Does the government lend to itself?
Since 2000, the government of Kazakhstan usually has managed to rack up tidy little surpluses of up to 4.2% of the size of the economy (measured in gross domestic product, or GDP). But when Kazakhstani banks crashed in 2008-9, the government attempted (with some success) to spend its way out of recession. Consequently, it began spending more money than it was collecting in tax revenues. By 2011, this deficit may amount to more than 6% of GDP – judging from the budget approved by the legislature -- although the prime minister vows to reduce it to less than 3%.
Kazakhstan does not have a deficit overhang of Grecian dimensions. (In Greece, where the government spent as if there would be no tomorrow, the deficit in 2009 exceeded 15% of GDP, although the European Union ostensibly limits the deficit of a member nation to 3% of GDP.) Even so, a persistent deficit in Kazakhstan could raise the spectre of higher interest rates, since the government might compete with entrepreneurs for loans by bidding up the price of a tenge loaned – the rate of interest.
To surreptitiously avoid this appearance, the government can quietly borrow from itself. The central bank can buy the government’s bonds, thus holding down the interest rate that Astana must pay on this debt. Because these transactions are inconspicuous, public borrowing might look affordable.
Monetizing the debt is a time-honored trick. In Germany of 1923, the Reichsbank held 190 million trillion marks of bonds sold by the government, wrote Robert Hetzel. When it comes to public deficits, the central bank is often a co-conspirator.
Who does your banker favor?
At the moment, net claims of the National Bank of Kazakhstan on the central government are negative, and the gross value of its government securities generally does not exceed 6 billion tenge. But as of December, net claims of commercial banks on the central government were nearly 400 billion tenge, the equal of more than 5% of their reserves, according to raw data from the National Bank. Claims on public nonfinancial institutions were more than twice as much – over 800 billion tenge (equaling more than 11% of reserves). This, of course, could not possibly have anything to do with the fact that since 2008 the government has become a major owner of large commercial banks.
Curiously, commercial bank loans to local governments – the oblasts and the cities – were less than 6 billion tenge, equaling just one-tenth of one percent of reserves. One would have thought that the banks would take more interest in the condition of their localities. Then again, we have a new owner.
All told, commercial bank loans to the public sector in Kazakhstan were easily more than half as much as their loans to households. To some extent, banks would rather finance the government than a local youth’s education.
Financial gumshoes
How can we tell whether we really can afford the public borrowing? By looking at the market rate of interest. This has two components.
One is the “real” interest rate, which reflects the real return to capital (that is, the return in terms of purchasing power). If people expect a proposed auto-assembly plant to earn 5 cents of profit per dollar spent on construction, then the entrepreneur is willing to pay up to 5 cents of interest to borrow a dollar for building.
The second component reflects the expected rate of inflation, since the lender wants to be compensated for any loss of purchasing power in his funds that is due to higher prices. When prices are twice as high, a tenge will buy only half as much. (Or less. In Argentina, a woman purchased a plane ticket to Lebanon in 1988 – only to find that the refund in 2001 would buy only an alarm clock, reported the Wall Street Journal.)
At present, the annual rate of inflation in Kazakhstan is about 8%. The creditor who lends a dollar for a year can expect to get back a dollar in 2012 that buys 8% less of goods than it would today. To offset this expected loss, the creditor will demand 8 cents of interest.
The expected rate of inflation may seem an evanescent idea. But for many long-term rates of interest -- such as on 30-year home mortgages a few years ago in the United States -- inflationary expectations make up the bulk of the rate. Before 2008, Americans expected prices to rise more and more sharply over time.
The market rate of interest sums the real rate of interest and the expected rate of inflation. The long-run real rate of return to capital per year in Kazakhstan is (very) roughly 8% to 10%, judging from the trend rate of economic growth. The expected rate of annual inflation may be 8%. Thus a typical interest rate on creditworthy corporate loans may be 16% or 18% over the long run.
Government borrowing may affect either component. If the government competes away resources from the private sector, then borrowers will have to propose more profitable projects than before in order to get funds. This increases the real rate of return to capital. Also, new government spending pressures prices upward when the economy already is producing at full capacity. Thus it increases the expected rate of inflation.
At present, the deficit does not have an overwhelming impact on private interest rates. The rate on short-term bank loans of tenge fell from 16.6% in 2008 to 16% in 2009, with rates continuing to fall into 2010, according to the National Bank. The rate on interbank loans rose from 4.67% in 2007 to 6.75% in 2009, but that probably reflected the growing riskiness of banking. All this notwithstanding, in any sustained recovery, one should consider whether government borrowing may contribute to inflation.
This examination would be simpler if we had a simple way to measure expected inflation.
In the United States, you can estimate this expectation by looking at the difference in rates between Treasury bonds that compensate you for inflation (on top of their usual yields) and Treasury bonds that don't. At present, a Treasury security maturing in five years yields .31% per year. That is, the bond would pay you 31 cents for every $100 that you spent on it, and it would also compensate for inflation on top of that. An ordinary Treasury bond maturing in five years yields 2.29% per year, according to data from the Federal Reserve. This suggests that people expected an average of 2.29% – .31% = 1.98% inflation per year until 2016.
Over the short run, this forecasting tool does pretty well: One can use the interest rates on one- to six-month Treasury bills to forecast inflation a month ahead in a way that is statistically reliable, noted economist Stephen Smith. The government of Kazakhstan may wish to give a thought or three to introducing inflation-indexed securities of its own. -- Leon Taylor, tayloralmaty@gmail.com
Good reading
Central Asia & Caucasus Business Weekly. Untitled article on Kazakhstani deficits. October 26, 2010 http://business.highbeam.com/436263/article-1G1-241679918/interfax-central-asia-amp-caucasus-business-weekly
Robert L. Hetzel. German monetary history in the first half of the twentieth century. Economic Quarterly. Federal Reserve Bank of Richmond. Winter 2002, pages 1-35. http://www.richmondfed.org/publications/research/economic_quarterly/2002/winter/pdf/hetzel.pdf
David Luhnow. For Argentina, no panacea in the dollar. Wall Street Journal. December 4, 2001. Page A12.
Stephen D. Smith. What do asset prices tell us about the future? Economic Review. Federal Reserve Bank of Atlanta. Third quarter 1999. http://www.frbatlanta.org/filelegacydocs/smith.pdf
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