Under pressure from the lockdown and low oil prices, the economy entered a recession. In the second quarter, the economy showed a decline of 5.6% yoy. The peak of the quarantine, together with the local minimum in oil prices and the exchange rate of the tenge, fell on April. In May and June, as a result of the easing of quarantine restrictions and the recovery of oil prices, accompanied by the strengthening of the tenge, there was some economic recovery.
The service sector has been hit harder than other sectors. At the end of the first half of the year, the trade and transport sectors experienced the largest decline, measured by double-digit figures of -11% yoy and -15% yoy. By contrast, construction and telecommunications maintained strong growth of 11% yoy and 9% yoy, respectively. The industry remained in the positive zone, while the planned recovery of oil production in the third quarter under the OPEC+ deal will support the industry.
In the first half of the year, inflation was 7% yoy. In the consumer market, food products (+11.1% yoy) were the main driver of price growth. At the same time, inflation in the second quarter was below the level of the first quarter – 1.9% versus 2.3%, as a result the rise in prices in 1H2020 amounted to 4.2%. The easing of inflationary pressures in the second quarter was facilitated by the stabilization of the situation on the foreign exchange market and the decrease in regulated prices for fuel and utility tariffs. In addition, there was a significant contraction in domestic demand as a result of the worsening economic situation.
NBK softened monetary conditions. After an abrupt reduction in the base rate from 12% to 9.5% in early April, the NBK no longer changed the rate during the 2q2020. However, in July, the NBK lowered the base rate from 9.5% to 9.0% and narrowed the liquidity window by 50 bps. The base rate cut was due to the stabilization of the money market situation, easing of inflationary pressure over the economy, de-dollarization of deposits and the decline in business, consumer and investment activity. The regulator is increasing monetary impulse in order to support the economy with cheaper lending.
FX rate of the national currency is to weaken. During the 2q2020, FX rate of the national currency strengthened against US dollar amidst the rising price of oil, strengthening of the currency of the trading partners, weakening of the US dollar itself, and, the most importantly, due to a significant increase in foreign currency supply by the National Bank as part of the conversion of transfers from the National Fund (70% of trade on the foreign currency market) with strict measures to limit the speculative stance at place. In 2H2020, sluggish foreign trade, relatively low oil prices, expected weakening of the Russian ruble, the reduction in currency sales by the National Bank from the National Fund and the expansion of the state budget deficit will put pressure on FX rate of the national currency to its weakening.
NBK's reserves are growing, the assets of the National Fund are shrinking. Amidst rising gold prices and an increase in the funds of commercial banks in foreign currency in the accounts of the NBK, the gross IRs of the NBK increased by 10.4% for the second quarter to $32.9 bn (13.6% ytd). Assets of the National Fund increased by 0.5% to $57.7 bn (6.5% ytd), despite an increase in transfers to the budget and a decrease in tax revenues by 31.2% yoy to T1.0 tn. ($2.6 bn). The growth of the National Fund's assets was due to an increase in investment income more than 6 times - to T2.6 tn or $6.3bn.
Current account deficit is expected to widen. In 1H2020, according to preliminary data of the NBK, the current account yielded a surplus of $2.1 bn or 1.3% of GDP. Originally, the current account surplus was the largest in the first quarter of 2020 at the amount of $2.0 bn, while in the second quarter it was reduced to $95 mn. The widening of the current account surplus in 1H2020 was facilitated by the deficit reduction of primary income balance by $5.2bn to to $6.3 billion (-45.2% yoy, deficit of $4.1 bn in 1q2020, deficit of $2.1 bn in 2q2020), slight reduction of the deficit of services balance by $15 mn to $1.8 bn (-0.8% yoy, deficit $879 mn in 1q2020, deficit in 2q2020 $921 mn), as well as the expansion of the surplus of balance of secondary income by $70 mn to $252 mn (38.2% yoy, surplus of $65 mn in 1q2020, surplus of $187 mn in 2020). According to the preliminary statistics of the NBK's financial account, in 1H2020 there was an inflow of capital of $3.2 bn (inflow of $365 mn in 1q2020, inflow of $2.8 bn in 2q2020) against capital outflow of $3.5 bn last year for the same period (outflow of $3.5 bn in 1q2019, inflow of $12 mn in 2q2019). The positive dynamics of capital inflows in the financial account was facilitated by the expansion of capital inflows in 1H2020 on the account of portfolio investments of $3.5 bn (inflow of $1.8 billion in 1q2020, inflow of $1.9 mn in 2q2020) compared to an outflow of $4.2 bn last year (outflow of $3.3 bn in 1q2019, outflow of $922 mn in 2q2019). In our opinion, this was due to the reduction of nominal holding of foreign assets by residents, as well as by reducing the foreign assets of the National Fund while increasing the obligations of the commercial sector of the Republic of Kazakhstan to non-residents. Sluggish foreign trade dynamics in 2H2020 will expand the current account deficit from 3.6% of GDP in 2019 to 5.1% of GDP in 2020.
2020 forecast: GDP contraction by 1.1%, inflation 7.3%, KZT435 per dollar. As we expected, the second quarter of this year was marked by a serious decline in economic activity. The crisis peaked in April, after which some improvement was registered in May and June. The economic contraction in the third quarter will not be as deep, given the gradual recovery in oil production and the adaptation of the economy to the inevitable constraints caused by the pandemic. The continuation of the quarantine, albeit in a less stringent format, so far limits the full restoration of the service sector, where the bulk of all employed people are concentrated, and mainly small and medium-sized businesses. A noticeably faster recovery in economic activity in the near term will be facilitated by the reduction of restrictions around the world, which will positively affect the demand for Kazakhstani exports. Increased budget spending compared to last year and numerous forms of fiscal stimulus will provide an important boost to business recovery. Consumer inflation, in our opinion, will stabilize at around 7% in the second half of the year, although a moderate increase in inflationary pressure against the background of the expected weakening of the tenge is possible.
