NBK Deputy Governor: Low rate in the current environment will bring us to a vicious circle
Why does the National Bank continue to signal the market that a further base rate hike and tightening of the monetary policy is necessary to prevent overheating of the economy. How is coordination of government agencies responsible for financial and price stability built, and is a high base rate really a significant constraint on lending to the economy in the current environment? We have talked about these monetary issues on the agenda with NBK Deputy Governor Akylzhan Baimagambetov.
– One gets the impression that the Government, the National Bank, the Financial Supervision Agency, like the Swan, Cancer and Pike, all pull in their own direction, pursuing their goals and following the instructions, but in the end, in fact, nothing sensible comes out: welfare does not get better, the economy is not rebuilt, and reforms do not take place. Do you agree with this?
– Let’s stick to the same order. There can be no alternative opinion that all the public institutions you have listed have different goals and objectives. Yes, indeed, the Government takes charge of economic growth, the National Bank pursues the goal of stable and low inflation, while the Agency is committed to ensure stability of the financial sector.
But these goals do not conflict with each other. Instead, they are achieved in coordination. Of course, during a period of global shocks such as war, rising global inflation, pandemic, where decisions have to be made in conditions of high uncertainty, parameters will be out of balance, and at the current moment it may seem that there is no coordination and everyone is a scene stealer.
But in fact, this is not the case, because we share the same strategic view of the future: we need a diversified economy, high competition, favorable investment climate and, most importantly, growing well-being of our citizens.
– What exactly is this coordination?
– By the example of the state budget, coordination is manifested through the joint development and implementation of a fiscal rule which is designed to smooth the economy from the impact of oil prices. That is, when prices are high, we will accumulate the National Fund, and when oil prices fall, we will spend, preventing a recession in economy. As a result, macroeconomic stability in the country will enhance, and structure of the economy will become more flexible and diversified, since we will not completely rely on external factors. This rule is already embedded in next year’s budget plan, and everything will depend on how it is actually followed.
We have also jointly developed and are implementing a Set of Measures to Control and Reduce Inflation with the Government. The document provides for efforts in five key areas: increase in production volumes; storage, logistics of goods and transport; retail trade in goods; pricing control, antimonopoly and foreign trade regulation; and system measures.
The Government, among the other things, is working to stabilize prices for socially important food products (the so-called SIFPs).
Also, a discussion on a change in the approach to control the inflation by the Government to targeted social assistance (at least by the example of tariffs) has already begun. This is when a ceiling is not set for prices, but assistance is provided to the category of citizens who really need it. Thus, subsidies can become more targeted, and supply of goods and profitability of production receive a significant boost. From here on, competition and demand must work to balance the price.
For our part, we are tightening monetary conditions by raising the base rate in order to bring demand into balance with supply and prevent the economy from overheating in order to reduce inflation in 2023 and subsequently achieve our medium-term goals from 2025. With respect to this issue, we are on the same page with the Government. We need to target and achieve low inflation levels. This will ensure macroeconomic stability and consolidate inflation expectations of economic entities closer to the target. Similar theses were voiced by the Prime Minister in his recent speech at a plenary session of the Senate.
– As for the rate hike, there is an opinion that, on the contrary, this results in more expensive goods, since, for example, retailers depend on the cost of loans, and they will increase the prices of products sold in response to an increase in the base rate, so the effect will be the opposite.
– Let’s still differentiate between a separate sector of the economy and aggregate supply and demand. First, our trade sector has a stable margin and profitability, and we see daily by personal example that the networks give little concern to their consumers increasing the prices, even if the base rate does not change. Thus, according to our monitoring of the real sector, profitability of sales of the retail industry was 21.3% in the 3rd quarter 2022. Historically, it has averaged at the level of 16.7%, that is, profitability is above the historical average. And the margin of this sector, according to our estimates, given the aggregated sales revenue and cost, in the 2nd quarter of 2022 made 25%. That is, in ordinary words, the trade industry transfers the burden of rising prices due to sustainable demand to you and me, to ordinary consumers. Thus, prices go up not because of the rate. An increase in the base rate does not entail increased inflation, but, on the contrary, it is intended to stabilize and mitigate it.
A low rate will bring us to a vicious cycle: high inflation – high demand – indexation of wages – high inflation, etc. In no case should we fall into this spiral.
In our opinion, one of the main reasons that limits the real growth of retail now is high inflation, which requires indexation of salaries for employees, complicates planning, suppresses demand, and ultimately can cause a decrease in margins and profitability of this business.
– So you state that the rate is not an obstacle to doing business in the Republic of Kazakhstan?
– No, I’m talking about the fact that this is not a first-tier deterrent. I’ll give you a specific example. We survey over 3,000 businesses on a quarterly basis, including trade, manufacturing and mining sectors. And now, enterprises indicate that the main obstacle in doing business from the 1st quarter of 2020 to the 3rd quarter of 2022 has always been: the state of the economy of Kazakhstan (ranked1st), market competition (ranked 2nd), while absence of obstacles being ranked 3rd.
In turn, historical dynamics evidence a decrease in impact of access to financing on activities of enterprises. In terms of significance it shifted from the 5th spot in the 1st quarter of 2020 to the 8th spot in the 3rd quarter of 2022.
Thus, the state of the economy, which is also determined by inflation, is a key obstacle to doing business in Kazakhstan. In these conditions, we must provide a solid foundation for our economy as stable and low inflation and a favorable investment climate. Only in that case it will be possible to build walls and put up a roof. Otherwise, we will be constantly repairing our common house.
– But a contradiction arises here because the economic growth is also a certain condition on which business depends, and the situation with growth this year is definitely worse than in 2021?
– There are no contradictions. Yes, indeed, the economic growth is slowing down, just like worldwide, and our major trading partner, Russia, is generally in a recession. But if you examine the structure of our growth, the picture is rather positive than negative. GDP for 10 months of this year rose by 2.5%. At the same time, growth in the manufacturing industry, transport, trade and construction is around 4% or higher, and in agriculture and information and communications it is generally above 7%. At the same time, we have a 1% decline in the mining sector, but this is due to well-known problems with transportation of oil and unscheduled repairs.
Thus, growth in the non-oil part of the economy is higher, while we do not expect a significant drawdown next year either.
– We have sorted it out with the growth. And what about inflation, why is everything going up in price?
– Inflation, according to recent data, accelerated to 18.8% in October. Let me remind you that in August we forecasted that by the year-end it would make 16-18%. That is, the inflation has already exceeded our forecast. This is a significant increase given that this is an average figure for the entire country.
Inflation grows due to both internal and external reasons. As for the internal reasons, high inflationary expectations are observed, which is, we are starting to get used to the widespread acceleration of prices and expect that in future prices will rise at the same pace or even faster. The so-called migration shock had a certain impact on our expectations. Along with that, a lot of new consumers appeared, which caused a significant increase in rental prices, as well as increased demand for food and a number of services. We see that median expected inflation bounced to a maximum of 18.3% in October. As a result, many people try to buy a product here and now, as they are sure that in the future it will become significantly more expensive. This stimulates demand, and when demand is stable, it is rather easy to transfer the burden of costs onto consumers by increasing prices. Against this background, consumer loans grow, budget expenditures are indexed and wages go up, which also provokes an increased inflationary background.
As for external factors, these are concentrated on the supply side. A break occurred in supply chains, global brands are leaving Russia, and Kazakhstan shifts its focus on new suppliers. For example, we imported a lot of household chemicals from the Russian Federation, so it also takes time to replace these goods, abandon the usual routes, build new supply chains, possibly more expensive ones. As a result, there is no proper supply for heated demand, which results in increasing inflation. Also, we have not yet passed the peak of global inflation, and we simply import it.
Therefore, our task is to ensure that this structural adjustment to external conditions occurs with minimal losses and the price growth pace levels off and then goes down in 2023.
– The President in his recent address has pointed out that the nature of our inflation is foreign, since we have a high import dependence, but at the same time, the National Bank also indicates internal factors that affect our inflation. So what is a catalyst for our inflation?
– Of course, even if you examine numbers, most of price increases already realized are certainly due to external factors, particularly the disruption in supply chains, pass-through effects, high external prices for food, energy, services. In this sense, the foundation is foreign. This is what caused inflation to accelerate strongly this year.
But we also note that the pace of inflation growth also depends on domestic country-related factors. Imagine a burning fire of an outer part of inflation, and now inner combustible factors are added to it in the form of high inflation expectations, consumer credit and a prolonged fiscal impulse. Without this fuel, the inflation rate would have been much lower, and stabilized more quickly, and began to fade. The examples are around. Inflation is rising worldwide, but the growth rate is different. Why? Because internal factors are different everywhere in the world. The US has a more diversified economy, lower inflation expectations, higher competition, etc. As a result, US inflation in October was 7.7%. In China, inflation was 2.1%. In Russia it was 12.6%.
Therefore, there is no contradiction here that we must work both to diversify the economy, increase competition and reduce import dependence, and to curb domestic factors, so that in times of turmoil no fuel was poured into the blazing inflationary fire.
– Almost every statement of the National Bank highlights impact of inflationary expectations on inflation. What is this indicator and how do you calculate it?
– The economy is people and their decisions. Situation in the economy depends on decisions. In turn, decision-making takes place based on incoming information, moods, expectations, and, in general, on economic internal and external environment. Therefore, in addition to real indicators, such as volume of output, we also care about indicators of sentiment and expectations of households, firms and professional market participants. For example, if tomorrow everyone urgently wants to rent an apartment, buy household appliances or buckwheat and, in general, stock up for future use, then at the moment demand will sharply exceed supply and we will see a significant bounce in prices. If people are not sure about the future, they try to consume as much as possible in the current moment, without saving money for future periods, and this directly affects inflation.
Expectations also work with firms: if firms expect high inflation in the future, they will plan for appropriate adjustments in selling prices to cover expected costs, and they will also build their investment plans in environment of high uncertainty.
As a result, it is important for us that expectations of economic agents were fixed at a low level and not respond to shocks in the medium term. Therefore, we examine expectations not only of households and firms but also expectations of professional macroeconomists to monitor these processes in the economy.
According to recent data received, we see that expectations of all monitoring subjects have grown. Households on average (in the scientific language, a median estimate) expect that inflation in one year will be 18.3%, this is the maximum for the entire monitoring period. Qualified expectations of firms in the fourth quarter rose to 17.6%, which is also a peak value. Meanwhile the macroeconomists updated their expectations: median inflation expectations for next year rose to 11%.
That is, we see in all respects that the psychological climate in the economy is pro-inflationary, and confidence of the population and businesses that inflation will fade is very low. In this connection, in order to reduce inflationary expectations, we need to gain confidence through a strong, transparent, accountable and independent monetary policy.
– Experts have described a move the National Bank to increase the rate by 150 b.p. as a monetary shock. In your opinion, did the market expect such a rate change?
– If we perceive conditions of monetary policy in several dimensions, tightening of monetary conditions has the following set of characteristics.
First, it’s important to look at the relative step size: we have raised it from 14.5% to 150 b.p., or about 10%.
Second, you need to pay attention to the very level of the rate: now it is 16% with an October inflation of 18.8%.
Third, it is important how long the rate remains at these levels. Let me remind you that we began to significantly tighten the policy only this year.
And fourth, cumulative effect of the rate hike matters: now it is 6.25 p.p. with inflation accumulated since the beginning of the year at 17.2%.
By all fundamental parameters, this decision cannot be called a monetary shock. Another thing is that we took a break in our previous decision, as we were at a crossroad with respect to the core inflation and inflation expectations, with a relatively favorable situation regarding price growth forecasts until the end of the year, given internal and external conditions. Along with that, in our previous communication there was an explanation that if inflation is not the same as we predicted it, our response will be appropriate.
Our macroeconomic survey also demonstrated that by the year-end, professional macroeconomists expect the median rate to go up by almost 200 b.p. Thus, for many it was not a shock, given the new statistics and the situation with inflation and expectations.