Where the money is

Why is Kazakhstan’s economy still spinning its oil-greased wheels?

Nearly a decade after the financial crisis, Kazakhstan’s economy has yet to work up a full head of steam. Its economy grew little more than 1% per year in 2015-6. It’s rebounding – it expanded by 3.6% in the first quarter of 2017 – but it has seen sunnier days.  From 2002 through 2008, the annual rate of growth (adjusting for price changes) averaged 8.8%; since 2008, 4.2%.

Oil is part of the story, of course. Black gold has the blues. The annual spot price of Brent crude – probably the best indicator for the long-run health of the global oil market – averaged $71 per barrel from 2002 through 2013 but only $65 since then (Figure 2).  Oil accounts for a fourth of Kazakhstan’s economy, even excluding knock-on effects.

But petroleum is not the end of the story. The growth rate of Kazakhstan’s economy has dropped steadily since 2006 (Figure 1), even though oil prices rose until 2012.  What’s up?

Real compared to what?

Well, entrepreneurs may not be taking risks, partly because banks won’t lend to them. According to the National Bank, bank loans in March dropped nearly 2% from the prior March, although the market interest rate fell from 14.3% to 13.7%. Loans to “nonbanking legal entities” (don’t you love the Bank’s English?) fell 15.6% despite a hack in the interest rate from 13.5% to 11.9%. 

From this pattern, you might think that the demand for loans is falling. But we must adjust the interest rates for inflation, since lenders care about what they can buy with their interest payments, not about the interest rate per se.  Since last year, the real interest rate has risen from  -.8% to 5.9% for all loans and from -1.6% to 4.1% for loans to firms.  No, today’s interest rates are not stratospheric; but neither do they represent free dough, as they did in 2016. Borrowing might have fallen because banks have raised their interest rates.

The banks are skittish because they are still groaning beneath the weight of bad debt. The share of loan volume that is 90 days delinquent is 10.7% (for Delta Bank, it’s 98%), up from 7.9% last July.  True, these shares pale in comparison to the bad old days of 2013-4, when they were 30% or more; but they are high enough for anyone’s blood pressure.  On a happier note, the National Bank says the capital adequacy ratio – which indicates whether the banks have set aside enough cash for emergencies -- has been rising steadily since 2014. But just to be on the safe side, it is preparing a $1.5 billion bailout fund.

(And, as always in Kazakhstan, we have intrigue. Halyk Bank, controlled by the family of President Nursultan Nazarbayev, has just taken over troubled Kazkommertsbank.  The government paved the way with gold, so to speak; in a $7.5 billion bailout, its “bad bank” bought up weak assets that KazKom had inherited from the late unlamented BTA Bank of 2008 fame.  But Kazkom’s capital adequacy ratio is less than half of Halyk’s.  The merger would claim more than a third of the bank market at first, although KazKom’s shedding of toxic assets will cut its size.) 

Sluggish lending is not unique to Kazakhstan. Around the world, economies are working off debts at glacial speed. In China, local governments have piled on so much debt that they can no longer safely borrow money to build roads, power plants and water treatment plants. The resulting Chinese slowdown could spell woe for emerging market economies. So could impending hikes in the US interest rate, since these may oblige central banks like Kazakhstan’s to raise their own rates to avoid losing funds to America. Higher interest rates may discourage people from borrowing to pay for college education and new factories – things, in short, that enable us to produce more over time.

A tale of two theories

Kenneth Rogoff, the former chief economist at the International Monetary Fund, thinks that debt overhang accounts for the lack of economic growth today, as it often has. Rogoff sketches a debt supercycle. In credit booms – that is, when lending soars – prices rise for assets like homes. Borrowers use these assets as collateral for more loans (“leveraging”).  When the boom busts, the cycle back-peddles. Collateral loses value, so banks call in loans to pay panicked depositors. People lose their homes and the recession deepens.

Not all economists subscribe to the theory of debt overhang. Lawrence Summers, who was secretary of the Treasury under President Bill Clinton, builds upon the ideas of early American Keynesians like Alvin Hansen to propose that demand is falling short of supply, partly because of demographics. As the population ages, workers retire, which reduces income. Also, the entry of women into the labor force is leveling off in the West, so it won't spur as much income as it had a few decades ago.

Who’s right? Both camps try to explain why real interest rates are low today (below 2% in most of the West, and often negative). Debt theorists say risk has risen, so people are not willing to borrow unless it's cheap. Stagnation theorists counter that trends in the futures markets don't suggest a rise in risk. After all, insurance against a fall in stock prices is getting cheaper. The real reason that interest rates are low is that creditors can't find borrowers. In any case, both sides agree that the world economy (especially the West) must absorb the excess saving – perhaps by building infrastructure – to ignite economic growth.

“The rest of the world is providing savings to the industrial world,” says Summers, “and the rest of the industrial world is providing savings to the United States.” The money isn't where it would do the most good – like in the pockets of Central Asian entrepreneurs. –Leon Taylor tayloralmaty@gmail.com

Figure 1.  Data sources: National Bank of Kazakhstan; Kazakhstan Committee on Statistics.

Figure 2: Annual spot prices of Brent crude in Europe per barrel.  Data source: US Energy Information Administration. 

Good reading

Olivier Blanchard et al., Progress and confusion: The state of macroeconomic policy. The IMF and the MIT Press. 2016. I based these notes on chapters by Rogoff and Summers.

References

Dmitry Belyanin. Troubled large Kazakh banks: To fail or to rescue? Notes from the Golden Horde. http://notes-from-the-golden-horde.blogspot.com/2017/07/    July 10, 2017.

Central Asia & South Caucasus Bulletin. Halyk Bank completes KazKom takeover. July 16, 2017. Page 3.

Central Asia & South Caucasus Bulletin. Propping up the banks. July 16, 2017. Page 10.

Kazakhstan Committee on Statistics. stat.gov.kz The source of 2017 GDP data used here.

National Bank of Kazakhstan. Information about owned capital, liabilities and assets.  Various issues.  nationalbank.kz The source of data on the bad-loan ratio; I used the July 1 report for each year. 

National Bank of Kazakhstan. Statistical Bulletin.  Various issues.  nationalbank.kz The source of GDP and banking data used here.

National Bank of Kazakhstan.  Status on compliance with prudential requirements on 01-06-2017. nationalbank.kz The source of data on capital adequacy ratios.

Reuters. Update 1-Kazakhstan announces $7.5 bln bailout of top lender Kazkommertsbank www.reuters.com/article/kazkommertsbank-ma-halyk-bank-idUSL5N1GS4NK   March 15, 2017.                                              

United States Energy Information Administration.  eia.gov  The source of oil-price data used here.

Belyanin on taxes in Turkmenistan

https://notes-from-the-golden-horde.blogspot.com/2017/07/taxation-in-turkmenistan-looking-behind.html

Surprise!

Why don’t central banks level with us?

Inflation, once the scourge of the West, has become a fabled gift. In the 1970s and early 1980s, rapid rises in average prices – partly due to oil shortages -- troubled consumers in Europe and the United States. But today, central banks yearn for a bit of inflation that would make their job easier. The global economy has not fully recovered from the financial crunch of 2008, and the central banks want wriggle room in order to prod demand by cutting interest rates, since this would encourage people to borrow and spend. To be pared, the market rates must be above zero. A modicum of inflation – say, 2% per year -- will do the trick: Lenders will raise their interest rates so that they can cover the higher prices when they are finally paid back.

That’s the situation in the West. But in the Third World, inflation is a little too healthy. In Kazakhstan, it has exceeded 7% since August 2015, when the National Bank began targeting the interest rate on overnight loans between commercial banks (the “base rate”) in order to manage the tenge supply. Our average rate of consumer inflation for that period is above 14%. At the moment, inflation rates elsewhere in Central Asia range from 4.1% in Kyrgyzstan to 9% in Tajikistan.

Inflation this brisk confuses us. It hits different markets at different times, so we aren’t sure how to interpret it. Has the price of a cup of coffee risen because people demand more coffee, or because it is a harbinger of inflation that will eventually infect the whole economy? If the cafés take the first view, they will extend their hours. So will other industries as they respond to surges in their own output prices. But eventually, people will figure out that prices are rising because of an inflated money supply, not because of new demand for particular products. The cafés will cut their hours and lay off waiters, and recession will ensue.

Central banks in poorer countries can avoid such confoundment by telling us the rate of inflation. The National Bank of Kazakhstan posts monthly rates on its Web page, but not all central banks in Central Asia are so diligent.  Like the Kazakhstani bank, the National Bank of the Kyrgyz Republic posts the actual and the target rate of inflation; and the National Bank of Tajikistan reports the actual rate of inflation but not a target rate.  But the Central Bank of the Republic of Uzbekistan does not post inflation rates in English or Russian in an easily accessible site.  The worst performer in the region (you won’t be astonished to hear this) is the Central Bank of Turkmenistan, which does not publish inflation rates in English or Russian – or, for that matter, statistics in general – in a site that is easy to reach.  So in Ashgabat, the average price that people expect may be miles from the price that they suddenly observe.

Monetary hijinks

This may tempt central banks into tomfoolery. When the price surprise is large, people may interpret it as a big rise in demand for their output, so they will produce a lot more. To spur the economy in this way, the central bank may secretly print a lot more money. This unexpectedly raises average prices, since more som than before chase every pizza and SUV. However, if the bank tries this chicanery too often, people will catch on and ignore the price surprises.

On the other hand, a more honest central bank will win the public’s trust. So when it does try the occasional price surprise, people will interpret it as mainly a rise in demand for their own work, and they will expand accordingly.

This suggests a negative relationship across countries between variation in output and variation in average prices. An honest central bank (think New Zealand) will keep the expected average price close to the actual average price, so the variation -- the price surprise -- is small. When the bank does try a surprise, people will respond, so the variation in output will be large. Now consider a dishonest central bank. It is always trying surprises, so its variation in price is large. Burned twice, people will usually ignore it (think Zimbabwe), so the resulting variation in output is small.

The Nobel laureate Robert Lucas found evidence of this negative relationship in a statistical study in 1973. Across countries, fluctuations in output were small when demand shocks were large, which would include shocks due to fluctuations in the money supply. In 1988, Laurence Ball, Gregory Mankiw and David Romer extended the result to a 43-country dataset.

That sounds like solid evidence for the surprise model, but a few holes exist. For example, announced changes in central bank policy affect the economy in the real world, notes Romer.  The simplest Lucas model says that only price surprises should matter.    

In short, price surprises may influence output, but not too often. Not even a central bank can fool most of the people most of the time, so it might as well publish what it knows. –Leon Taylor tayloralmaty@gmail.com             

Notes

A simple form of the Lucas supply function is Q = a [P – E(P)], where Q is the log of output, P is the price level, E(P) is the public expectation of the price level, and a is a parameter.  Thus Var(Q) = a^2 Var[P – E(P)]: Given a, the variance of output relates positively to the variance of the unexpected price change, P – E(P).

But a, the response parameter, may vary from one country to another, because it depends on economic history. In a country with large and frequent price surprises, the public may eventually learn to ignore them; a there is small.  But in a country where price surprises are rarely large, the public may interpret a big one as mainly due to changes in demand and so would adjust output; a there is large.

In sum, across countries, frequent and large price surprises lead to small changes in output, and infrequent price surprises lead to large changes in output.      

References

Laurence Ball, N. Gregory Mankiw and David Romer. The New Keynesian economics and the output-inflation tradeoff. Brookings Papers on Economic Activity 1: 1-65. 1988.

Robert Lucas. Some international evidence on output-inflation tradeoffs. American Economic Review 63: 326-334. 1973.

David Romer. Advanced macroeconomics. Third edition. Boston: McGraw-Hill Irwin. 2006.