Macroeconomic report Q4 2017

Halyk Finance ResearchJanuary 11, 2018

The acceleration of economic growth at the end of 2016 began to lose momentum from the second half of 2017, GDP growth in 2017 according to the preliminary data has reached 4%, 3.5% yoy in the fourth quarter, whereas it was 4.8% yoy in the second quarter. On the one hand, it is explained by the influence of the shrinking effect of the low base in 2016, on the other hand, as we have repeatedly pointed out, the momentum for economic growth is primarily generated by the commodity sector, therefore as the previous plans for oil extraction at Kashagan were not achieved, the growth in oil production after the March peak has been virtually stagnating during the rest of the year.

The acceleration of economic growth at the end of 2016 began to lose momentum from the second half of 2017, GDP growth in 2017 according to the preliminary data has reached 4%, 3.5% yoy in the fourth quarter, whereas it was 4.8% yoy in the second quarter. On the one hand, it is explained by the influence of the shrinking effect of the low base in 2016, on the other hand, as we have repeatedly pointed out, the momentum for economic growth is primarily generated by the commodity sector, therefore as the previous plans for oil extraction at Kashagan were not achieved, the growth in oil production after the March peak has been virtually stagnating during the rest of the year.

The construction activity went into abrupt decline in 2017, which was previously backed by the public investment of the construction of facilities for international events, infrastructure. It is also worth noting that the character of injections of public funds in 2017 was that huge funds have been allocated to the banking system (4% of GDP), but they didn't go into the real sector of the economy – bank lending hadn't started.

The real wages, despite the positive growth of the economy, continued to fall and according to our estimates, will remain in the red in 2018. This situation reflects the large share of inefficient public sector in total employment, where salaries weren’t growing. The falling real wages is also associated with weak rise in non-primary sector of the economy that largely depends not on self-efficiency, but on either inflow of resources from the commodity sector, or due to Government support.

The inflation amounted to 7.1% (corridor of the National Bank in 2017 was 6-8%) in 2017. The effect of the devaluation of tenge in 2015-2016 years evaporated, but there are certain doubts about the reliability of the official data due to dramatically weakening inflation in December 2017. An abrupt turn in the behavior of inflation in December (contrary to the traditional rise in prices in the run up to the New Year and rising inflationary expectations, witnessed in November 2017) left the impression of manipulated data on inflation.

During the fourth quarter of 2017, the regulator took a neutral position in its monetary policy. Acceleration of inflation in view of national currency weakening, growth of inflation expectations, shocks in the fuel market restricted NBRK’s actions towards easing the conditions on money market: the regulator twice during the quarter – in October and November – decided to keep the base rate unchanged at 10.25%. In such conditions, repo and swap rates were concentrated at the lower border of the corridor (the average repo spread with a lower limit of 0.06pp).

The National Bank continues to withdraw free cash of the banking system using notes, despite the fact that yields on these instruments are falling (since the beginning of the year by 2.7pp, while the decrease in the base rate explains only 1.75pp decrease). Considering this, the regulator has so far failed to stimulate banks to lend and not to accumulate liquidity. The volume of credit in the country, according to the latest data, fell again in November, and since the beginning of the year, there has been practically a zero growth. The base rate in the current situation serves more as a benchmark for the price of lending, since the influence of interest rate policy on activity of loan issuance is still limited by the risks of asset quality and capitalization deterioration and banks are not in hurry to reduce the premium on borrowed funds.

Despite the favorable oil prices, tenge significantly depreciated at the end of the 3Q-beginning of the 4Q in view of the population’s devaluation expectations. So according to the results of the reporting quarter, despite that the average price for oil increased significantly by 22% qoq to $63.5 per barrel, the average national currency rate for the quarter was 334.41 with a weakening by 2 tenge. Starting from the second half of 2017, the dependence of the tenge's exchange rate on oil fell. According to our estimates, the elasticity of the national currency to the price of oil declined to 0.10 against 0.14 in the first half of the year.

The regulator conducted official interventions in the FX market from August to October, which amounted to more than $500 million, while tenge continued to strengthen also in November, reaching the level of 333. Return of the exchange rate to a fundamentally justified level probably became possible due to currency conversion operations of NF funds. However, in order to adjust the exchange rate, the NBRK, in our opinion, could spend more – as previously the regulator announced the possible sale of around $1 billion, which apparently is not reflected in the NBRK's statistics.

It is noted that the influence of interest rates on the exchange rate is weak due to low capital mobility, which leads to a fundamental dependence of the nominal rate on the trade balance. Therefore, in our opinion, the main factors influencing the exchange rate are the price of oil, the ruble/dollar exchange rate (both factors influence the balance of payments balance through the trade balance), as well as inflation.

State budget revenues (excluding transfers) in January-November of 2017 amounted to T6.3 trillion with a rise of 9% yoy. 

However, compared to the nominal growth of the economy, the growth rate of tax revenues (excluding transfers) lags behind GDP, so in 2017 their share in GDP has become a little lower, reaching 12.2% (12.5% in January-November 2016) what we see as a negative factor. The lag in the pace is apparently due to uneven economic growth that is concentrated solely in few mining sectors. Therefore, incomes in other sectors of economy (agriculture, trade, construction, manufacture), and, consequently, taxes paid being not as impressive as in oil sector, apparently, contribute to a deceleration of revenues collected.

Expenses of the state budget in January-November 2017 amounted to T11.2 trillion (+34.9% yoy), which is about 21.5% of GDP (significantly higher than the previous year of 17.9% yoy), implementation of the plan for the use of funds is also at the level of almost 90%. Excluding funds for the improvement of the banking sector, state budget expenditures increased by 9.6% yoy in January-November, which only slightly exceeds the growth rate of the state budget revenues.

The deficit of the consolidated budget for 11 months increased to 5.9% (against 5.2% in 2016 and 4% in 11 months), but without taking into account the allocated funds to support the banking sector, the deficit is about 2% of GDP.

Due to a more favorable price situation on commodities market, for 9 months of 2017, export of goods in comparison with the previous year grew faster (+31.1% yoy) than import (+15.6% yoy). This resulted in the trade balance being 80% higher than in 2016 ($11.98 billion). The improvement in terms of trade, as well as the physical growth of exports in comparison with the previous year, still has a positive effect on the balance of payments (the average price for oil for 9 months of this year was $51.8/barrel, +24% yoy).

For 9 months of 2017, the current account deficit decreased by 16.4% compared to the same period last year. However, it should be noted that the growth in primary income payments, mainly representing direct investment, has grown more since the beginning of the year – almost 1.5 times for 3 quarters compared to the same period in 2016 to $13.21 billion, which reduced the positive effect of trade conditions improving.

For three quarters of 2017, capital inflows through the financial account compared to the same period in 2016 decreased from $11.6 billion to $6.7 billion (-43% yoy). The decrease is due to the drop in inflow of direct investment by 3 times to $4.8 billion compared to 2016, when foreign investments were at a record level ($14.9 billion for 9 months of 2016).

By the end of 9 months of this year, the reserves of the NBRK due to operations related to balance of payments grew by $0.5 billion, while in the first 2 quarters the reserves of the regulator were used to finance the balance of payments, in the third quarter there was a sharp increase by $1.3 billion. This growth is apparently related to the NF assets transfer to the regulator's accounts. The total balance for 9 months amounted to a positive value – an inflow of $0.5 bn.

The consolidated international reserves (NBRK reserves and National Fund) at the end of November 2017 amounted to $88.6 billion and were down by $2.3 billion since the beginning of the year due to reduction of assets of the National Fund by $3.6 billion while increasing reserves of the NBRK by $1.4 billion. Decrease in consolidated reserves was due to the allocation of T1 trillion ($3 billion) from the National Fund for rehabilitation of banks, otherwise, aggregate reserves of the country could have increased.

Scenario forecasts

Scenario projections of major macroeconomic indicators, we implemented with symmetrical deviation from baseline scenario assuming average annual oil price of $57 per barrel in 2018 (based on an assessment of the expectations of international organizations and market participants). Pessimistic – average price $47 per barrel in 2018 and optimistic – the average annual oil price of $67 per barrel in 2018.

Next year, we see good prospects for growth in the mining industry due to expanding production at Kashagan, in refining –  after the completion of modernization, carried out at refineries, in the food industry – there were serious investments in 2017, bearing in mind short production cycle in that sphere, the impact on the pace of expansion should be realized fast. In general we see industrial output growth at around 5% in 2018.

In 2018, one can expect a sizable easing of inflation to 6.5 percent, which would be facilitated by the likely strengthening of tenge at the beginning of the year and the stabilization of fuel prices due to the increase of oil refining at the modernized refineries. Weak demand, driven by declining real incomes, would serve as a deterrent for rising prices. The planned reduction of the injection of funds from the National Fund to the budget and the overall reduction in budgetary expenditure relative to GDP will also have positive impact on the easing of inflationary pressures.

We believe that, despite the slight decrease in public investments in the economy in 2018, further easing of inflationary pressure opens more space for softening monetary policy and intensify the credit activity that should partly outweigh the reduction in budget expenditures. As the reaching of full capacity of oil production at Kashagan was moved to 2018, we see opportunities for good growth in the extractive sector, oil refining, metallurgy, transport and, consequently, a positive overall impact on the economy. Given all the above, we expect GDP growth of 3% in the 2018. The planned budget cuts will reduce the official budget deficit to 1% of GDP, which will have a positive impact on the dynamics of the exchange rate of tenge, which we are seeing at the level of 340-345 in 2018. At the same time, higher oil prices (+5% to the average level of 2017) can contribute to the strengthening of the national currency.

As a result of increased oil production and ongoing investment in its expansion, the dependence of the economy on the oil sector in the coming years will grow. This means that the risks of a deeper crisis of Kazakhstan's economy seriously increase in case of negative developments in the oil industry.

Аccording to our forecasts, tenge in 2018 will be close to 340-345 tenge per dollar, given that the average price for oil will be about $57 per barrel (consensus forecast Bloomberg) and the ruble exchange rate during the year will be at a stable level. Therefore, the more rapid price increase in the country in comparison with the world level will be a factor affecting the decrease in the purchasing power of the tenge and its depreciation.

Based on our forecasts for the level of annual inflation at 6.5%, we expect that the base rate will continue to decrease in 2018 from 10.25% to 9%. The next decision on the rate will be made on January 15. In our opinion, the regulator will be more cautious in its actions at the next meeting and probably will not go on with rate cut. Since, despite the slowdown in inflation at the end of the year, the instability of the price level is still preserved, while also increased inflation expectations is one of the risk factors for the CPI acceleration.

According to government forecasts in 2018, the level of spending will remain at the level of 2017 (T10.8 trillion, excluding T2.1 trillion). Thus, according to our expectations, in real terms, government expenses will decrease in 2018, which will also result in a reduction of its share in GDP (~19%). We also expect an increase in budget revenues (excluding transfers), proportionate with a growth in the gross output of the economy, which will stabilize its share in GDP at around 12.5%.

In general, the deficit of the consolidated budget may be about 2% (at the level of 2017 without taking into account the funds for recovery), we also expect that the non-oil deficit in 2018 will remain at the level of 8-8.5% of GDP. 

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