Author: Advisor to the Chairman of the Board Halyk Finance Murat Temirkhanov
On December 4 of this year, the new Budget Code was approved in the Mazhilis and sent to the Senate for consideration. We have repeatedly raised issues regarding the challenges of budget policy in Kazakhstan. While there were notable improvements in the draft Budget Code (BC), important recommendations from esteemed international organizations such as the IMF, the World Bank, and the OECD were not included in the document. Additionally, the BC lacks several key provisions from the "National Development Plan of the Republic of Kazakhstan until 2029," which was approved by the head of state in July of this year. Specifically, to ensure the long-term sustainability of public finances and to enhance fiscal discipline, this strategic document planned to include targeted transfers from the National Fund within the framework of the budget rule, which is not specified in the new BC.
In our document "What Reforms Does Kazakhstan Need," we noted that a significant revision of macroeconomic policy approaches (primarily fiscal and budgetary) is essential to reduce the economy's dependence on oil prices and to overcome the "resource curse" (a situation where countries rich in natural resources end up being less economically and technologically developed than countries with much smaller resource reserves). Through effective counter-cyclical budget rules, macroeconomic stability is created in the country by stabilizing economic growth, budget expenditures, inflation, and the national currency's exchange rate. As a result of reducing the economy's dependence on oil prices, a favorable environment is established for the development of private business and for economic diversification.
Why are counter-cyclical budget rules crucial for Kazakhstan?
In oil-dependent and non-diversified countries like Kazakhstan, counter-cyclical budget rules play a vital role in the state's macroeconomic policy to stabilize the economy and its indicators (GDP, inflation, interest rates, and the national currency's exchange rate) as well as to stabilize the state budget during sharp fluctuations in oil prices on global markets. A key element of counter-cyclical budget rules in Kazakhstan is the National Fund (the country's oil fund).
According to current legislation in Kazakhstan, the National Fund has two functions. First, it serves a savings function, meaning it preserves the state's financial resources by forming reserves for future generations. Second, it fulfills a stabilization function, which entails reducing the economy's and the state budget's dependence on global commodity market conditions. The stabilization function of the National Fund can only operate under strict adherence to counter-cyclical budget rules.
In the "National Development Plan of the Republic of Kazakhstan until 2029," approved in July of this year, the following is noted regarding budget rules: "One of the priorities in implementing macroeconomic policy will be strict adherence to counter-cyclical budget rules and maintaining the stability of budget parameters. This will contribute to ensuring the balance of public finances, reducing the non-oil deficit, safeguarding and accumulating National Fund assets, and generally coordinating fiscal policy with monetary policy, which will help reduce inflationary pressure."
The essence of counter-cyclical rules is that when oil prices are high, the government does not increase public expenditures but instead accumulates oil dollars in the so-called sovereign oil fund. In our case, this role is performed by the National Fund. Thus, during favorable periods of high oil prices, authorities sterilize the economy from an excess of oil dollars. Such sterilization prevents the economy from overheating and inflation from accelerating. The withdrawal of excess oil dollars from the economy prevents the national currency from strengthening and interest rates from rising. As a result, during periods of high oil prices, counter-cyclical budget rules prevent the emergence of the notorious "Dutch disease."
On the other hand, when oil prices fall, according to counter-cyclical budget policy, the government can use its oil fund to maintain public expenditures at the previous level, which means supporting economic and budget growth regardless of the sharply decreased revenues from the oil sector. Sales of dollars from the oil fund for transfers to the budget prevent the national currency from weakening due to falling oil prices, which in turn stabilizes inflation and interest rates in the market, which are very sensitive to the national currency's exchange rate in our import-dependent country.
Over the past two years, despite favorable oil prices, we have observed that instead of counter-cyclical budget policy, a reverse – pro-cyclical – approach has been used in Kazakhstan. In these two years, the price of oil in international markets averaged around $80 per barrel and above, which is considered a favorable price level for all oil exporters. At such oil prices and under the condition of proper counter-cyclical rules, the inflows into the National Fund should significantly exceed the withdrawals from it into the country's budget.
However, since 2022, there has been a significant increase in republican budget expenditures, while in the past and current years, inflows into the National Fund were significantly less than withdrawals from it (including operations with shares of state companies "KazMunayGas" and "Kazatomprom"). This indicates that during high oil prices in the last two years, the country is experiencing a buildup of budgetary and economic imbalances. This, in turn, signals a high risk of a deep economic and financial crisis in Kazakhstan even with a relatively small drop in oil prices, such as to $60 per barrel.
We would like to reiterate that counter-cyclical budget rules are very important for the monetary policy of the National Bank. As noted in our report "What Reforms Does Kazakhstan Need?", in non-diversified oil countries, counter-cyclical budget rules have a much greater impact on inflation, the key rate, and the national currency's exchange rate than the monetary policy of the central bank. The recent use of a reverse – pro-cyclical – budget policy in Kazakhstan greatly reduces the effectiveness of the monetary and exchange rate policies of the National Bank.
When will counter-cyclical budget rules be included in the Budget Code?
In general, in any country, budget rules should be regulated by budget legislation of the highest level. In some countries, specific budget rules are even included in the Constitution. As mentioned earlier, budget rules play a special role in non-diversified oil countries like Kazakhstan.
A key element of counter-cyclical budget rules in Kazakhstan is the National Fund. However, there are no clear and strict budget rules regarding the use of the National Fund in either the current Budget Code or the draft of the new Budget Code. The draft of the new Budget Code introduced a separate Article No. 51 "System of Budget Rules," where two rules from the current BC were transferred without changes: (1) the rule on guaranteed transfers; (2) the rule on the growth of republican budget expenditures.
According to best global practices, a unified rule for all transfers from the National Fund should be the main condition for its counter-cyclical use. The current limitations on the size of guaranteed transfers from the National Fund to the budget will not be effective until targeted transfers from the National Fund to the budget are included within the legislative limits on transfer sizes. This omission is well noted in the "National Development Plan of the Republic of Kazakhstan until 2029": "An important aspect of ensuring the long-term sustainability of public finances and enhancing fiscal discipline will be the inclusion of targeted transfers from the National Fund within the framework of the budget rule on guaranteed transfers, which will reduce arbitrariness in conducting responsible fiscal and budgetary policy."
Despite this focus on the necessity of including targeted transfers within the budget rule at the highest level, relevant changes did not occur in the new BC.
Once again, we emphasize that the use of the National Fund plays a key role in implementing budget policy in Kazakhstan. This has led to the introduction of a key budget rule since December 2016, which states that funds from the National Fund must enter the economy only through the republican budget, following standard budgetary procedures and only with the approval and oversight of Parliament. However, in addition to the fact that the draft of the new BC does not include budget rules regarding the size of targeted transfers from the National Fund, starting from December 2022, the government has gained a new opportunity to inject funds from the National Fund into the Kazakhstan economy bypassing the republican budget (in the form of purchasing shares and bonds of companies from the Sovereign Wealth Fund "Samruk-Kazyna").