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p. 42 of 69 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia Southeast Asia South Asia Central Asia Azerbaijan Kazakhstan Kyrgyz Republic Tajikistan Turkmenistan Uzbekistan The Pacific III. Foreign Direct Investments in Developing Asia

Asian Development Outlook 2004 : II. Economic Trends and Prospects in Developing Asia : Central Asia

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Kazakhstan

The economy continued to grow rapidly in 2003 with greater pace in manufacturing showing the first fruits of economic diversification. An Industrial-Innovation Development Strategy will help deepen economic diversification and maintain growth momentum in the medium term. Policy measures will need to avoid overreliance on capital-intensive sectors and continue their emphasis on employment creation by expanding an enabling environment for private sector development.

Economic Assessment

Early structural reforms and sound macroeconomic management laid the basis for the economic progress that the country has made in recent years. GDP growth, led by the oil sector, averaged 11.0% during 2000-2002, and continued in 2003 at 9.2%. On the demand side, most of the 2003 expansion was driven by a 15% increase in real private consumption, supported by public sector wage raises and an expansion of bank credit.

On the production side, industry and, especially, services played major roles. Industry sector output grew by 8.8%-with manufacturing at 8.9% and mining at 8.1%-revealing the first signs of economic diversification, as food processing, machinery building, oil refining, and chemicals all showed marked production increases. Construction climbed by 9.3%, remaining a dynamic sector fueled by vigorous investment in housing and infrastructure development in the new capital, Astana. The services sector continued its very strong growth, of 11.1%, mainly due to a large rise in transport and communications. A slight decline in the grain harvest in 2003, offset by the good performance in the livestock subsector, led to agricultural growth of just 1.4%.

Continued economic growth helped foster employment and improve living standards. In 2003, real incomes rose by 8.3% with average monthly wages totaling T23,250 ($156). For the first time, real wages increased in all sectors, unlike previous years when wages rose significantly only in the manufacturing and financial subsectors. Unemployment declined to 8.7% from 9.3% in 2002, mainly due to greater employment in construction, services, and agriculture (Figure 2.22). Sustained economic growth and targeted poverty interventions helped reduce the number of people living below the subsistence minimum (T5,200 or $35 a month) to 21.0% from 24.2% in 2002. However, unemployment remains sizable in rural areas, where poverty remains three times as high as in urban areas.

The fiscal position remained robust in 2003. Buoyant tax collections led the Government in May to revise upward both revenue and expenditure targets. For the year, the budget deficit amounted to 0.9% of GDP, well below the planned 2.0% target. The revenue-to-GDP ratio edged up to 22.6% from 21.4% in 2002, largely due to strengthened tax administration. General budget expenditures rose to 23.5% of GDP, 2 percentage points higher than in 2002, as the supplemental budget lifted wages and pensions and raised expenditures for social sectors and national security. Social assistance and education remained the major items of recurrent expenditures, together accounting for 45% of such expenditures.

The monetary policy of the National Bank of Kazakhstan (NBK) continued to be accommodative in 2003. Broad money supply (M3) rose by 26.8% in response to continued economic growth and financial deepening. Credit to the economy jumped by about 46% as banks became more responsive in meeting the credit needs of small and medium enterprises and households. End-of-period inflation rose to 6.8% (the annual average figure was 6.6%), 1 percentage point higher than the planned target, mainly due to higher prices for gasoline and bread products in the last months of the year. This was caused by a jump in the prices for gasoline in the Russian Federation, which led to an increase in exports of local gasoline to that country (Kazakhstan’s main trading partner), thus reducing domestic supply; and by government intervention to raise the price of grain.

During 2003, the tenge strengthened against the dollar by 12.6% in real terms, driven by large export earnings and foreign exchange inflows from increased private external borrowing and FDI. Under the managed float arrangement, NBK continued its policy of intervening in the market to prevent undue appreciation of the currency, though with limited tools for sterilization this led to a 52.2% expansion in reserve money. In contrast to its performance against the dollar, the tenge recorded real devaluations against the Russian ruble by 5.3% and the euro by 6.9%, which helped sustain the competitiveness of domestic producers.

The balance-of-payments position strengthened because of high world oil prices. The current account deficit was reduced from 2.8% of GDP in 2002 to 0.2% ($69 million) in 2003, reflecting a much improved trade balance. Merchandise exports soared by 32.0%, driven mainly by buoyant world oil prices; the increase in oil volume was only 7.9%. Imports surged by 18.4%, led by greater imports of capital goods and construction materials. Gross international reserves (including the assets of the National Fund of the Republic of Kazakhstan, which accumulates part of the Government’s oil and mineral revenues for stabilization purposes and savings for future generations) leaped by 69.3% over the year to $8,565 million at end-2003. The National Fund’s assets jumped by 89.0% to $3,606 million due to the strong hydrocarbon exports while NBK’s net international reserves shot up by $1,820 million or 58.1% to $4,959 million (4.8 months of imports).

While public external debt continued to fall in 2003, by 3.5% to $3.4 billion (equivalent to 12.4% of GDP), private external debt rose by 5.5%, pushing total external debt to $19.9 billion at end-2003, including intracompany debt (mainly among oil companies) that accounts for about 70% of private external debt. However, excluding intracompany debt, the debt-to-GDP ratio is 29.3%, representing a low external debt burden.

Policy Developments

The new Government, formed in June 2003, endorsed the existing policy of maintaining rapid economic growth, increasingly fostered through economic diversification. It adopted an Industrial-Innovation Development Strategy to 2015 that targets 8% average annual growth in manufacturing and a threefold gain in manufacturing productivity by 2015. The strategy also sets up priority sectors, namely oil refining, agriculture, and space and information technology. The Government created five institutions to help implement the strategy, i.e., the Innovation Fund, Investment Fund, the State Insurance Corporation for Export Credits and Investment, the Engineering and Technology Transfer Center, and the Marketing-Analytical Research Center.

The Government continued to implement an adaptive, sound fiscal stance while advancing structural fiscal reforms. The 2003 budget revision in May reflected policy by raising wages and pensions and providing initial capital to the four newly created institutions. The 2004 budget has expanded government efforts to stimulate growth through tax rate reductions. The VAT rate is to be reduced from 16% to 15%, personal income tax from 30% to 20%, and the social (payroll) tax from 21% to a range of 7-20%. The tax cuts, effective 1 January this year, are estimated to reduce revenues for 2004 by about 1.2% of GDP, though the simultaneous introduction of a new tax on oil exports, which doubles the tax burden for new oil contracts, is expected to be fully offsetting. In terms of institutional change, the Government began preparing its first medium-term fiscal policy plan for the period 2005-2007, and started revising the budget code to promote better planning and transparency in budgeting, greater fiscal independence of local governments, and a clearer delineation of responsibilities between the various levels of government.

NBK announced that it would adopt EU monetary policy standards by 2007 and focus on the single objective of price stability in the medium term. However, in 2003 it continued to pursue a difficult twofold task-moderating inflation and preventing a real appreciation of the tenge against the dollar. The accumulation of a large part of oil revenues in the National Fund and NBK’s intervention in the market to make large foreign exchange purchases helped limit appreciation of the tenge against the dollar. NBK recognizes that it will be increasingly difficult to carry out sterilized intervention in view of expected rising oil export earnings, and some real appreciation of the tenge can no longer be avoided. Moreover, NBK’s move to an inflation targeting framework would preclude intervention (except to calm a disorderly market). While this change will reinforce the tenge’s strengthening, the National Fund remains available to limit undue movements. With the establishment of an independent financial market supervisory and regulatory agency in January 2004, NBK has been freed to concentrate solely on its macroeconomic policy functions.

The banking sector continued to strengthen, with the ratio of total assets to GDP increasing to 37% at end-2003 from 25% a year earlier. Growing public confidence in the banking system was reflected in a 30% rise in household deposits. Public response to the first ever appreciation of the tenge against the dollar made foreign currency deposits less attractive and helped raise the share of local currency deposits in total deposits to 52.6% from 40.0% in 2002. A slight reduction of the refinance rate (from 7.5% to 7.0%) led to a 1 percentage point decline in the commercial interest rate, from 15.2% to 14.2%. Despite declining in recent years, lending rates are now high in real terms as inflation has fallen. This appears to be due to high deposit rates demanded by customers, stemming from their experience of previous bank defaults, untested creditor rights, and weak competition both among banks and from other financial institutions.

The Government made progress in implementing structural reforms in 2003 when a Land Code and a Law on Joint-Stock Companies were enacted. The Land Code provides for private ownership of agricultural land, which lays the foundation for strengthening productivity and competitiveness of the agriculture sector by enhancing incentives and opportunities for both investment and financing. The Law on Joint-Stock Companies tightened the requirements for enterprises’ capital base and promoted better corporate governance practices. During 2003, the Government succeeded in selling its share in the two largest mining sector companies and in one of the largest banks, the Halyk Saving Bank.

Outlook for 2004-2005

The medium-term outlook is positive, as likely strong FDI inflows continue to rapidly expand development in the oil sector and as the Government steps up its efforts to diversify the economy. Although the Government remains cautious in its projections for GDP growth at 7-7.5% in the medium term, it will likely be higher due to the phased start of production at Kazakhstan’s largest gas and oil projects at Karachaganak and Kashagan in 2004-2005. Also, regional demand is expected to remain strong. Accordingly, ADO 2004 forecasts that average annual GDP growth will remain at about 9.5% in 2004-2005. While the oil sector will continue to be a driving force, growth in the non-oil sector is also expected to pick up due to the projected increases in capital investment in manufacturing. Services are likely to remain dynamic, with annual average growth of 7-8% over the medium term. Agricultural output is forecast to expand by 3-4% due to ongoing reforms as well as increased budget allocations for rural revival during the next 2 years (total government investment is expected to be 2-3% of GDP).

The fiscal stance is likely to remain cautious with the Government’s projections for the general budget deficit at 1.9% of GDP in 2004 and 1.0% in 2005. Budget revenues are expected to be around 23% to GDP over the forecast period, based on conservative budget assumptions for world oil prices. The expenditure-to-GDP ratio is projected to decline from 25.2% of GDP in 2004 to 23.1% of GDP in 2005 as expenditure growth is to be held to less than nominal GDP growth. Social sectors and rural development will be the major expenditure items in 2004-2005.

In view of large projected foreign exchange inflows, the tenge is likely to continue appreciating and NBK expects a real appreciation of about 4-5% against the dollar over the next 3 years. The Government will seek to foster greater productivity in the non-oil sector to help prevent loss of competitiveness. NBK projects inflation in the range of 3-6% over 2004-2005 and will adopt monetary policies tailored to this objective. The expected substantial increases in public sector wages and pensions will likely keep inflation at the higher end of this range.

Exports of goods and services are forecast to grow moderately (about 6% each year), reflecting cautious assumptions on the world oil price. Imports are projected to rise faster than exports due to the increase in capital goods imports, led by implementation of the large oil and gas investment projects and expected technological modernization of enterprises. The current account balance is projected to remain in deficit, at 1.1% of GDP in 2004 and 0.6% of GDP in 2005.

Enhancing living standards remains a key government objective. Through its programs on medium-term poverty reduction (2003-2005) and rural development, it plans to reduce the number of people living below the subsistence minimum to 18% from the current 21%. To this end it is expected that the minimum wage will increase by 32% and the pension level by 30% over the period 2004-2005. The unemployment rate is projected to fall but at a moderate pace and expected to be around 8.0% by 2005, as overall growth will continue to be driven by capital-intensive sectors.

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