What is potential on further monetary policy easing?

On April 10, NBK decided to keep the level of the base rate at 11% with the corridor +/-1pp. The decision of NBK reflects remaining inflationary risks caused by the positive dynamics of incomes, an increase in budget expenditures and a sensitivity of inflation processes to the conditions on international markets.

On April 10, NBK decided to keep the level of the base rate at 11% with the corridor +/-1pp. Earlier in February, according to the regulator, due to the entry of inflation into the target corridor and the recovery of business activity, the rate was lowered from 12% by 1pp.

The current decision of NBK reflects remaining inflationary risks caused by the positive dynamics of incomes, an increase in budget expenditures and a sensitivity of inflation processes to the conditions of international markets. The level of annual inflation is falling and is within the regulator target corridor (7.7% in March), but inflation is yet at a high level, apparently due to a rise in producer prices in 1Q, an increase in tariffs and prices for imported goods.

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Our opinion

The inflation jump in November last year coincided with the decision of NBK in mid-November to reduce the base rate to 12%. However, in the statements of regulator, the factors of this inflation rate rise were not announced and the reasons for the sharp monthly hikes are unclear to us.

We also note, that the level of the real rate under current conditions of the base rate and inflation in the country is at the level of ~3%, in Russia this indicator is higher at ~5%. Given the similarity of the economies (both are developing, emerging markets countries), as well as commitment to inflation targeting in the monetary policy and the floating exchange rate regime of the national currencies in both countries, this difference in rates is not entirely clear to us. The Central Bank of Russia regularly comments on the validity of the real rate, explaining its level by the fact that it keeps incentives for making savings and at the same time provides demand for credit, which does not lead to an increase in inflationary pressures. In NBK rhetorics, this indicator is not covered.

Taking into account that imports from Russia make up just over a third of the country's total imports, and most part of imports are investment goods (machinery and equipment), as well as mineral products (gasoline and fuels), in our view, the real and nominal weakening of tenge to the ruble has a significant impact on price increases. However, we do not find any comments on this factor in NBK's statements.

In our opinion, an increase in public spending by 31% after the amendments to the budget is an underestimated risk of inflation this year. An allocation of T2.1 trillion to improve the banking sector will provide additional liquidity, and it is also exactly unknown how the NBK plans to sterilize it in order to prevent the acceleration of inflation.

According to our calculations, the effect of lowering the base rate on loan rates is insignificant: if the base rate is reduced by 1pp, the rates on loans are reduced by only 0.09p. Therefore, we think, the regulator is likely to adhere to the policy of lowering the base rate in order to demotivate banks to send free funds to NBK notes purchase. Thus, in conditions of low profitability of NBK instruments, banks may direct it to lending.

We believe, that the somewhat changed sentiment in the NBK's rhetoric, due to the replacement of the phrases: "the potential for further easing of monetary policy is limited" in the previous statement to "possibilty of lowering the base rate increases" in the current statement, also gives reason to believe that the next decision in the 2nd quarter 2017 allows a reduction in the rate.

However, we think, that the factors for allowing further lowering of the interest rate are somewhat limited this year because of an increase in government spending (growth in social payments), an increase in tariffs and prices for imported goods due to the weakening of the tenge against the ruble.

In our opinion, the decline in inflation in March is a temporary factor and inflation expectations remain volatile, so the easing of monetary policy is likely to proceed more cautiously.