On the Base Rate

At its latest meeting, the NBK cut the base rate by 0.25%. This was in line with my expectations, and I will try to explain why I think it is a logical decision.

The inflation data look fairly good: annual inflation now stands at 10.8% and monthly inflation at 0.7%, which gives hope that inflation will fall below 10%. If we want market interest rates below 10%, we must bring inflation down to 4-6%. This is a very difficult task, and the NBK is working hard to reach these levels. The very cautious pace of the base rate cuts reflects the very large fiscal impulse, which expands the money supply in the country and stimulates domestic demand and imports of goods and services. Here is how it works. All government spending flows into the economy and then, through wages and various expenditures and projects, reaches the market, where buyers spend the money. That money goes either to goods and services produced in the country, where rising demand pushes prices up, or to imports. Buying imports means buying foreign currency, which leads to a weaker tenge, which in turn makes imports more expensive and raises inflation.

To prevent this, fiscal policy must be coordinated with monetary policy, especially in the fight against inflation. When inflation is high, the first priority should be to bring it down, and only then to target economic growth. That is not quite how we operate. We are trying to achieve economic growth at any cost, even at the cost of high inflation. In the long term, however, this leads to unsustainable growth and even to recession, because without low interest rates it is hard to stimulate the economy through higher government spending alone.

Besides fiscal policy, consumer lending also affects inflation, and we can see that the NBK is paying attention to this and wants to discourage banks from issuing consumer loans. Consumer lending works in the same way: people use installment plans and consumer loans to buy goods and services, either domestically produced or imported (imports clearly make up a much larger share of consumption financed by credit). Both push prices up by raising demand and putting pressure on the tenge. Prices can only come down if supply grows, and supply grows only if production grows. Yet lending to the real sector of our economy is very sluggish, especially to large businesses. That is why the NBK, together with the regulator, is trying to stimulate lending to the real sector. But this is a very difficult case. It requires a dedicated program that identifies the bottlenecks, and incentives alone will not solve it. Real-sector lending is a systemic problem that involves collateral creditors' rights, business transparency, owner accountability, long-term liquidity, the AQR and so on and so forth.

For this reason, I believe that the base rate will not be cut quickly. The NBK will look first of all at budget expenditures, as well as at the planned liberalization of prices of natural monopolies, such as utility tariffs and fuel prices, which will affect inflation.