The Role of the Central Bank in Sustaining Economic Growth

Smolyakov OlegNational Bank of Kazakhstan

Monetary Side of Sustainable Development:(framework of analysis)

Necessary PreconditionsNecessary Preconditions

I. Macroeconomic Stability

Low Inflation Rate

Maintenance of Competitiveness

Sufficient Level of International

Reserves

II. Financial Sector Strength

Capital Market

Money Market

Effective Intermediation

Central Bank’sCentral Bank’s ChallengesChallenges

I. Inconsistency Triangle

Inflation vs. Exchange RateInflation vs. Exchange Rate

II. External Shocks Vulnerability

Normal vs. Crisis timeNormal vs. Crisis time

III. Dollarization

Following vs. LeadFollowing vs. Lead

IV. Public confidence

Rules vs. DiscretionRules vs. Discretion

Exchange RateRegime

Foreign Exchange Market Financial Sector: structural policy

1993 Nov. 1993:Introduction of theNational Currency"Tenge"

Centralized credits to banks and Government were themain tools of NBK to manage broad money and banks’credits to the economy

199450% exports receipts surrender requirement

1. Operations with T-bills have begun2. NBK started to use traditional tools of monetary policy

1995

Surrender requirement has been lowered to 30%and abolished afterwards

1. The practice of providing directive credits to theeconomy by NBK has been abandoned2. Interbank money market has started to operate3. The laws "On National Bank" and "On banks andbanking" determined main principles of two-tier systemand functions of Central Bank4. The law “On insurance” created the basis forqualitative changes of insurance sector

1996 1. July 16: Article VIII, IMF Articles ofAgreement2. The new "Foreign Exchange Regime" law wasintroduced

1997 Introduction of Exports-Imports Foreign ExchangeControl aimed at suppressing the capital flightthrough trade channels

1. REPO opeartions was liven up2. NBK started to implement the Programme ofinternational standards introduction in the banking system

1998

Unofficial CrawlingPeg

1. The practice of Budget deficit direct financing byNBK was abandoned;2. Gov. Debt was transformed into T-bonds3. NBK became in charge of insurance industrysurveillance4. Implementation of the Three-Pilar Pension System

1999 April – November: 50% exports receipts surrenderrequirement was introduced

November: Deposits Insurance System was introduced

2000

1. Advanced Repayment of IMF loans by NBK2. Capital Amnesty

1. Discount operations have started2. Introduction of Mortgage Financing System 3. A new law on Insurance Activity was adopted inDecember: National Bank of Kazakhstan introduced basic17 principles of the insurance supervision accepted byInternational Association of the Insurance Supervision(IAIS)

2001National Fund started to accumulate extra receiptsfrom natural resource sector

1. Establishment of Banking Supervision onConsolidated Basis2. Development Bank was found

2002

April, 1999:Floating Exhange

Rate Regime(Managed)

1. NBK became in charge of securities market andpension funds supervision2. Implementation of Internal Risk Management Systemshave started in banks

Vulnerability to external shocks

1. World commodity markets volatility(i) Extent of trade structure diversification, Kazakhstan, Exports, 2001: Oil - 49.3%, non-CIS - 70%

Metals - 25%, non-CIS - 94% Oil budget revenues - 20%(ii) Persistence of the shock and whether it is anticipated. Asymmetric shocks

2. Trade and financial contagion from other countries

(i) Trade spillovers Kazakhstan - Russia bilateral trade, 2001 - 30% (1996 - 47%)(ii) Financial linkage (iii) Shifts in investor sentiment

The contagion of crisis effect through financial linkages in the case of Kazakhstan is not so severe compared to East Asian countries and even Russia, and can be viewed as the consequence of shocks originating in commodity markets and trade spillover that cause the fundamentals to change.

1996 1997 1998 1999 2000 2001I. External Shocks Indicators1.External TOT (% to prev. per.) 7,8 1.7 -18.1 15.4 27.1 -7.0 1.1 World prices of exports 5,1 -5.2 -24.0 12.9 30.1 -9.4 1.2. World prices of imports -2.4 -6.8 -7.1 -2.3 2.6 -2.72. Real effective exchange rate (dec .as % to dec.) 10,5 8.9 16.2 -26.4 2.8 -1.6 Relative to Russia -2,8 1 68.6 -30 -8.5 -6.7

II. Balance of Payments and External Debt Current Account (% to GDP) -3,6 -3.6 -5.6 -1.4 2.3 -7.8 FDI – Current account (% to GDP) 2 2 0 7 9 5 Trade Balance (% to GDP) -1,6 -1.2 -3.6 2.0 13.4 4.0 Exports (% to GDP) 30 31 27 36 51 41 Imports (% to GDP) -31,5 -32.4 -30.2 -33.6 -37.5 -36.8 Gross External Debt, at the end of period (% to GDP) 20 28.6 44.9 71.4 68.9 66.7 Short-term external debt in total external debt (%) 40 30.0 23.0 15.0 7.8 8.6 Government and government-guaranteed debt in total external debt (%) 45 42.0 40.3 33.6 31.3 25.5

III. Memorandum GDP (real, %) 0.5 1.7 -1.9 2.7 9.8 13.2 Inflation (%, dec. to dec.) 28.7 11.2 1.9 17.8 9.8 6.4 Exchange rate (% ch., at the year end) 15.4 2.8 10.7 64.6 5.2 3.8 Money ratio (%, M3/GDP) 9,5 10.3 8.6 13.6 15.3 17.3 Refinance rate (%, at the year end) 35 18.5 25 18 14 9

(at the end of period) Dec.96 Dec.97 Dec.98 Dec.99 Dec.00 Dec.01

Ratio of FX deposits to total deposits 0.2 0.23 0.37 0.48 0.51 0.61Ratio of FX loans to total loans 43 0.42 0.43 0.54 0.51 0.71

Money Coverage RatioGross International Reserves/M2 1,17 1.05 1.23 1.17 1.04 1.10 Memo: Reserves (incl. Oil Fund)/M2 1.64

Kazakhstan: Selected Indicators

Macroeconomic Indices

First half of 2002 the real GDP growth : Russia – 3,8% Ukraine – 4,3% Kazakhstan – 9,2% Kyrgyzstan – (-)4,9% Azerbaijan – 8,4% Uzbekistan – 4,0%

The first half of 2002 real GDP

percentage to 1996 level Russia – 117,0% Ukraine – 102,5% Kazakhstan – 138,1% Kyrgyzstan – 144,5% Azerbaijan – 168,0% Uzbekistan – 128,2%

Real GDP Growth in 1996-2002, in percent

-15

-10

-5

0

5

10

15

1996 1997 1998 1999 2000 2001 june 2002

Ukraine Kazakhstan Russia Kyrgyzstan Azerbaijan Uzbekistan

GDP as a percentage of 1996 real GDP, %

60

90

120

150

180

1996 1997 1998 1999 2000 2001 june 2002

Kazakhstan Russia KyrgyzstanUkraine Azerbaijan Uzbekistan

Change in USD rate of exchange during six and half recent years: Russia – 466,8% Ukraine – 181,9% Kazakhstan – 107,7% Kyrgyzstan – 174,7% Azerbaijan – 18,9%

Accumulated inflation for six and half years: Russia – 333,8% Ukraine – 106,4% Kazakhstan – 60,8% Kyrgyzstan – 122,6% Azerbaijan – (-)1,3% Uzbekistan – 248,8%

Particular Features of the Monetary Policy Implementation

Change in USD rate of exchange during 6,5 recent years, %

181,9

107,7

466,8

174,7

18,9 40,349,6

0100200300400500

Uk

rain

e

Kaz

akh

stan

Rus

sia

Ky

rgy

zsta

n

Aze

rbai

jan

Hun

gary

Po

lan

d

Cumulative Inflation for 6,5 years, %

106,460,8

333,8

248,8

122,677,3

53,7-1,3

-203080

130180230280330

Ukr

aine

Kaz

akhs

tan

Rus

sia

Uzb

ekis

tan

Kyr

gyzt

an

Aze

rbai

jan

Hun

gary

Pola

nd

Broad money to GDP ratio: Russia – 24,3% Ukraine – 21,5% Kazakhstan – 18,7% Kyrgyzstan – 15,3% Azerbaijan – 14,1%

Percentage of cash in broad money

by the end of June, 2002: Russia – 27,4% Ukraine – 41,8% Kazakhstan – 21,9% Kyrgyzstan – 60,7% Azerbaijan – 45,5%

Particular Features of the Monetary Policy Implementation

Broad Money to GDP Ratio (disregarding cash USD in circulation), %

0

10

20

30

1996 1997 1998 1999 2000 2001 june

Ukraine Kazakhstan Russia Kyrgyzstan Azerbaijan

Major Instruments of the Monetary Policy : Open Market Operations

Secondary Market Government Bonds Operations

National Bank does not have a right to purchase Government Bonds on a primary market therefore NBK portfolio is not sufficient enough to adjust reserve money

Notes of the National Bank of Kazakhstan Liquidity Adjustment Short-term with maturity beginning

from 7 to 91 days

Weighed Average Note Yield: 18,36% in 1999 9,11% in 1999 6,02% in 2001 5,99 by the end of June, 2002

Refinancing rate: Russia – 23,0% Ukraine – 10,2% Kazakhstan – 8,0% Kyrgyzstan – 8,0% Azerbaijan – 10,0%

Uzbekistan – 30,0%

Particular Features of the Monetary Policy ImplementationIssuance of NBK notes over the period,. USD million

0

200

400

600

800

1000

1200

1995 1996 1997 1998 1999 2000 2001 june2002

Weighted Average Note Yield in percent

45,35

36,29

18,1221,35

18,36

9,116,02 5,99

0

10

20

30

40

50

1995 1996 1997 1998 1999 2000 2001 june2002

O fficial refinancing rate, end of period, %

01020304050607080

1996 1997 1998 1999 2000 2001 june 2002

Ukraine Kazakhstan RussiaKyrgyzstan Azerbaijan Uzbekistan

Number of banks by the end of June, 2002: Russia – 1281 Ukraine – 154 Kazakhstan –39 Kyrgyzstan – 23 Azerbaijan – 47

Capitalisation per bank

by the end of June, 2002: Russia – 12,7 Ukraine – 8,2 Kazakhstan –22,9 Kyrgyzstan – 1,4

Banking System Development

Total Capitalisation per Bank USD million

0

5

10

15

20

25

1997 1998 1999 2000 2001 june 2002

Ukraine Kazakhstan Russia Kyrgyzstan

Commercial banks’ credit to the economy by the end of June, 2002

in percentage to the GDP : Russia – 19,0 Ukraine – 17,0 Kazakhstan –16,8 Kyrgyzstan – 3,0 Azerbaijan – 19,5

Banking System Development

Percentage of medium-term and long term loans in total by the end of June, 2002: Russia – 22,4 Ukraine – 24,5 Kazakhstan –55,0 Kyrgyzstan – 24,6

Interest rates on national currency denominated loans by the end of June, 2002: Russia – 18,3 Ukraine – 27,1 Kazakhstan – 15,0 Kyrgyzstan – 39,4

Households deposits per capita

(first half of 2002), USD: Russia – 177,6 Ukraine – 51,5 Kazakhstan – 95,0

Percentage of Long-term Loans in Total

0

10

20

30

40

50

60

1998 1999 2000 2001 june 2002

Ukraine Kazakhstan Russia Kyrgyzstan

Interest Rate on National Currency Denominated Loans

0102030405060708090

1996 1997 1998 1999 2000 2001 june 2002

Ukraine Kazakhstan Russia Kyrgyzstan

Personal Deposts per capita, USD

51,5

177,6

95

020406080

100120140160180200

Ukraine Kazakhstan Russia

Pension Reform

Investment Portfolio Structure by the end of June, 2002: Government bonds – 58,6%

(private funds – 52,4%) Non-government bonds – 43,1%

(only private funds) Bank deposits – 9,0% (4,5%)

Funds, accumulated in the pension system have grown significantly: 1 year after the transition to the new pension

system (as of end of 1998) - USD 281 mln (1,4% to GDP)

2 years (as of end of 1999) – USD 467mln (3,2% to GDP)

3 years (as of end of 2000) – USD775mln (4,4% to GDP)

4 years (by the end of 2001) - USD 1213mln (5,7% to GDP)

4 years and 6 months after - USD 1450mln (6,8% to GDP)

Exchange rates and prices dynamic (in logs)

10,00

100,00

1000,00

Jan1994

Apr Jul Oct Jan1995

Apr Jul Oct Jan1996

Apr Jul Oct Jan1997

Apr Jul Oct Jan1998

Apr Jul Oct Jan1999

Apr Jul Oct Jan2000

Apr Jul Oct Jan2001

Apr Jul Oct Jan70,0

80,0

90,0

100,0

110,0

120,0

130,0

140,0

150,0

160,0

170,0

CPI Goods/Services

-5,5

-5

-4,5

-4

-3,5

-3

-2,5

-2

94M1 94M7 95M1 95M7 96M1 96M7 97M1 97M7 98M1 98M7 99M1 99M7 00M1 00M7 01M1 01M7 02M1 02M74

4,2

4,4

4,6

4,8

5

5,2

KZT/USD REER NEER

Weights, assigned to foreign currencies in determining changes in value of KZTYear Constant USD DM/EUR YEN RUR R2 adj. S.E. DW N.O.1995 0.0008 0.99** -0.0007 0.63 0.00829 1.63 196

(0.0006) (0.0693) (0.0815)0.0006 0.74** 0.04 -0.11 0.25* 0.64 0.00818 1.68

(0.0006) (0.1410) (0.0823) (0.0886) (0.1087)1996 0.0006** 0.94** -0.06 0.83 0.00235 1.96 223

(0.0002) (0.03629) (0.0413)0.0006** 0.92** -0.06 0.003 0.029 0.83 0.00235 1.94(0.0002) (0.04999) (0.0415) (0.0359) (0.0303)

1997 0.0001 0.96** 0.041 0.84 0.00282 1.82 228(0.00019) (0.03342) (0.03582)

0.0000 0.64** 0.05 -0.048# 0.34* 0.85 0.00278 1.91(0.0002) (0.15859) (0.0355) (0.0258) (0.1501)

1998 0.0005** 1.01** 0.02 0.98 0.00108 1.93 227(7.1E-05) (0.0120) (0.016)0.0004** 1.006** 0.02 0.01 0.002 0.98 0.00107 1.81(7.1E-05) (0.0124) (0.0165) (0.0165) (0.0012)

1999 0.0005# 0.99** -0.02 0.80 0.00315 2.01 139(0.0003) (0.0466) (0.0568)0.0005# 0.97** -0.01 0.02 0.012 0.80 0.00321 2.02(0.0003) (0.0809) (0.058) (0.035) (0.0596)

2000 0.0002** 1.02** -0.003 0.99 0.00083 1.32 230(5.5E-05) (0.00784) (0.00713)0.0002** 0.96** -0.003 0.002 0.05** 0.99 0.00082 1.36(5.4E-05) (0.02017) (0.00704) (0.0082) (0.0168)

2001 0.00018** 1.003** -0.008 0.99 0.00071 1.61 223(4.78E-05) (0.00737) (0.00832)0.00015** 0.92** -0.008 0.009 0.07# 0.99 0.00071 1.68 223(4.88E-05) (0.03816) (0.00836) (0.0076) (0.0362)

** Statistically significant at the 99 percent level* Statistically significant at the 95 percent level# Statistically significant at the 90 percent level

Daily Volatility in Nominal Exchange Rate

Period Range St. dev. +/- 0.1% band +/- 0.5% bandUS$/EUR (DM) Jan 73- Dec 01 0.10667 0.00695 15.8% 63.8%

Jan 95 – Dec 01 0.07343 0.00660 14.7% 61.1%US$/JPY Jan 73- Dec 01 0.11930 0.00650 23.3% 70.0%

Jan 95 – Dec 01 0.08768 0.00780 14.8% 57.9%US$/RUR Jan 95 – Aug, 14, 98 0.10730 0.00361 61.2% 93.5%

June 99 – Dec 01 0.03247 0.00298 50.6% 93.2%US$/KZT Jan 95 – Mar 99 0.08417 0.00405 58.7% 93.8%

June 99 – Dec 01 0.02420 0.00161 77.5% 98.1%

Monthly Volatility in International Reserves

Period Mean Abs. Ch. St. dev. +/- 1% band +/- 2.5% bandGermany Jan 73- Dec 01 0.0347 0.0702 21.6% 56.2%

Jan 95 – Dec 01 0.0223 0.0351 36.1% 71.1%Japan Jan 73- Dec 01 0.0259 0.0432 42.9% 73.2%

Jan 95 – Dec 01 0.0188 0.0308 65.1% 81.9%Russia Jan 95 - Aug 98 0.1467 0.1928 0% 11.6%

June 99 – Dec 01 0.0674 0.0700 9.7% 25.8%Kazakhstan Jan 95 – Mar 99 0.0796 0.1085 8% 22%

June 99 – Dec 01 0.0646 0.0708 9.7% 22.6%

Statistical measures of exchange rate and foreign reserves volatility

Weak version of PPP

Pt = + ( Et Pt* )

Vector Error Correction (VEC) with 4 lags

Long-run relation reveals that coefficient of pass-through is significantly different from 1 and estimated to be 0.6.

The function has a relatively low speed of adjustment to its long-run equilibrium – it takes approximately 1 year the 50 percent of the deviation from the long-term stable equilibrium to be eliminated.

Pt is the domestic price level, namely CPI; Et is the nominal effective exchange rate calculated against 23 countries – main trade partners of Kazakhstan; Pt

* is the index of international prices, approximated by the weighted average of PPI of the main trade partners of Kazakhstan; - is the murk up constant; - estimated coefficient of pass-through.

SummaryWhy do Kazakhstan pursue the policy of smoothing high frequency

exchange rate fluctuations to the USD?There are not enough hedging instruments to allow agents to insure fully There are not enough hedging instruments to allow agents to insure fully against abrupt changes in the exchange rateagainst abrupt changes in the exchange rate

1. Currency of invoicing

2. Profitability of FDI

3. Underdeveloped money and capital markets

4. High dollarization

5. Sensitive expectations

6. Unknown equilibrium <=> margin of safety

Short-run Rigidity vs. Long-run Flexibility

PreconditionsPreconditions: Pass-through effectPass-through effect

TOT shockNormal vs. “Troubles“ Time

Contagion

Period Main objectives CB actions Outside factors

“Tenge” Introduction -External Shocks(Nov, 93 – Aug, 98)

1. Public confidence2. Lower inflation3. Exchange rate stabilization

Unofficial crawling peg 1. Initial undervaluation2. Structural reforms3. Price mark-up adjustment

Macro adjustment tothe shocks(Sep, 98 – Jun, 99)

1. Restore competitiveness2. Prevent crises spreadingto the banking sector

1. Monetary contraction2. Gradual devaluation3. Effective Devaluation4. Compulsory surrenderrequirement5. Implicit guarantee of tengedeposits6. Lower reserve requirement

1. Fiscal contraction2. Trade measures

Booming period(Jul, 99 – Dec, 01)

1. Fear of appreciation2. Monetary expansion3. Financial sectordevelopment

1. Exchange rate riskminimization(managed floating)2. Strengthening of prudentialregulations & financialsupervision

3. Fiscal Conservatism

Perspective 1. Gradual removal ofrestrictions on capital outflow2. Inflation control3. Shocks VulnerabilityMinimization4. Enhance FinancialIntermediation

1. Capital AccountLiberalization2. Inflation Targeting2. Single Financial SupervisionBody3. Derivatives Market Dev.4. Stock Market Dev.5. Mortgage Lending6. Micro-crediting

4. Oil Boom possible “Dutch Disease”problem

5. “Blue chips”

Summary