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Kazakhstan's Ratings: Post-mortem
It is no secret that the downgrading of Kazakhstan’s sovereign and corporate ratings by the international rating agencies, Moody’s, Standard and Poor’s and Fitch Ratings, has significantly cooled down their relations with the Kazakh authorities and issuers. This fact gave a special edge to a conference that Fitch organised in Almaty in February 2008.
From Stable to Negative Outlook
The conference, entitled “Kazakhstan in the Context of Global Liquidity Crisis: Risks and Ways for Resistance”, became the second annual meeting between Fitch analysts and Kazakh ministers and chairs of the Financial Monitoring Agency and the National Bank of Kazakhstan. In addition, European Bank for Reconstruction and Development economists were invited to act as arbiters of a kind at the conference.
The conference started with an assessment of the macroeconomic situation. In contrast to its colleagues, Fitch did not downgrade Kazakhstan’s sovereign rating in 2007, affirming it at BBB in foreign currency. However, it had twice revised its outlook on this rating: first in October it lowered it from positive to stable, then in December from stable to negative. Andrew Colquhoun, Director in Fitch’s Sovereigns team, said that the main reasons for this revision were the problems of funding in the banking sector, a fall in the country’s currency reserves, economic slowdown and a growth in inflation rates.
In the past few years, commercial banks’ foreign loans had created a credit boom in Kazakhstan. According to Fitch forecasts, the ratio of loans to GDP will reach about 60% in the country in 2008, which is comparable to figures in countries with BBB ratings. On the other hand, by their actions the banks helped accumulate risks in the sphere of foreign finance. As a result, demand for foreign borrowing accounted for about 40% of GDP in 2007, which is double the average in the BBB group.
Sharp restrictions Kazakh banks faced with accessing foreign loans have led to the government increasing support to the financial system, taking significant obligations upon itself. The National Bank offered commercial banks a certain amount of liquidity in foreign currency that was necessary to observe the deadlines on loan payments. However, this strategy also influenced the country’s current account balance – the National Bank’s foreign reserves fell by 22% to $18.2 billion between July and November 2007 alone.
The government has already set aside $4 billion in the central budget for supporting lending, above all, in the property and construction sectors. At the same time, spending on this support may turn out to be even greater, if the country’s economic indicators prove to be worse than expected. According to Fitch estimates, the net value of the country’s foreign assets will fall from 31% of GDP in late 2007 to 19% by the end of this year. This reduction increases the risk of the local private sector losing confidence in the national currency and the authorities’ ability to support the financial system, which may cause capital flight and crisis phenomena on a larger scale. In connection with this, maintaining the tenge’s exchange rate, the agency believes, will become a priority. At the same time, Fitch regards such an outcome as unlikely.
Fulfilling the government’s plans to ensure financial stability is complicated by an unfavourable combination of macroeconomic factors such as a significant price hike and the deterioration of development prospects. For example, inflation stood at 18.8% in 2007 (December 2006 to December 2007). Moreover, in late 2007 the National Bank increased the refinancing rate from 9% to 11%. This decision was taken despite concerns over a possible slowdown in economic growth. At the same time, Fitch forecasts that the growth of Kazakhstan’s GDP will fall to 5% in 2008.
Favourable factors that back up Kazakhstan’s sovereign rating, Mr Colquhoun said, are the lowest ratio of public debt to GDP among countries that have BBB ratings. This figure stood at 7% at the end of 2007. Moreover, in the long term, thanks to large reserves of natural resources, the country will still rely on foreign direct investment attracted to the mining sector. In conclusion, the analyst said that in general, Fitch expected a gradual correction with a moderate weakening of Kazakhstan’s current account balance. He noted, however, that the complicated situation on the global market would increase the risk of a slump.
The EBRD also expects Kazakhstan’s macroeconomic indicators to fall. In particular, according to the bank’s principal economist, Ralph de Haas, the bank forecasts GDP growth at 6.2% in 2008 and 7.2% in 2009. It estimated that inflation would stand at 10.9% and 7.3% respectively. The banker stressed that these indicators were very close to forecasts made by the Kazakh government itself. Having noted Kazakhstan’s advantages in terms of natural resources, Mr de Haas drew particular attention to the fact that in the situation of limited access to foreign funds the Kazakh economy would directly depend on world oil prices. It is hard not to agree with this – the speculative component has been gradually growing on the raw materials markets which, as a rule, may result in price hikes. As a result, reliance on raw materials may turn out to be very unreliable, which is why the issue of the real diversification of the economy is topical for Kazakhstan as never before.
We are Realists!
Kazakh government officials also expressed their views on how the situation had developed, noting that they had already complained some time ago that the international experts’ vision was somewhat different from the reality.
Kazakh Minister of Finance Bolat Zhamishev said the government’s initial forecasts had been more optimistic than its present ones. The country’s authorities believed that the international financial markets would open up as early as spring 2008, and, consequently, there was an expectation that government support to the economy would be a short-term measure. At the same time, they also considered scenarios that envisaged large-scale budget funds, but later this position was changed and expressed in a joint statement made by the government, the National Bank and the Financial Monitoring Agency.
This statement explains their vision of the situation and possible measures which the government and the regulatory bodies intend to take in the future. Mr Zhamishev reassured the audience that these measures would be targeted and not too large in terms of budget funds, as expected by some market players.
In the situation when inflationary pressure considerably grew, the government, the National Bank and the Financial Monitoring Agency focused their attention on, first of all, averting those risks that may push inflation further up. It was decided to keep it at 10% this year. For this purpose, the government has built up food reserves to keep prices down by market intervention. In the fuel and lubricants sphere, the oil refineries’ workload has been increased, partly with the help of Russian oil imports. The minister said that these were specific measures prompted by the current situation.
As systematic measures, the finance minister specified a task to cut funds for the so-called development budget but spare social spending. On the other hand, this is a reaction to a jump in budget spending as a factor exerting pressure on the macroeconomic situation. On the other hand, this measure takes account of a potential decrease in budget collections this year because economic growth forecasts had been reduced considerably. In addition, Mr Zhamishev emphasised that tax collections in January did not give any signals of economic slowdown or potential problems in fulfilling the budget.
A switch to drafting a three-year budget is also linked to a more efficient implementation of the development budget, whose share in government spending is growing larger every year. A growth in the budget’s investment component envisages the extension of the duration of investment projects. In addition, this step will have a positive impact on socioeconomic stability in Kazakhstan.
However, the government has to draft and submit a new Tax Code to parliament this year. The minister of finance said that the new code’s concept could be briefly explained in this way: “First, reduction in tax burden for the non-extractive sector; second, redistribution or compensation for temporarily lost tax collections at the expense of the extractive sector, and third, the revision of tax breaks that have grown big in number.”
In response to concerns raised by international experts over an increase in government spending on supporting certain rates of the economy, Mr Zhamishev stressed that there would not be any direct budget siphoning into the financial sector, except for those measures which would be taken by the Kazyna Sustainable Development Fund. As a result, it was decided that the Development Bank of Kazakhstan would buy commercial banks’ claims to borrowers, given that projects to be refinanced by the bank should correspond to its mission. However, these operations should not be large-scale, although this mechanism, which will be implemented systematically, will produce a certain effect. Speaking about funds for small businesses, the minister said that loans issued by the Small Business Development Fund to this sector accounted for only 1.4% of the commercial banks’ total loans issued to small and medium-sized businesses. He believes that no state support will be able to change this ratio and no financial institution, except for commercial banks, is capable of ensuring funds for small and medium-sized businesses in full. As banks will be solving issues relating to liquidity, conditions for funding small and medium-sized businesses will also be improving. “Proceeding from the structure of our economy and the structure of loans issued to small and medium-sized enterprises, I do not see other scenarios,” Mr Zhamishev said.
Support to the construction sector will be limited only to projects conducted in Astana and Almaty, and only in certain projects in which individuals make up the majority of investors.
The chair of the National Bank, Anvar Saidenov, explained the reasons for a jump in inflation rates. He said that in 2007 the country’s economy was squeezed by two negative processes that took place at the same time. On the one hand, there was the global financial crisis, on the other hand, world food prices started rising quickly. Actually, monthly inflations rates in September-November 2007 contributed exactly half of annual inflation – 9.4% out of 18.8%. As a result, starting from the second half of the last year, there were both shortages of liquidity in the banking sector and the growth of inflationary pressure. The National Bank faced a dilemma – in order to maintain the stability of the banking system it needed to inject additional liquidity, but in order to reduce inflationary pressure it needed to withdraw it. In this situation, “precisely for that short period of time” the National Bank prioritised the maintenance of the stability of the banking system because it has a direct impact on the stability of other segments of the financial market, including pension funds. This choice led to the situation when despite measures adopted in the first half of 2007 to cut inflation, inflation targets were not met. In general, Kazakhstan’s chief banker expects that inflation will slow down in 2008-2009. The National Bank forecasts it to be within a corridor of annual 7.9-9.9%. In conclusion, Mr Saidenov said that the objective of the National Bank’s actions in the next two years would be to maintain a complex but achievable balance between the stability of prices and the stability of the financial system.
Banks Facing a Blow
A separate round table at the conference was devoted to the banking sector. Fitch banking analyst Alexei Kechko presented the first report, starting with the ‘customary’ thesis that the banks’ high dependence on foreign funds posed considerable risks to this sector.
It is worth mentioning that since 2005 Fitch experts had been talking about the pressure applied to Kazakhstan’s sovereign rating by extremely aggressive foreign borrowings by Kazakh banks. However, they did not manage to persuade the commercial banks, with the result that by November 2007 48% of the latter’s liabilities were in the form of foreign borrowing. Thus, ignoring the warnings led to the December downgrading of the ratings outlook of the country’s top six banks to negative.
Mr Kechko said that despite the fact that there had been a sharp growth in clients’ deposits in Kazakhstan in recent years, their share in commercial banks’ funding remained flat or fell. In addition, regulative measures adopted in 2006 and the first half of 2007 had had no significant impact on reducing growth in foreign borrowing. That is why it is no surprise that it has become very hard for Kazakh banks to refinance their liabilities in the current situation.
However, Fitch pointed only to a moderate risk in refinancing in the short term. Over 80% of the leading commercial banks’ major loans should be repaid after 2008. According to Mr Kechko’s information, the banks should pay off no more than $3 billion each quarter next year. This is an affordable figure, given that Kazakh commercial banks’ total assets now stand at $100 billion. Moreover, the second half of 2007 showed that capital markets had not shut down fully – most banks managed to attract certain amounts of foreign funds through securitisation or syndicated loans.
Alexei Kechko pointed to the good state of liquidity: the banks are not experiencing problems with paying off their short-term liabilities. The liquidity risk, in general, is manageable, while funding from clients is stable. Although there was some withdrawal of deposits last year, in November-December this trend was reversed. In addition, the Kazakh authorities are also providing liquidity support. As a result, the refinancing risk, Fitch believes, is not a current factor.
In the short term, the main risks are linked to the quality of assets. Firstly, banks increased their loan portfolios very quickly and the real quality of the loans they issued will only be revealed in the coming 12 to 18 months. By the end of 2007, a downward trend was apparent, which is why prospects so far are unclear. Factors such as reduction in the liquidity of borrowers, negative pressure on property prices (which may put pressure on the value of collateral) and a possible devaluation of the tenge – because commercial banks shifted this risk onto borrowers who do not always have access to earnings in foreign currency – may all play a negative role in this situation.
Among positive creditworthiness factors, Mr Kechko noted a low level of loan depreciation, good current profitability and liquidity levels and quite strong regulation. The analyst believes that the changed market situation may have a positive effect on standards of underwriting of loans, the capitalisation of commercial banks, and, later, the structure of funding.
The chair of the Financial Monitoring Agency, Yelena Bakhmutova, discussed banking sector indicators in detail. She said that the loan portfolio grew by only 48% in 2007, which is the lowest figure since 2003 (for example, the growth was 95.7% in 2006). However, the quality of assets changed considerably – the share of standard loans fell from 52.6% to 39.8% in a year, while the share of doubtful loans went up from 45.8% to 58.7%. Mrs Bakhmutova explained that a sharp fall in the quality of the portfolio was caused by tightening requirements for classifying loans from 1 April 2007. At the same time, the share of losses did not change much at 1.5%. As for the share of loans with delayed payments, it varies from sector to sector with the highest figures in the construction sector and industry (6.7% in each). The share of losses in total retail loans grew from 4.35% to 8% in the past six months. Although the share of loans issued to the construction sector in the commercial banks’ loan portfolios grew from 14.2% to 19.4%, it remains relatively low. At the same time, the share of mortgages (all loans issued on security of property) is 37.7%. About 50% of all loans were issued in foreign currency, which is why Mrs Bakhmutova admitted that Fitch’s concerns about currency risks were not that groundless. The total volume of the banks’ foreign liabilities stood at 5,403 billion tenge or 52.7% of their total liabilities. However, she stressed that in terms of maturity there was uncertainty about liquidity around loans with a maturity of six to 12 months.
Among the positive factors, the head of the Financial Monitoring Agency noted, were a teething growth in the deposit basis and the growing fixed capital (by 52.5% in 2007). “The Financial Monitoring Agency has never fought against absolute figures of foreign borrowing; we have always drafted requirements which set a proportion between foreign liabilities and the size of equity capital of a bank. Our measures aimed to increase banks’ equity capital. This boosted the competitiveness of the banking sector, especially in the situation of the forthcoming membership of the WTO,” Mrs Bakhmutova explained. She reassured delegates that her agency would continue to stick to strict regulation. The agency will set up a technical committee which will conduct rapid reaction monitoring procedures. The agency’s priorities are to inspect and assess risk management procedures adopted by financial organisations, prevent crises on the financial market, strengthen the agency and expand its cooperation with foreign regulators. Summarising her report, Mrs Bakhmutova stressed that “the picture is not being painted in bright colours but followed in real terms”. There are risks in terms of both the quality of portfolio and liquidity. This raises concern, but “regulatory measures are being taken on time and properly”. However, some food for thought was raised by the chair’s remark that the agency’s information concerning the quality of portfolio was based on data provided by the banks themselves. That is why the reliability of this information and the management of banks’ attitudes to their direct functions raise great concerns.
Will Everything Be OK?
As for forecasts for the future development of the banking sector and the Kazakh economy, in general, it should be noted that the assessments made by bankers, the regulators and international experts largely coincided.
Roman Solodchenko, the chair of the board of directors of BTA Bank, believes that banks are continuing to play a great role in the economy. “Conservatively, we expect a growth at about 19%, of course, this is higher than GDP growth,” he said. This slowdown will make it possible to clean up portfolios and balance the funding basis. Loan interests will be equalised and become more stable, which means there will be the possibility of long-term planning. “We will arrive at a quieter banking system, because any system that grows by 100% a year raises concern even among those who are growing within this system. I think that the path we are moving along is positive,” Mr Solodchenko concluded.
The chair of the Financial Monitoring Agency noted that a moderate balanced development of the banking sector would stabilise the entire financial system further and change the attitudes of borrowers who were tempted by “quick money”. She forecast that the loan portfolio would grow by 10-15% on average, which does not pose a serious threat either to commercial banks or the economy in general. In the future, the gap between growth in the banking sector and real economic growth should narrow. In addition, Mrs Bakhmutova believes that other financial intermediaries now have a chance to seize the initiative from commercial banks.
Andrei Timchennko, managing director at Kazkommertsbank, stressed that on average in the world the growth of bank assets is about three times higher than GDP growth, which is why this ratio may be applied to Kazakhstan as a long-term scenario. Small and medium-sized businesses and the consumer sector are also expected to grow because these segments are still at the initial stages of their development.
David Nangle, director of research at Renaissance Capital, believes that the growth rates of Kazakh commercial banks will range between 0% and 10% this year. Much will depend here on the state of global capital markets.
Forecasts for 2008 made by the conference organisers were announced by James Watson, senior director of financial institutions at Fitch: a small growth in assets and loan portfolios, a moderate deterioration in quality and a moderate increase in delays in payments on losses. In addition, this will be compensated by a higher margin and a quite stable liquidity situation.
Closing the conference, Dmitry Surkov, managing direct at Fitch, noted that the overall view that the agency intended to convey was that, despite short-term risks, Kazakhstan had very positive long-term prospects. “Many must have thought that we would have a horrible confrontation here today. Actually, I have not seen a fundamental difference in views and I only hope that this will be the same in the future,” Mr Surkov said.

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Stock Market: RFCAsums up Results  Chingiz Kanapyanov 
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