Document of The World Bank Report No: ICR00001738 IMPLEMENTATION COMPLETION AND RESULTS REPORT (IBRD-79110) ON A LOAN IN THE AMOUNT OF US$1 BILLION TO THE REPUBLIC OF KAZAKHSTAN FOR A DEVELOPMENT POLICY LOAN FEBRUARY 14, 2012 Poverty Reduction and Economic Management South Caucasus and Central Asia Europe and Central Asia Region CURRENCY EQUIVALENTS (Exchange Rate Effective February 5, 2012) Currency Unit = Tenge US$ 1.00 = 148.72 Tenge FISCAL YEAR January 1 – December 31 ABBREVIATIONS AND ACRONYMS ADB Asian Development Bank BTA Bank TuranAlem CAS Country Assistance Strategy CET Common External Tariff CFC Committee of Financial Control CDS Credit default swap CFCPP Committee for Financial Control and Public Procurement CPAR Country Procurement Assessment Report CPS Country Partnership Strategy DPL Development Policy Loan FSA Financial Supervision Agency FSAP Financial Sector Assessment Program GDP Gross domestic product IBRD International Bank for Reconstruction and Development IDA International Development Association IMF International Monetary Fund JERP Joint Economic Research Program KCSL Countercyclical Support Loan for Kazakhstan KKB Kazkommertsbank KTZ Kazakhstan Temir Zholy MOF Ministry of Finance NBK National Bank of the Republic of Kazakhstan NPL Nonperforming loans NF National Fund PER Public Expenditure Review PEFA Public Expenditure and Financial Accountability Assessment SME Small- and medium-sized enterprises SOE State-owned enterprises TA Technical assistance Vice President: Philippe H. Le Houerou Country Director: Motoo Konishi/Saroj Kumar Jha Sector Manager: Kazi Matin/Ivailo Izvorski Task Team Leader: John Litwack/Ekaterine Vashakmadze ICR Team Leader Ekaterine Vashakmadze KAZAKHSTAN DEVELOPMENT POLICY LOAN CONTENTS Data Sheet A. Basic Information B. Key Dates C. Ratings Summary D. Sector and Theme Codes E. Bank Staff F. Results Framework Analysis G. Ratings of Program Performance in ISRs H. Restructuring 1. Program Context, Development Objectives and Design ........................................................ 1 2. Key Factors Affecting Implementation and Outcomes .......................................................... 9 3. Assessment of Outcomes ...................................................................................................... 11 4. Assessment of Risk to Development Outcome ..................................................................... 26 5. Assessment of Bank and Borrower Performance ................................................................. 26 6. Lessons Learned ................................................................................................................... 28 Annex 1: Bank Lending and Implementation Support/Supervision Processes ............................. 29 Annex 2. Stakeholder Workshop Report and Results .................................................................... 31 Annex 3. Summary of Borrower's ICR and/or Comments on Draft ICR ....................................... 34 Annex 4. List of Supporting Documents ........................................................................................ 37 MAP ............................................................................................................................................... 38 iii A. Basic Information Kazakhstan Country: Kazakhstan Program Name: Development Policy Loan Program ID: P119856 L/C/TF Number(s): IBRD-79110 ICR Date: 02/16/2012 ICR Type: Core ICR REPUBLIC OF Lending Instrument: DPL Borrower: KAZAKHSTAN Original Total USD 1,000.00M Disbursed Amount: USD 1,000.00M Commitment: Revised Amount: USD 1,000.00M Implementing Agencies: Ministry of Finance Cofinanciers and Other External Partners: B. Key Dates Revised / Actual Process Date Process Original Date Date(s) Concept Review: 03/02/2010 Effectiveness: 07/09/2010 07/23/2010 Appraisal: 04/09/2010 Restructuring(s): Approval: 05/25/2010 Mid-term Review: Closing: 01/07/2011 01/07/2011 C. Ratings Summary C.1 Performance Rating by ICR Outcomes: Moderately Satisfactory Risk to Development Outcome: Moderate Bank Performance: Satisfactory Borrower Performance: Satisfactory C.2 Detailed Ratings of Bank and Borrower Performance (by ICR) Bank Ratings Borrower Ratings Quality at Entry: Satisfactory Government: Not Applicable Implementing Quality of Supervision: Satisfactory Not Applicable Agency/Agencies: Overall Bank Satisfactory Overall Borrower Satisfactory iv Performance: Performance: C.3 Quality at Entry and Implementation Performance Indicators Implementation QAG Assessments Indicators Rating: Performance (if any) Potential Problem Quality at Entry Program at any time No None (QEA): (Yes/No): Problem Program at any Quality of No None time (Yes/No): Supervision (QSA): DO rating before Closing/Inactive status: D. Sector and Theme Codes Original Actual Sector Code (as % of total Bank financing) Banking 44 44 Central government administration 39 39 Sub-national government administration 17 17 Theme Code (as % of total Bank financing) Public expenditure, financial management and 56 56 procurement State-owned enterprise restructuring and privatization 44 44 E. Bank Staff Positions At ICR At Approval Vice President: Philippe H. Le Houerou Philippe H. Le Houerou Country Director: Saroj Kumar Jha Motoo Konishi Sector Manager: Ivailo V. Izvorski Kazi Mahbub-Al Matin Program Team Leader: Ekaterine T. Vashakmadze John Litwack ICR Team Leader: Ekaterine T. Vashakmadze ICR Primary Author: Luis Alvaro Sanchez v F. Results Framework Analysis Program Development Objectives (from Project Appraisal Document) The operation supports the Government's program of policy measures to foster economic growth and sustain living standards of the population in the aftermath of the economic crisis. The program's objective is to support the Government's efforts in: (i) strengthening public resource management (including oil revenues) through increased efficiency and re-orientation of spending, and (ii) reducing vulnerabilities in the financial sector through restructuring large problem banks, and strengthening the bank supervisory, regulatory and resolution frameworks. The proposed DPL is the major portion of the revised lending program in Kazakhstan, consistent with the CPS objectives presented to the Board in 2004. The proposed DPL is aligned with the first pillar of the CPS, "reducing losses in competitiveness through prudent management of the oil revenues and increased public sector efficiency," and indirectly supports the other three pillars by helping the Government to strengthen public resource management and address vulnerabilities in financial sector. NOTE: TABLE 6 (PROGRAM OBJECTIVES AND RESULTS) OF THE ICR DOCUMENT PRESENTS THE DETAILED PDO INDICATORS INCLUDING THEIR BASELINE VALUES, ORIGINAL TARGETS AND ACTUAL VALUES AT COMPLETION OF TARGET YEARS. Revised Program Development Objectives (if any, as approved by original approving authority) NA (a) PDO Indicator(s) Original Target Formally Actual Value Values (from Revised Achieved at Indicator Baseline Value approval Target Completion or documents) Values Target Years Indicator 1 : Indicator 1. Official adoption of new NF rules Approve, adopt, and implement President requested that action by the Met. New rules Value new rules be drafted for government of were adopted and (quantitative or NA NF operations by Q1 new rules for are being Qualitative) 2010. governing the implemented. operation and use of NF. Date achieved 01/10/2010 06/15/2010 02/09/2011 06/15/2011 Comments (incl. % achievement) Solvency of the system as measured by the capital adequacy ratios (FSA ratio Indicator 2 : k1-1 and k1-2) Value Actual capital adequacy Capital adequacy Met. (quantitative or ratios as of Jan 1, 2010: ratios for entire NA K1-1: .115 Qualitative) k1-1: –0.115 (0.107*) system should be K2: .181 vi k1-2: –0.116 (0.126*) no less than new prudential norms: * Without BTA and k1-1: 0.06 Alliance k1-2: 0.09 as of July 2011 (0.06 currently) Date achieved 01/01/2010 06/15/2010 06/15/2010 07/01/2011 Comments (incl. % achievement) (b) Intermediate Outcome Indicator(s) Original Target Actual Value Formally Values (from Achieved at Indicator Baseline Value Revised approval Completion or Target Values documents) Target Years Indicator 1 : NA Value (quantitative or Qualitative) Date achieved Comments (incl. % achievement) G. Ratings of Program Performance in ISRs Actual Date ISR No. DO IP Disbursements Archived (USD millions) H. Restructuring (if any) Not Applicable vii 1. Program Context, Development Objectives and Design 1.1 Context at Appraisal Before the Crisis 1. Kazakhstan grew rapidly from 2000 through 2007 and made considerable progress in reducing poverty. Growth in output and incomes was supported by sizable revenues from natural resources and market economic reforms. Annual GDP growth averaged 10 percent and average real incomes more than doubled, transforming Kazakhstan into an upper-middle-income economy relatively quickly. The estimated share of the population living below the official poverty line declined from 44.5 percent in 2002 to 12 percent by year-end 2007. Meanwhile, the unemployment rate as defined by the International Labor Organization declined from an estimated 13 percent in 2000 to less than 7 percent by 2007. However, the rapid growth, which was concentrated in large cities and resource-rich western regions, resulted in income disparities. While the poverty headcount dropped below 10 percent in urban areas, in rural locations it remained over 20 percent. 2. Thanks to responsible fiscal and macroeconomic management, the National Fund of the Republic of Kazakhstan had accumulated substantial resources before the crisis hit. Total government spending averaged about 22 percent of GDP for most of the pre-crisis period, and the non-oil deficit averaged about 4 percent of GDP even as oil prices and revenues rose. Because the government resisted pressures for major increases in spending, by the end of 2008 the National Fund (NF) had built up savings of US$27 billion (21 percent of GDP) and inflation was relatively low for most of the period. Sterilization of a large part of the oil inflows through the NF and repatriation of a large share of oil profits also reduced pressure on the exchange rate. 3. By 2008 large capital inflows to the banks, coupled with public and private foreign investment spending, had overheated the economy, which led to currency appreciation and planted the seeds of financial instability. Encouraged by soaring commodity and real estate prices, international creditors supplied the large commercial banks with abundant unsecured credit. As a result, the external debt of domestic banks rose from US$8 billion in 2005 (14% of GDP) to $45.9 billion in 2007 (43.8 percent) and the nominal value of commercial bank credit to the economy more than doubled, from 25 percent of GDP in 2004 to about 56 percent in 2007. Most of this credit went to construction and real estate, which together accounted for loans amounting to 30 percent of GDP at the end of 2007. Finance and construction had become the major drivers of economic growth. 4. While at the micro level the prudential position of banks seemed comfortable, macro-prudentially there were signs of building pressures. The surge in real estate prices supported bank comfort levels, but the heavy exposure to short-term external sources of financing was becoming problematic. Efforts in 2006 to limit the ability of banks to borrow abroad brought heavy resistance from the financial sector and housing lobbies, which prevailed. By the time prudential regulations on foreign borrowing were tightened in early 2007, it was too little too late. Responses to the Shocks of the late 2000s 5. In 2007 and 2008 Kazakhstan was hit by two external shocks in quick succession. The first came in August 2007 when a sudden brake on foreign inflows (loans) triggered a banking liquidity crisis, which was exacerbated by a speculative run on deposits and on the national currency. The authorities reacted rapidly, but just as the Kazakh economy was starting to 1 stabilize in 2008, it was again negatively affected by the plunge in oil prices and the world financial crisis. 6. In 2008 sinking commodity prices and intensification of the global crisis hit the Kazakh economy hard. First, exports dropped. Monthly exports fell from US$3–5 billion in the first 11 months of 2008 to less than US$1.5 billion in December and the first quarter of 2009. Correspondingly, the current account moved from a surplus of US$3.7 billion in the first half of 2008 to a deficit of US$3.5 billion in the first half of 2009. Meanwhile, Kazakh banks lost virtually all access to rollover opportunities in global financial markets, weakening the capital account and putting excessive pressure on the tenge. 7. As the financial crisis deepened and the economy fell into recession in late 2008, the Government tapped into its National Fund to finance an Anti-Crisis package of US$ 10 billion. US$4 billion was spent on the recapitalization of the four largest commercial banks through the purchase of ordinary (up to 25 percent ownership) and preferred shares. A small share of this sum was placed as deposits in the two relatively less distressed banks to facilitate lending to the economy. The remaining US$6 billion financed economic stimulus programs for construction, agriculture, real estate, small business, and key infrastructure projects. A large share of this Anti-Crisis spending package was financed off-budget from National Fund resources through the State holdings Samruk-Kazyna and Kazagro, and was administered through larger Kazakhstani banks. 8. The Government also introduced measures to alleviate the social consequences of the crisis. The Government protected social expenditures from budgetary sequestration, insured all pension payments (including those from private pension funds) indexed to inflation, extended unemployment benefits from four to six months, and promoted the signing of memoranda between regional authorities and larger enterprises on preserving jobs. As of mid-2009, memoranda with 5,215 enterprises employing 813,000 workers were reportedly signed. Special shops selling subsidized food products and medicines to the poor which were set up during the rapid food price increases in 2007-2008 continued to operate. In the spring of 2009, an additional public works program of US$1.5 billion (1.5 percent of GDP) called the ―Road Map‖ was set up for the creation of jobs, training, and the provision of temporary wage subsidies to vulnerable groups at the regional level through special budgetary transfers to local authorities. Public salaries were increased significantly. The share of social spending in the consolidated Government budget increased from 52 percent in 2008 to 60 percent in 2009. 9. The National Bank stepped up its liquidity support for commercial banks in late 2008 and 2009, while deposit insurance was increased seven-fold. By March 2009, reserve requirements for commercial banks had been progressively decreased from 6 percent to 1.5 percent for internal liabilities, and from 8 percent to 2.5 percent for external liabilities. Reverse REP0 operations were used for liquidity support (US$2.9 billion by the end of the third quarter of 2009). The accounts of a number of state-owned organizations were also shifted from the National Bank to commercial banks. As a measure to support depositor confidence, household deposit insurance was increased seven-fold from 700 thousand tenge to 5 million tenge (from US$5,833 to US$41,667). 10. Instead of the initial plan to recapitalize the four largest banks by buying minority shares, the Government decided to seize control of BTA and Alliance on February 2, 2009, while going ahead with the minority equity injection into the other two banks. The downward spiral in real estate prices and the imminent devaluation of the tenge implied that the approved recapitalization package for BTA and Alliance of October 2008 would be insufficient. Consequently, the authorities feared that the remaining assets of these banks might be in 2 jeopardy. BTA had severe liquidity problems and, being the biggest bank in Kazakhstan at the time, its failure had systemic implications. On February 2, 2009, the Government decided to acquire control of BTA through a share issue, purchased by the state holding. 11. The period August 2007 - December 2009 is associated with US$21 billion dollars of anti-crisis support. The majority of this came from the Republican budget or the large state corporate conglomerate Samruk-Kazyna). Table 1 summarizes the primary sequence of events and programs of 2007-2009, as well as estimated costs to the Government and foreign creditors. Approximately half of this money (US$11 billion) was devoted to direct assistance to struggling commercial banks (primarily BTA), while the other half (over US$10 billion) financed anti-crisis stimulus measures in various sectors of the economy. In addition to public works programs, the Government increased other social spending significantly during this period, mainly through a structural reallocation of budgetary spending. Core Issues before Loan Approval 12. Kazakhstan’s fiscal position deteriorated and the non-oil fiscal deficit widened to 10.5 percent of GDP in 2008 and hit 13.8 percent in 2009. Consolidated state budgetary revenues dropped by about 4 percent of GDP in 2008 due to the recession, low commodity prices, a lowered corporate income tax rate, and the granting of uniform investment credits. Outlays increased from 23 percent of GDP in pre-crisis years to 27.9 percent in 2009 to finance higher social commitments and off-budget stimulus spending. The guaranteed transfer from the NF financed half of the deficit; the rest was financed by an additional transfer (1.5% of GDP), a loan amounting to 0.5% of GDP from the Asian Development Bank, and local borrowing (2.4% of GDP). It was decided to resist populist pressures to fully finance the deficit with NF resources. 13. The fiscal difficulties highlighted the need for more budget flexibility and more effective targeting of countercyclical fiscal policies. The immediate priority became to make public spending more efficient so as to make budgets more strategic and budget execution more flexible. The government undertook a major revision of the 2004 Budget Code and Parliament approved its first three-year national budget for 2009–11 based on the strategic plans of government ministries in 2008. Those reforms were in line with a Public Expenditure and Financial Accountability Assessment (PEFA) published in early 2009, which reflected how public finances were managed in 2006 and 2007, highlighted progress in expenditure management, and identified areas that needed attention. 14. How to protect the poor was a major challenge. The government had to quickly re- prioritize spending toward social outlays and keeping social spending adequate despite the deteriorating fiscal position. Kazakhstan had traditionally allocated fewer resources to social expenditures than other countries with similar levels of per capita income. To maintain social spending, the government cut administrative expenditures and phased out production subsidies for construction, agriculture, and financing of loans to small and medium enterprises (SMEs), which were channeled through the state-owned Samruk-Kazyna and Kazagro. To speed the responses to the crisis, the authorities introduced a number of ad hoc measures: The US$1.5 billion (1.5 percent of GDP) public ―Road Map‖ was set up in the spring of 2009 to create jobs, offer training, and provide temporary wage subsidies to vulnerable groups at the regional level through special transfers to local authorities. The government also protected social expenditures from budgetary sequestration, ensured that all pension payments (including those from private pension funds) were indexed to inflation, extended unemployment benefits from four to six months, and promoted the signing of memoranda between regional authorities and larger enterprises on preserving jobs. 3 Table 1. 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