP growth rates for the whole year, analysts, the government and financiers give an affirmative answer, whereas they do not have a common opinion on how significant or long this slump will be. According to the government’s official position which has been made public by Prime Minister Karim Masimov, real GDP growth will stand at 5-7% next year, or almost a half of the earlier forecast 10%. In turn, analysts from Russia’s Aton investment company have also forecast a slowdown in GDP growth in Kazakhstan in the short-term. They believe that it will stand at about 7.5% this year, falling to 6.6% in 2008, while reaching the previous level of 10% growth in GDP only in 2010.
According to more pessimistic forecasts, the liquidity crisis on the Western capital markets will drag on over the next two years. This will result in a gradual depreciation of the tenge because of a further growth in the current account deficit, which, the National Bank forecasts, will exceed 4% of GDP this year. Therefore, we have all grounds to predict that GDP will grow only by 4-6% over the next two years. At the same time, the depreciation of the tenge will boost the competitiveness of local goods produced for the domestic market. In any case, this will have no significant impact on economic growth rates because the Kazakh market is very small, despite the high purchasing power of the population.
According to the most optimistic forecasts, the previous economic growth rates will pick up at the end of the first quarter of 2008. However, only few people believe this, because the scale of the global liquidity crisis was far more serious than it was assumed earlier, while our banks’ ability to borrow on Western markets will be limited by high interest rates and negative expectations of foreign investors.
In this situation, more realistic assessments are being made by those analysts who forecast the development of the banking and construction sectors in the first half of 2008 in a side trend with a possible further insignificant slowdown in their growth. Only in the second half of the year may the trend change upwards.
One way or another, there will not be the previous growth rates in the financial and construction sectors next year, which means that there will not be the previous GDP growth rate either.
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