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					The Role of the Central Bank in Sustaining
            Economic Growth



Smolyakov Oleg
National Bank of Kazakhstan
           Monetary Side of Sustainable Development:
                    (framework of analysis)

     Necessary Preconditions
I. Macroeconomic Stability                Central Bank’s Challenges

  Low Inflation Rate                  I. Inconsistency Triangle

  Maintenance of Competitiveness        Inflation vs. Exchange Rate
  Sufficient Level of International   II. External Shocks Vulnerability
    Reserves                             Normal vs. Crisis time
II. Financial Sector Strength          III. Dollarization
  Capital Market                        Following vs. Lead
  Money Market                        IV. Public confidence
  Effective Intermediation              Rules vs. Discretion
         Exchange Rate                   Foreign Exchange Market                            Financial Sector: structural policy
             Regime
1993   Nov. 1993:
                                                                                  Centralized credits to banks and Government were the
       Introduction of the
                                                                                  main tools of NBK to manage broad money and banks’
       National Currency
                                                                                  credits to the economy
       "Tenge"
1994                                                                              1. Operations with T-bills have begun
                             50% exports receipts surrender requirement
                                                                                  2. NBK started to use traditional tools of monetary policy
1995                                                                              1. The practice of providing directive credits to the
                                                                                  economy by NBK has been abandoned
                                                                                  2. Interbank money market has started to operate
                             Surrender requirement has been lowered to 30%        3. The laws "On National Bank" and "On banks and
                             and abolished afterwards                             banking" determined main principles of two-tier system
                                                                                  and functions of Central Bank
                                                                                  4. The law “On insurance” created the basis for
                                                                                  qualitative changes of insurance sector
1996                       1. July 16: Article VIII, IMF Articles of
                           Agreement
       Unofficial Crawling
                           2. The new "Foreign Exchange Regime" law was 1. REPO opeartions was liven up
               Peg
                           introduced                                       2. NBK started to implement the Programme of
1997                       Introduction of Exports-Imports Foreign Exchange international standards introduction in the banking system
                           Control aimed at suppressing the capital flight
                           through trade channels
1998                                                                        1. The practice of Budget deficit direct financing by
                                                                           NBK was abandoned;
                                                                            2. Gov. Debt was transformed into T-bonds
                                                                            3. NBK became in charge of insurance industry
                                                                           surveillance
                                                                            4. Implementation of the Three-Pilar Pension System
1999                         April – November: 50% exports receipts surrender
                                                                                  November: Deposits Insurance System was introduced
                             requirement was introduced
2000                                                                              1. Discount operations have started
                                                                                  2. Introduction of Mortgage Financing System
                                                                                  3. A new law on Insurance Activity was adopted in
                             1. Advanced Repayment of IMF loans by NBK
                                                                                  December: National Bank of Kazakhstan introduced basic
           April, 1999:      2. Capital Amnesty
                                                                                  17 principles of the insurance supervision accepted by
        Floating Exhange                                                          International Association of the Insurance Supervision
          Rate Regime                                                             (IAIS)
2001       (Managed)                                                              1. Establishment of Banking Supervision on
                             National Fund started to accumulate extra receipts
                                                                                  Consolidated Basis
                             from natural resource sector
                                                                                  2. Development Bank was found
2002                                                                              1. NBK became in charge of securities market and
                                                                                  pension funds supervision
                                                                                  2. Implementation of Internal Risk Management Systems
                                                                                  have 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.
                                      Kazakhstan: Selected Indicators
                       (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     0.61
Ratio of FX loans to total loans                                             43           0.42      0.43          0.54     0.51     0.71

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

                                                                                  1996           1997   1998       1999     2000    2001
I. External Shocks Indicators
1.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     -2.7
2. 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
                                      Macroeconomic Indices
   First half of 2002 the real GDP growth :                             Real GDP Growth in 1996-2002, in percent

      Russia – 3,8%                           15


      Ukraine – 4,3%                          10


      Kazakhstan – 9,2%                        5


      Kyrgyzstan – (-)4,9%                     0

                                                -5
      Azerbaijan – 8,4%
                                               -10
      Uzbekistan – 4,0%
                                               -15
                                                      1996        1997           1998             1999           2000           2001      june 2002

                                                              Ukraine    Kazakhstan      Russia     Kyrgyzstan     Azerbaijan     Uzbekistan



   The first half of 2002 real GDP                                        GDP as a percentage of 1996 real GDP, %

                                                180
    percentage to 1996 level
      Russia – 117,0%                          150


      Ukraine – 102,5%                         120

      Kazakhstan – 138,1%                       90
      Kyrgyzstan – 144,5%
                                                 60
      Azerbaijan – 168,0%                             1996         1997          1998             1999           2000          2001       june 2002

      Uzbekistan – 128,2%                                        Kazakhstan               Russia                   Kyrgyzstan
                                                                  Ukraine                  Azerbaijan               Uzbekistan
        Particular Features of the Monetary Policy Implementation

   Change in USD rate of exchange                             Change in USD rate of e xchange during 6,5
    during six and half recent years:                                      re ce nt ye ars, %
                                                                                                                466,8
      Russia – 466,8%                        500
                                              400
      Ukraine – 181,9%                       300              181,9
      Kazakhstan – 107,7%
                                                                                                                                         174,7
                                              200                                       107,7
                                                                                                                                                                                               49,6             40,3
      Kyrgyzstan – 174,7%                    100                                                                                                                   18,9

                                                0
      Azerbaijan – 18,9%




                                                                                                                                                                                                                 Poland
                                                                                                                  Russia
                                                                Ukraine




                                                                                                                                                                                                Hungary
                                                                                                                                          Kyrgyzstan


                                                                                                                                                                     Azerbaijan
                                                                                         Kazakhstan
   Accumulated inflation for six and half
                                                                                        Cumulative Inflation for 6,5 years, %
    years:                                                                                            333,8
      Russia – 333,8%                       330
                                             280                                                                           248,8
      Ukraine – 106,4%                      230
                                             180
      Kazakhstan – 60,8%                    130    106,4
                                                                                                                                                       122,6
                                                                                                                                                                                                    77,3
                                                                          60,8
      Kyrgyzstan – 122,6%                    80                                                                                                                              -1,3
                                                                                                                                                                                                                   53,7
                                              30
      Azerbaijan – (-)1,3%                  -20
                                                     Ukraine




                                                                                                       Russia




                                                                                                                                                                                                                     Poland
                                                                                                                                                                                                      Hungary
                                                                                                                                                        Kyrgyztan



                                                                                                                                                                                  Azerbaijan
                                                                                                                            Uzbekistan
                                                                           Kazakhstan




      Uzbekistan – 248,8%
       Particular Features of the Monetary Policy Implementation

                                           Broad Money to GDP Ratio (disregarding cash USD in circulation),
   Broad money to GDP ratio:     30                                     %

      Russia – 24,3%
                                  20
      Ukraine – 21,5%
                                  10
      Kazakhstan – 18,7%
      Kyrgyzstan – 15,3%          0

      Azerbaijan – 14,1%               1996      1997        1998       1999        2000        2001     june

                                               Ukraine   Kazakhstan   Russia    Kyrgyzstan   Azerbaijan



   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
   Major Instruments of the Monetary Policy :                         Issuance of NBK notes over the period,. US D million

      Open Market Operations                             1200
            Secondary Market Government Bonds            1000
              Operations                                   800

            National Bank does not have a right to        600
                                                           400
              purchase Government Bonds on a primary
                                                           200
              market therefore NBK portfolio is not
                                                               0
              sufficient enough to adjust reserve money              1995         1996      1997        1998       1999       2000          2001       june
                                                                                                                                                       2002
      Notes of the National Bank of Kazakhstan
            Liquidity Adjustment                                                 Weighted Average Note Yield in percent


            Short-term with maturity beginning           50       45,35

                                                          40                 36,29
               from 7 to 91 days
                                                          30
                                                                                                    21,35
                                                                                         18,12                 18,36
                                                          20
   Weighed Average Note Yield:                           10
                                                                                                                              9,11
                                                                                                                                            6,02       5,99

      18,36% in 1999                                      0
                                                                   1995       1996       1997       1998       1999       2000          2001           june
      9,11% in 1999                                                                                                                                   2002

      6,02% in 2001
                                                                             O fficial refinancing rate, end of period, %
      5,99 by the end of June, 2002                       80
                                                           70
                                                           60
   Refinancing rate:                                      50
                                                           40
      Russia – 23,0%                                      30
      Ukraine – 10,2%                                     20
                                                           10
      Kazakhstan – 8,0%                                    0
      Kyrgyzstan – 8,0%                                                   1996      1997        1998       1999       2000          2001          june 2002


      Azerbaijan – 10,0%                                                         Ukraine                   Kazakhstan                      Russia
                                                                                  Kyrgyzstan                Azerbaijan                      Uzbekistan
                                Banking System Development

   Number of banks by the end of June, 2002:         Commercial banks’ credit to the
      Russia – 1281                                   economy by the end of June, 2002
      Ukraine – 154                                  in percentage to the GDP :
      Kazakhstan –39                                    Russia – 19,0
      Kyrgyzstan – 23                                   Ukraine – 17,0
      Azerbaijan – 47                                   Kazakhstan –16,8
                                                         Kyrgyzstan – 3,0
                                                         Azerbaijan – 19,5


                                                     Total Capitalisation per Bank USD million
                                    25
   Capitalisation per bank
                                    20
    by the end of June, 2002:
                                    15
      Russia – 12,7
                                    10
      Ukraine – 8,2
                                     5
      Kazakhstan –22,9
                                     0
      Kyrgyzstan – 1,4                   1997        1998          1999         2000           2001   june 2002

                                                          Ukraine   Kazakhstan   Russia   Kyrgyzstan
                            Banking System Development
                                                                        Percentage of Long-term Loans in Total
                                                  60
   Percentage of medium-term and long term       50

    loans in total by the end of June, 2002:      40
                                                  30
       Russia – 22,4                             20

       Ukraine – 24,5                            10
                                                   0
       Kazakhstan –55,0                                  1998               1999            2000               2001           june 2002

       Kyrgyzstan – 24,6                                                 Ukraine    Kazakhstan     Russia     Kyrgyzstan


                                                        Interest Rate on National Currency Denominated Loans

   Interest rates on national currency           90
                                                  80
    denominated loans by the end of June, 2002:   70
                                                  60
      Russia – 18,3                              50
                                                  40
      Ukraine – 27,1                             30
                                                  20

      Kazakhstan – 15,0                          10
                                                   0

      Kyrgyzstan – 39,4                                1996       1997            1998     1999             2000      2001         june 2002

                                                                         Ukraine     Kazakhstan     Russia      Kyrgyzstan


   Households deposits per capita                                       Personal Deposts per capita, USD


    (first half of 2002), USD:                    200
                                                  180
                                                                                                                            177,6


       Russia – 177,6
                                                  160
                                                  140
                                                  120
       Ukraine – 51,5                            100                                         95
                                                   80
       Kazakhstan – 95,0                          60
                                                   40
                                                                 51,5


                                                   20
                                                    0
                                                               Ukraine                    Kazakhstan                        Russia
                                   Pension Reform


   Funds, accumulated in the pension system have        Investment Portfolio Structure by
    grown significantly:                                  the end of June, 2002:
      1 year after the transition to the new pension       Government bonds – 58,6%
        system (as of end of 1998) - USD 281 mln               (private funds – 52,4%)
        (1,4% to GDP)                                       Non-government bonds – 43,1%
      2 years (as of end of 1999) – USD 467mln                (only private funds)
        (3,2% to GDP)                                       Bank deposits – 9,0% (4,5%)
      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)

 -2                                                                                                                                  5,2


-2,5
                                                                                                                                     5


 -3
                                                                                                                                     4,8

-3,5
                                                                                                                                     4,6
 -4

                                                                                                                                     4,4
-4,5

                                                                                                                                     4,2
 -5


-5,5                                                                                         4
   94M1 94M7 95M1 95M7 96M1 96M7 97M1 97M7 98M1 98M7 99M1 99M7 00M1 00M7 01M1 01M7 02M1 02M7
                                               1000,00                                                                                                                                                                                          170,0

                                  KZT/USD         REER                NEER
                                                                                                                                                                                                                                                160,0


                                                                                                                                                                                                                                                150,0


                                                                                                                                                                                                                                                140,0


                                                                                                                                                                                                                                                130,0


                                                100,00                                                                                                                                                                                          120,0


                                                                                                                                                                                                                                                110,0


                                                                                                                                                                                                                                                100,0


                                                                                                                                                                                                                                                90,0


                                                                                                                                                                                                                                                80,0


                                                 10,00                                                                                                                                                                                          70,0
                                                      Jan Apr   Jul   Oct    Jan Apr   Jul   Oct    Jan Apr   Jul   Oct    Jan Apr       Jul   Oct    Jan Apr Jul Oct Jan Apr   Jul   Oct    Jan Apr   Jul   Oct    Jan Apr   Jul   Oct   Jan
                                                     1994                   1995                   1996                   1997                 CPI   1998Goods/Services 1999                2000                   2001
Weights, assigned to foreign currencies in determining changes in value of KZT
     Year          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
Statistical measures of exchange rate and foreign reserves volatility
   Daily Volatility in Nominal Exchange Rate

                            Period                 Range     St. dev.    +/- 0.1% band   +/- 0.5% band
US$/EUR (DM)       Jan 73- Dec 01                 0.10667    0.00695         15.8%           63.8%
                   Jan 95 – Dec 01                0.07343    0.00660         14.7%           61.1%
US$/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% band
 Germany            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%
                          Weak version of PPP

                           Pt =  +  ( Et Pt* )
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.

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.
                                Summary
 Why 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
against 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
Preconditions: Pass-through effect
                                                    TOT shock
         Normal vs. “Troubles“ Time
                                                    Contagion
                                                    Summary
        Period                  Main objectives                      CB actions                     Outside factors

“Tenge” Introduction -   1. Public confidence              Unofficial crawling peg           1. Initial undervaluation
External Shocks          2. Lower inflation                                                  2. Structural reforms
(Nov, 93 – Aug, 98)      3. Exchange rate stabilization                                      3. Price mark-up adjustment

Macro adjustment to      1. Restore competitiveness        1. Monetary contraction           1. Fiscal contraction
the shocks               2. Prevent crises spreading       2. Gradual devaluation            2. Trade measures
(Sep, 98 – Jun, 99)      to the banking sector             3. Effective Devaluation
                                                           4. Compulsory surrender
                                                           requirement
                                                           5. Implicit guarantee of tenge
                                                           deposits
                                                           6. Lower reserve requirement
Booming period           1. Fear of appreciation           1. Exchange rate risk             3. Fiscal Conservatism
(Jul, 99 – Dec, 01)      2. Monetary expansion             minimization
                         3. Financial sector               (managed floating)
                         development                       2. Strengthening of prudential
                                                           regulations & financial
                                                           supervision
Perspective              1. Gradual removal of             1. Capital Account                4. Oil Boom 
                         restrictions on capital outflow   Liberalization                    possible “Dutch Disease”
                         2. Inflation control              2. Inflation Targeting            problem
                         3. Shocks Vulnerability           2. Single Financial Supervision
                         Minimization                      Body                              5. “Blue chips”
                         4. Enhance Financial              3. Derivatives Market Dev.
                         Intermediation                    4. Stock Market Dev.
                                                           5. Mortgage Lending
                                                           6. Micro-crediting

				
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