Trade Balance Slump and a Strong Tenge

As I wrote earlier, Kazakhstan's trade balance has deteriorated sharply (from USD 34 billion to USD 19 billion). Imports rose by a full USD 10 billion on the back of fiscal stimulus and a strong tenge, while exports fell by USD 6 billion owing to lower oil exports and declines in other categories. The current account has swung deep into the red (-USD 9.8 billion). Last year the tax revenue plan was not met (a shortfall of KZT 1.3 trillion), yet spending was not cut, so the government had to resort to selling shares of KazMunayGas. In effect, additional dollars were sold from the National Fund, and shares were moved from Samruk to the National Fund, which further strengthened the tenge and topped up the budget. It is a questionable operation, but there was no other option, since tax receipts fell short by KZT 1.3 trillion, of which KZT 1 trillion was the CIT shortfall. This raises the question of SME tax breaks, which large businesses use to optimize their taxes. The scheme is very simple: dozens of individual entrepreneurs (IEs) and limited liability partnerships (LLPs) with preferential rates proliferate around a business, and expenses are inflated through various services, which then become income at reduced rates in those IEs and LLPs.

Even so, a strong tenge encourages import growth and will put pressure on domestic producers and, in time, on the tenge itself. Incidentally, if the exchange rate were not so strong, exporters would earn more and therefore pay more CIT. That is another factor behind the budget shortfall. But here the likelier consideration was different: inflation had to be beaten. A strong tenge helps enormously in that, although it would be more logical to cut subsidies, government lending and the various state programs that stimulate consumption, which would have a more effective impact on inflation.

But cutting subsidies and concessional loans is not on the agenda for now, for a number of reasons, which I will try to write about another time.

Back to the tenge exchange rate. In January the tenge was supported by dollar sales above the usual volumes, and it strengthened in a way that was unusual but explicable. As I wrote earlier, our exchange rate formation is not entirely free, because not all economic agents can buy foreign currency. We therefore cannot say that the current rate reflects a fair price: importers cannot buy currency without contracts, and they are the main consumers of currency. This means the market is restricted, and we do not know the fair rate.

The economy is growing, but the main driver of growth remains the fiscal impulse, or in other words, government spending. Such a model does little to add to sustainability, but it can quite plausibly lead to imbalances.

For February, dollar sales were announced at USD 700 million, and the NBK, aware that a strong tenge also accelerates the decline of the National Fund, reserved the right to buy USD 500 million of foreign currency from the UAPF. The February tax week will undoubtedly support the tenge, but what to do in March is a big question. Because of accumulated short-term imbalances, the tenge could drop sharply, and the National Bank would then have to intervene to prevent it from weakening too much. Sharp currency swings create considerable uncertainty for economic agents, who in such a situation will build their plans around worst-case scenarios. Inflation expectations may therefore rise, and we will again have to wait a long time for the base rate to come down, and with it for affordable loans.

I think the core problem lies precisely in the lack of any understanding of what to do with the budget: revenues are not growing, expenditures keep rising, and the deficit can only be covered from the National Fund.

In the short term, my summary is as follows. The tenge is under pressure and may weaken sharply in spring, since transfers are due to be reduced and most of the guaranteed transfers have already been drawn in the first months. Government spending is bloated, and unproductive megaprojects have been launched that will increase imports, which will also weigh on the tenge and on inflation. Inflation is hard to contain, which means cutting the base rate quickly will be problematic, and that will affect lending. Tax revenues need to be raised, but no one wants to take responsibility for increasing rates. Everyone will try to find reserves through tax administration, but this is not systemic and will not deliver the desired effect, because building a transparent administration system is very difficult. Many people also overestimate the effect of the shadow economy, since there is an absorbing-income effect: taxes unpaid by one entity turn into taxes paid by others through consumption. But that, too, is a topic for another time. I have written about taxes many times, and it seems to me that administration will not solve the problem; what needs to change is the structure of taxes and their underlying logic: progressive taxation, higher property taxes, and a complete reform of subsoil use taxation. For VAT, we need to move to prepaid VAT, or accounting through separate accounts. But I will write about that next time.