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Implementation Completion Report (ICR) Review - Kazakhstan Development Policy Lending


  
1. Project Data:   
ICR Review Date Posted:
05/03/2012   
Country:
Kazakhstan
Is this review for a Programmatic Series?
 No
First Project ID:
P119856
Appraisal
Actual
Project Name:
Kazakhstan Development Policy Lending
Project Costs(US $M)
 1000  1000
L/C Number:
Loan/Credit (US $M)
 1000  1000
Sector Board:
Economic Policy
Cofinancing (US $M)
   
Cofinanciers:
Board Approval Date
  05/25/2010
 
 
Closing Date
01/07/2011 01/07/2011
Sector(s):
Banking (44%), Central government administration (39%), Sub-national government administration (17%)
Theme(s):
Public expenditure financial management and procurement (56%) State-owned enterprise restructuring and privatization (44%)
         
Prepared by: Reviewed by: ICR Review Coordinator: Group:
James A. Hanson
Jorge Garcia-Garcia Ismail Arslan IEGPS2

2. Project Objectives and Components:

a. Objectives:


    The program document (PD) states the objectives as “The program supported by the proposed DPL focuses on improving public resource management [Pillar 1] and addressing financial sector vulnerabilities [Pillar 2] and is thus comprised of two pillars. Under the first, the Government is enhancing budgetary discipline through new rules for limiting use of National Fund resources, reorienting budgetary expenditures toward (mostly social) priorities, and implementing major budgetary reforms at the national and local level. Under the second, the Government, the National Bank and the Financial Supervision Agency have coordinated their actions to facilitate the restructuring of large problem banks, strengthen the bank resolution framework, and step up significantly the framework and implementation of banking supervision and regulation.” (PD, par. 119)

b. If this is a single DPL operation (not part of a series), were the project objectives/key associated outcome targets revised during implementation?
No

c. Policy Areas:

Improved Public Resource Management

The key policy actions for improving public resource management sought to set limits in the use of funds from the National (Oil) Fund (NF) –which is derived from petroleum revenues­, to reform budget legislation and practice to make budgets more strategic and their execution more flexible, and to align the budget better with national priorities, including social ones, during the crisis period. The prior actions were:

(1) Issuing a decree that limited the investment of NF funds to internationally traded assets and to US$8 billion the total annual disbursements from the National Fund (NF), which is derived from petroleum revenues;

(2) Taking the necessary normative acts in the Budget Code for:

    • Developing and approving three-year rolling budgets at the republican and local level based on three-year strategic plans;
    • Delegating authority to budget administrators at the republican (national) and local level to reallocate money across sub-programs during budget;
    • Issuing regulations to establish internal audit units in budgetary organizations at the republican (national) and oblast levels to conduct regular internal audits; and
(3) Reducing the non-priority administrative fiscal expenditures and targeted budgetary transfers to the Republican budget, purchase of domestic securities.

Prior actions (1) and (3) would help to increase fiscal discipline, both in the use of the NF, which was being depleted by withdrawals, and in the government budget to provide fiscal space for increased social expenditures.

Prior actions (2) and (3) would help to improve long-run budget making, the use of budget appropriations, and control over fiscal spending through audits.

Reduced Financial Sector Vulnerabilities

The key policy actions supported reforms that sought to address the banking crisis and restore domestic credit through changes in the incentive framework for commercial banks, improving prudential regulations, and strengthening the capacity to supervise and intervene in banks. The prior actions were:

(1) BTA and Alliance banks, each entered into a terms sheet agreement with their credit committees on a restructuring plan providing for their financial viability, and for writing down the majority of outstanding foreign debts;

(2) The government enacted law to provide for strengthening the bank resolution framework, including through the creation of stabilization banks, execution of purchase/assumption agreements and restructuring of banks by a specialized financial court.

(3) The government enacted law to provide for establishing an early warning system to empower the Financial Supervision Agency to:

    • Monitor indicators of bank performance;
    • Require banks to submit to a contingency plan in the event of a deterioration of such indicators; and
    • Take other additional measures as required to provide for financial stability, even in the absence of the explicit violation of prudential norms; and

(4) The Financial Supervision Agency would issue decree to:
    • Introduce an increase to the capital adequacy requirements for commercial banks, starting in July 1, 201 1; and
    • Limit the total liabilities of commercial banks to nonresidents relative to their equity.
Prior action (1) would generate further clearance of the portfolio from distressed assets, reduce burden on national debts and focusing on further development of banks, which had taken over the banks and was responsible for their debt. Prior actions (2) and (3) established an early warning system for weak banks that allowed the Financial Supervision Agency to require their owners to strengthen the banks, by adding capital and take action to reduce bad loans, and, if this proved insufficient, to take over weak banks and sell off their assets. Prior action (4) forced banks to create greater capital buffers against shocks and reduce their dependence on volatile capital inflows.

d. Comments on Project Cost, Financing, Borrower Contribution, and Dates

The Kazakhstan DPL was a US$1,000 million single tranche loan. It was approved by the Board on May 25, 2010, disbursed on effectiveness on July 23, 2010; and closed on schedule, on January 7, 2011.


3. Relevance of Objectives & Design:

a. Relevance of Objectives:

      The loan objectives of a) stronger public resource management of petroleum revenues and government expenditure, and b) addressing financial sector vulnerabilities were substantially relevant to Kazakhstan’s longer-run development, as well as a prompt response to the crisis. The objectives addressed a) the run-down of the NF and the lower world petroleum price that was putting pressure on the fiscal accounts and b) the global financial crisis and the potentially costly crisis in some major Kazakh banks that the government had been forced to take over. Although the DPL was not specifically part of the 2004 CPS or the 2008 CPS update, it was fully consistent with the goals of the CPS and the Government of prudent management of oil revenues and public sector financial discipline and efficiency.

b. Relevance of Design:
Design of the loan was substantially relevant in the context of lower petroleum prices and the financial crises globally and in Kazakhstan. The DPL’s prior conditions strengthened public resource management by reducing the rapid rundown of the NF, improving efficiency of government spending, and orienting it toward social expenditure. It involved greater control of spending and reducing transfers to state enterprises and administrative expenses. The DPL prior conditions also reduced the potential drain on the government budget from the two problem banks through a settlement with foreign creditors that reduced the banks’ excess offshore liabilities by an estimated US$11 billion. Also in the financial sector, the DPL prior conditions reduced financial sector vulnerabilities through support for regulations that raised banks’ capital and reduced banks’ reliance on volatile foreign funding. Other prior conditions in the financial sector supported laws and regulations that set up “early warning” procedures to identify weak banks and procedures for restructuring and resolution of banks that were unable to strengthen themselves.


4. Achievement of Objectives (Efficacy) :

Objective 1: Improving Public Resource Management (Substantial)

Kazakhstan has largely achieved the overall PD objectives (par. 119) of improving the management of the National Fund, modernizing public finance and enhancing budgetary efficiency and reorienting budgetary expenditures to better align with national priorities.

Improve management of the National Fund. The government capped annual transfers from the NF to less than US$8 billion and forbade budget transfers to state-owned enterprises. As a result, the balance in the NF has risen from US$24.4 billion in 2009 to about US$46.6 billion at the end of 2011.

Modernize public finance and enhance budgetary efficiency. Results in this area have been less than expected. As prior action the government enacted the Budget Code of the Republic Kazakhstan that authorized to carry out the following changes at the national and oblast level: developing and approving 3-year rolling budgets based on strategic plans, delegating more authority to budget administrators, and establishing audit units in budgetary organizations. The ICR reports that the central administration has already drafted a first round of strategies and has put in place medium-term budget frameworks for the national government and sectors; it also reports that in 2010 the authorities implemented a results-oriented budgeting at the local level with three-year budgeting and using strategic-results oriented plans. On delegating authority, the ICR reports that there is more flexibility than in the past, but the flexibility it is limited and handicapped by a narrow definition of budget programs. On internal audits, the agencies were created but the current internal control arrangement does not provide the heads of public bodies with independent and impartial opinions and advice to help them improve performance and use resources efficiently; what exists today are internal control agencies not audit services. Prior to the loan, the Bank's economic and sector work had concluded that the existing legal basis for these audits was sufficient, but implementation of the audit system demonstrated that a stronger legal basis was needed to generate useful, independent audits for the managers.

Reorient budgetary outlays. On budgetary efficiency, the overall fiscal position went from a deficit of 1.4 percent of GDP in 2009 to a surplus of 1.5 percent in 2010; the surplus further rose to 2.6 percent in 2011 and is projected to remain at 2.6 percent in 2012 according to the IMF. This achievement also reflects the reduction of anti-crisis spending and transfers to state-owned enterprises from 17 percent of GDP in 2008 to 7.9 percent in 2010, slightly above the target indicator of 7 percent of GDP set in the PD (p. 66, policy matrix). Although not part of the expected results, it is worth noting that social expenditures (education, health, and social security) have risen to 48.3 percent of the budget, compared to 46.8 percent in 2009; also, in November 2011, Standard & Poor’s followed the other two rating agencies and raised Kazakhstan to low investment grade on the basis of this performance.

Objective 2: Addressing Vulnerabilities in the Financial Sector (Modest)

Kazakhstan has made progress in achieving the overall PD objective of addressing vulnerabilities in the financial sector. In particular, Kazakhstan’s financial sector avoided a potential second crisis in 2011 from potential contagion from the Euro-zone governments’ debt crisis. Such progress resulted from restructuring of large banks, strengthening the frameworks for bank restructuring and bank resolution and for regulating and supervising banks.

Restructuring large problem banks. The government increased the capital buffer against unexpected shocks in the two large problem banks (BTA and Alliance) through their restructuring and the settlement with foreign creditors. By early 2011 these two banks had substantially increased their reported Tier I Capital (common stock plus retained earnings) and overall capital ratios. For BTA, the indicators were Tier I Capital of 12.3 percent of risk weighted assets and an overall capital of 15.7 percent of risk weighted assets. For Alliance Bank, the indicators were 8.2 percent and 13.5 percent, respectively. These figures exceeded the new, higher regulatory minimums of 6 percent Tier I capital and 9 percent overall capital, and corrected the two banks’ earlier insolvency (negative capital ratios) at end- 2009. Still, the two banks are insolvent by international financial reporting standards, and in the case of BTA its interest payments exceed the income from its assets. According to the Financial Supervision Agency non-performing loans constitute 60 and 66 percent of Alliance’s and BTA’s loans.

Strengthening bank restructuring and bank resolution framework. The Government established an early warning system to anticipate bank problems and a procedure for resolving weak banks. All banks were monitored in the early warning system in 2011.

Strengthening bank regulatory and supervisory framework. The Government increased the capital buffer in the whole banking system by raising minimum regulatory capital ratios of Tier I capital to 6 percent of risk weighted assets and overall capital to 9 percent. At the beginning of 2011, the ratios for the entire banking system exceeded the new regulatory ratio, with a reported average Tier I capital of 11.5 percent (ICR Project Indicators) and an overall capital of 18 percent (ICR Project Indicators; IMF Article IV 2012). All figures are based on the country’s existing accounting system and bank regulations, as done in all DPLs in response to sudden crises. Although the actual results exceeded the expected ones, further strengthening of bank regulations and the accounting system, as well as further reduction of the non-performing loans, would be desirable, as pointed out by the ICR and the IMF in its Article IV consultations of 2011.

Also, to reduce the potential volatility of banks’ funding the Government reduced the banks’ reliance on foreign borrowing. This reduction was achieved by lowering the regulatory maximums of foreign debt to bank capital to 200 percent of Tier I capital (previously 250 percent) and 300 percent of overall capital (previously 500 percent). In the first quarter of 2011 the reported system-wide ratios of foreign borrowing were much lower than the new maximums: 38 percent for Tier I capital and 13 percent for overall capital.


5. Efficiency (not applicable to DPLs):

6. Outcome:


The loan had objectives and design of substantial relevance. Its efficacy was substantial in improving public resource management and modest in reducing financial sector vulnerabilities.

The DPL largely achieved its overall objectives. Regarding in public resource management, the Government enhanced budgetary discipline and reoriented budgetary expenditures toward social priorities. The most important factors in this achievement were a) the settlement with external creditors on the borrowings of the two problem banks that reduced the government’s potential costs by an estimated US$11 billion; b) the new annual limit of US$8 billion on expenditures from the NF; and c) stronger rules for expenditures from the NF. The government also increased expenditures for social sectors as a percentage of the budget and reduced administrative expenditures and transfers to state enterprises.

Regarding the reduction in financial sector vulnerability, the Government: a) increased the capital stock buffer in the two problem banks, largely as a result of the settlement with external creditors; b) increased the required capital stock buffer in the whole banking system; c) reduced the maximum borrowing of potentially volatile external capital flows by the banks; and d) put in place an early warning system for potentially problem banks and a legal framework for resolving banks if they became an actual problem. Despite these improvements, the financial system still suffers from large non-performing loans and accrued interest accounts (NPLs in BAT and Alliance exceed 60 percent of total loans); further reductions in financial sector vulnerability will depend on reducing these problems.

a. Outcome Rating: Moderately Satisfactory

7. Rationale for Risk to Development Outcome Rating:

Three possible risks may arise for the DPL’s outcomes since the loan was closed in 2011. The first risk is related to the volatility of oil prices and the risks of a general slowdown worldwide. The risk will be aggravated if current high oil prices lead the government to follow less prudent fiscal policy, tap into the NF, and slow reforms. The government committed itself to maintain a prudent fiscal policy in its 2020 Vision and the 2012 election returned the ruling party. Nonetheless, this strategy may be upset by the temptation represented by current high oil prices. However, current high oil prices may fall as a result of a slow-down in world growth, which appears to be beginning in Europe and China. If this sequence of events occurs, and oil prices do fall, then the government would have to recommit itself to a more prudent fiscal policy promptly.

A second possible risk involves the state owned enterprises borrowing in international markets beyond what is prudent. In the past, the government has made substantial transfers to the state-owned enterprises but the DPL supported a reduction in these transfers. A new law (March 2011) provides for better monitoring and control over the state-owned enterprises. Nonetheless, Kazakhstan’s improved international debt rating may lead state-owned enterprises to increase direct international borrowing. The government will need to closely monitor the state-owned enterprises and their borrowing, and make clear its responsibilities for international borrowing by them.

A third possible development relates to the still-high level of non-performing loans in the financial sector. The clean-up of the banking system has reduced the excessive volatility facing the banking system by limiting its exposure to external inflows, and increasing the system’s capital buffer. However, the banking system still has a high level of NPLs, as noted by the IMF and in the ICR. A pro-active clean up of NPLs and the growth of banking profits that will permit a write-down of NPLs will be needed to reduce their potential costs to the government and limit any possible disruption of a prudent fiscal policy.

In sum, these three possible developments would all affect the DPL’s outcome of more prudent fiscal policy over the longer-term, after the DPL’s closure in 2010. The first two developments would directly affect the government’s prudent fiscal stance. The third would weaken the financial system and, through this weakening, worsen fiscal policy.

a. Risk to Development Outcome Rating: Moderate

8. Assessment of Bank Performance:

a. Quality at entry:

The strategic need for a fast disbursing DPL was clear: a major banking crisis in Kazakhstan that arose from growing foreign borrowing that had been cut-off; an expansion of fiscal deficit; and increasing spending from the NF and non-transparent rules for these expenditures that were rapidly using up previous savings from petroleum revenues. The DPL was based on work carried out under the Bank’s Joint Economic Research Program with Kazakhstan and the second Financial Sector Assessment Program (FSAP) Update. As a result of the obviousness of the crisis and the previous interaction with the Government, the DPL was able to support significant, achievable objectives in a time frame appropriate to a crisis. The Bank also prepared a good results framework that indicated what was to be achieved from the prior conditions, generally using straightforward, publicly available indicators or passage of laws and regulations with effects that could largely be verified.

There were no implementation issues. Indicators for Monitoring and Evaluation were appropriate and could be tracked from publicly available data and through the close relationship between the Government and the Bank in the ongoing Joint Economics Research Program, even after the loan closed soon after effectiveness. The risk assessment in the PD correctly identified the major potential issues in a situation of continuing global financial crisis, slow growth in the industrial countries, and the possibility of slow reform in Kazakhstan. Bank inputs and processes were satisfactory. The DPL was prepared rapidly, going from concept note in March 2010 to Board Approval in May 2010. The speed and low cost of the loan was based on previous Bank work and substantial discussions with the Government prior to the loan, on major issues such as the banks’ excessive foreign borrowing and the use of the NF.

Quality-at-Entry Rating: Satisfactory

b. Quality of supervision:

The loan was a one-tranche DPL based on prior actions that were completed before loan presentation to the Board. The loan fully disbursed a short while after it was declared effective and was closed within 7 months after effectiveness. Hence issues of supervision were not applicable. The indicators in the loan provided a way of monitoring the outcomes.

Quality of Supervision Rating: Not Applicable

Overall Bank Performance Rating: Satisfactory

9. Assessment of Borrower Performance:

a. Government Performance:

The government was committed to the objectives of the DPL and had carried out the strategically important prior actions before the DPL was approved, including maintenance of macroeconomic stability. In addition to the prior actions the objectives were contained in the Government’s published 2020 Vision document. As the DPL supported prior actions, there were no implementation issues. Monitoring & Evaluation of the results of the loan was largely based on publicly available information. The Government has continued its close relationship with the Bank through the Joint Economic Research Program.

Government Performance Rating: Satisfactory

b. Implementing Agency Performance:

The Ministry of Finance was the implementing agency for the DPL. The Ministry is in close contact with the Bank; is a major partner in the Joint Economic Research Program; and has ensured coordinated availability of information regarding the results of the DPL.

Implementing Agency Performance Rating: Satisfactory

Overall Borrower Performance Rating: Satisfactory

10. M&E Design, Implementation, & Utilization:

a. M&E Design:

The PD describes the M&E framework design for the DPL. The DPL was based on prior actions and the loan framework indicators are almost wholly quantitative and publicly-available.

b. M&E Implementation:

The DPL was a one tranche operation based on prior actions and was closed 7 months after loan effectiveness. The M&E indicators were used in the ICR and form a basis for interactions with the Government under the Joint Economic Research Program and further discussion of development issues. The Bank closely monitors the DPL’s quantitative and non-quantitative indicators in a coordinated manner through its close relationship with the Ministry of Finance and through the Joint Economic Research Program.

a. M&E Utilization:

The M&E results and the Bank’s close relationship with the Government have been used to support dialogue on further reforms in Kazakhstan and improve future outcomes related to the DPL, for example, better public sector auditing and the recently passed law on State-owned Property.

M&E Quality Rating: Modest

11. Other Issues:

a. Safeguards:
IEG is not aware of any Safeguard issues related to the DPL

b. Fiduciary Compliance:
IEG is not aware of any issues related to Fiduciary Compliance in the DPL.

c. Unintended Impacts (positive or negative):
IEG is not aware of any unintended impacts of the DPL

d. Other:
None.



12. Ratings:

ICR
IEG Review
Reason for Disagreement/Comments
Outcome:
Moderately Satisfactory
Moderately Satisfactory
 
Risk to Development Outcome:
Moderate
Moderate
 
Bank Performance:
Satisfactory
Satisfactory
 
Borrower Performance:
Satisfactory
Satisfactory
 
Quality of ICR:
 
Satisfactory
 
NOTES:
- When insufficient information is provided by the Bank for IEG to arrive at a clear rating, IEG will downgrade the relevant ratings as warranted beginning July 1, 2006.
- The "Reason for Disagreement/Comments" column could cross-reference other sections of the ICR Review, as appropriate.

13. Lessons:

Experience with the DPL suggests that a single tranche DPL can yield significant benefits, in the context of a quick response to a crisis and obvious short-term issues, as the ICR states. Such benefits will depend on the government and the Bank having a sound, long-term relationship and the government’s willingness to undertake significant actions. The DPL also illustrates that support of the Bank can be helpful in international markets and address domestic political concerns as noted in the ICR.

At the same time, the experience with the DPL suggests it is less appropriate to deal with longer-term policies and the associated changes in behavior that are needed to make them effective. Programmatic DPLs may help, but they make take too long to prepare and reach agreement with the Government, relative to the demands imposed by a crisis.


14. Assessment Recommended?

No

15. Comments on Quality of ICR:

The ICR provided a clear and frank analysis of the causes of the crisis in Kazakhstan, the rationale for the DPL and its prior actions, the DPL’s results and ongoing developments in the country, following the closure of the loan 7 months after Board Approval. In particular, the ICR noted the substantial benefit from the settlement that was achieved with foreign creditors of the two problem banks.

The ICR’s section on the lessons of the DPL was good. It pointed out how a DPL could support the government internally to take strong actions, notably limiting annual disbursements from the NF, and in external credit markets, by showing the Bank’s support for the government’s program. The ICR’s Risk section was also good, pointing out the risks of not continuing fiscal discipline and reform, even in the context of rising world petroleum prices. In the Risk section, more emphasis would have been desirable on the need for further strengthening of the banks that was expressed earlier in the ICR, as well as the continuation of fiscal discipline and reforms.

a. Quality of ICR Rating: Satisfactory

(ICRR-Rev6DPL-Jun-2011)
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