All those people who are getting increasingly bored by my technocrat posts, please disregard the following - again I have to succumb to my inner drive to write about Kazakhstan’s financial sector. In my earlier post, I highlighted some of the issues at stake and got into a discussion with Mergen, who criticised me for over-emphasising the importance of oil in Kazakhstan’s current economic boom.

In the couple of paragraphs to follow, I want to extend a little bit on this by adding some hard data which I retrieved for a uni assignment.

One of the most direct effects of the growing financial sector is the fast credit expansion - that means lending to consumers and corporations is growing at a rapid pace. I think the following table illustrates this very clearly:

How is this expansion in credit financed? Due to insufficiently developed domestic financial instruments, most Kazakh banks supplement their capitalisation by borrowing heavily abroad. That’s a relatively smooth process thanks to Kazakhstan’s liberalised current account and also due to relatively lax limits on foreign borrowing (more on that below). This graph shows the upward trend in foreign borrowing. Note that short-term borrowing is quite a significant proportion of overall loans, but fell quite sharply at the end of last year.

The Kazakh regulators are trying to keep foreign borrowing in check - but that might prove to be a difficult undertaking: Bank profitability is high and global capital abundant. With abundant money translating into a rapid expansion of domestic credit, this of course puts pressure on the inflation rate.

This news item of Interfax here caught my attention recently. It says that money supply (M3) fell by 2.9% month on month in January - so I thought that this might have been a sign that the new regulations from last year (new reserve requirements for external borrowing) have shown some effect. After exchanging a couple of emails with a market analyst at a leading investment bank, however, I was informed that:

Given that this is not a seasonally adjusted data we have to go back and check what has been normally happening in Januaries. In January 2006 the M3 drop was 3.2% mom and in January 2005 it was a 5.3% mom drop. Thus, the seasonal fall in M3 in January is getting smaller and smaller.

Unsurprisingly, M3 growth in year-on-year terms has actually accelerated. In fact, M3 was up a staggering 80.5% yoy in January, up from 79% yoy in December. To get a feel for what is up and what is down … M3 growth was below 50% yoy in mid-2006 and stood at 25% yoy at end-2005.

So, M3 growth is rampant - but due to financial deepening (or “catching up”), this does not translate into exorbitant inflation rates - yet. However, it has to slow down and monetary policies employed by the NBK are too loose in the eyes of most analysts. What were these measures?

In 2006, the NBK has tightened the monetary policy stance: It increased the policy interest rate, stepped up the issuance of central bank bills (thereby relieving pressure off the inflation rate), and increased the reserve requirements for commercial banks. Noteworthy in this respect are the new limits on foreign borrowing, for which reserve requirements were initially introduced in October 2005 at 6%.

The effective rate tripled in 2006, but banks have, despite a minor slowdown in short-term borrowing, not reduced their appetite for borrowing abroad (as you can see in the graph above). With current rates of bank profitability and the rate at which credit is growing, external borrowing is set to increase even with raised reserve requirements.

Furthermore, banks will continuously opt for Loan Participation Note structures (issued by a Netherlands-based special purpose vehicle) as well as Eurobonds (see e.g. Alliance Bank). The new reserve requirements valid from March 2007 do also leave further room for more external borrowing by four of the six biggest Kazakh banks. Furthermore, the expected tenge appreciation in 2007 will reduce costs associated with the new limitations.

So - some people think that the Kazakh credit boom is showing no signs of deceleration. While this does not mean that a financial crisis is imminent in Kazakhstan, it certainly raises the stakes for market participants should the favourable external conditions (cheap and abundant money, high oil prices) worsen.

Things to look for are thus the regulators themselves - who has what say in these organisations, does the new FMSA have the teeth to push through legislation that many banks of course won’t like?

There are many more aspects worth mentioning in this regard, but maybe I should outsource this finance rant to another blog :)