Fixed Income - Political Instability in Kazakhstan Causes Asset Volatility

Kazakhstan has been suffering from domestic instability since January 2. Although the Kazakh government has announced several concessions in the form of new economic measures, the protests have continued. We expect increased volatility in the short term until the situation can be resolved, though we retain our long-term positive view on the country's creditworthiness.The political instability began on January 2 in Mangistayt Region, sparked by a doubling in the price of LPG at the start of the year (though it remains very low compared to other countries). On January 4, the government made several concessions: it reduced gas prices and proposed additional measures to stabilize the socio-economic situation (see below). However, the protests have continued. President Kassym-Jomart Tokayev has extended a state of emergency in the capital to January 19 and has accepted the government's resignation. First Deputy Prime Minister Alikhan Smailov has been appointed acting prime minister. Tokayev has also replaced former President Nursultan Nazarbayev on the Security Council. The announced measures to stabilize the situation include:> The introduction of price controls for liquefied gas, gasoline and diesel for 180 days;> Price controls for certain "socially significant" food products. Decisions will be made by regional governments based on the situation in the specific region;> Proceeding with the development of a personal bankruptcy law;> Considering the introduction of a moratorium on household utility tariff hikes for 180 days;> Considering rent subsidies for vulnerable categories;> The creation of a public fund financed via private and public sources to tackle health care and childcare issues.> Economic impact. The announced measures appear to tackle the protestors' initial complaints about high inflation (food and energy) and low incomes. We do not rule out additional social measures being announced. > Kazakhstan coped relatively well in 2020 despite the pandemic and drop in oil prices. GDP contracted by 2.6% that year, and the economy began to recover in 2H20. We expect that GDP grew 3.7% in 2021. The recovery is being supported by rising oil production and more robust external demand. > The government's expansionary fiscal policy was an important factor driving growth last year. To combat the virus and support struggling sectors of the economy, the government announced measures totaling almost KZT6 trln (9% of GDP) in 2019-20. Fiscal policy will remain expansionary this year. We project a budget deficit of 2.5% of GDP this year, despite higher oil prices and a recovery in non-oil revenues. Considering the current political uncertainty and the government's pledges to provide additional social support, we expect a further increase in budget spending this year, as well as a delay to fiscal tightening (including the introduction of a fiscal rule).> We close our recommendation to buy the Kazakhstan 45 until the uncertainty is resolved. The likelihood of an increase in the geopolitical risk premium has risen. In periods of domestic instability, the geopolitical risk premium for regional peers has climbed to 100 bps, while we expect Kazakhstan's to rise to 70-80 bps. The market has already significantly repriced part of that risk today, as the bond has slipped 6 pp to 137% (YTM 4.05%), and its spread over regional benchmark Russia has risen to 40 bps from 15 bps at the beginning of the year. We expect the bond to remain weak until the uncertainty is resolved, though we do not change our long-term positive outlook on the country's creditworthiness. > Local FX/rates outlook. The tenge's reaction has been mild so far, with USD/KZT up 0.4% YTD to 436.4. By contrast, over the past two days, the ruble has tumbled 2% to almost 76. There is no clear reason for this, and it is likely to be a combination of factors: illiquid trading amid the holidays, dollar appreciation against EM FX due to rising UST yields on expectations of more Fed hikes, and last but not least the unrest in Kazakhstan. As we noted in our latest edition of Kazakhstan Local Rates, local retail demand for hard currency was elevated in November and early December. With domestic political uncertainty in place, it is likely to become even more pronounced in January. Hence, we believe the tenge should at least catch up with the ruble weakening over the short term, even assuming that the NBK steps in with FX interventions. We see the tenge likely moving into a 445-450 range in the coming days. As easier fiscal policy now looks more likely on a medium-term horizon, we also revise our year-end target for the tenge from 415 to 435 (the level it was trading at the end of 2021). As for the Finance Ministry's local bonds, we also expect to see some pressure - the yield curve will likely climb to the 12% area (primary market yields were in the 10.5-11.0% range in November and early December).