Currency Forecast - KZT: Improving Fundamentals Drive Further Appreciation - JULY 2017

BMI View: After a strong performance in Q117 the Kazakh tenge will stabilise against the US dollar in the short term. Over the longer term, rising global oil prices and domestic energy production, the central bank's commitment to inflation targeting, and tenge outperformance versus the Russian rouble will support further appreciation over the next two years.

Spot 2017 2018 2019
Last Updated: April 28. Source: Bloomberg, National Bank of Kazakhstan, BMI
KZT/USD, ave 314.33 315.00 307.50 305.00
KZT/EUR, ave 343.98 324.45 313.65 305.00
National Bank Of Kazakhstan Policy Rate, eop (%) 11.00 10.00 9.00 8.50

Short-Term Outlook (three-to-six-months)

Following significant upward pressure on the Kazakh tenge (KZT) since the end of 2016, we expect the currency to stabilise over the coming months. Recent appreciatory pressures primarily emanated from the resumption of oil production at the Kashagan oil field ( see 'Kashagan Output To Ramp Up Gradually', September 13 2016) and higher global oil prices. Boosted by these two factors, the currency broke an important level of resistance at KZT326.0/USD in late January, and has since then formed a base around KZT310.0/USD ( see chart below).

Looking ahead, our Oil and Gas team forecasts additional gains in oil prices by end-2017, but price movements in KZT and Brent have actually been inversely correlated in recent weeks. While we do not expect the inverse correlation to last and believe oil prices will remain an important determinant of the tenge's trajectory over the long term, in the short term we do not believe further gains in Brent crude prices will drive the tenge significantly higher and anticipate that the unit to trade within a range of KZT316.0/USD - KZT310.0/USD.

KZT Finding A Short-Term Trading Range
KZT/USD Exchange Rate, Daily (LHS) & Monthly (RHS)
Source: Bloomberg, BMI

However, a break below KZT310.0/USD could imply further upside potential, as there is no clear resistance level remaining between the spot rate and KZT195.0/USD, the value of the currency before the National Bank of Kazakhstan (NBK) removed the peg to USD in mid-2015.

Long-Term Outlook (six-to-24-months)

Looking beyond the coming six months, a variety of factors underpin our view that the tenge will remain on an appreciatory trajectory. We forecast KZT to appreciate from an average of KZT341.9/USD in 2016 to KZT315.0/USD and KZT307.5/USD in 2017 and 2018, respectively, which places us significantly stronger than consensus projections. Rebounding real GDP growth will be primarily driven by higher global oil prices and increased energy production boosting exports, and accelerating fixed investment growth in the oil and non-oil sectors ( see 'Broad - Based Recovery Ahead', April 21).

According to our Oil & Gas team, global oil prices and Kazakh hydrocarbon production will increase by 33.0% and 9.2% over the next two years, which will support export growth and foreign investment in the Kazakh oil sector. That being said, we also expect non-oil export growth to pick up pace, as Kazakhstan's biggest non-oil export market Russia emerges from a two-year recession. Additionally, we anticipate an uptick in mining and infrastructure investment, both of which will be fuelled by China's ambitious 'Belt & Road' initiative. Taken together, the uptick in exports and foreign direct investment (FDI) will support foreign demand for the KZT, which will exert upward pressures on the currency over the next two years.

Correlation Has Weakened Recently
Kazakhstan - KZT/USD Exchange Rate & Brent Crude Oil
Source: Bloomberg, BMI

Moreover, we anticipate that Kazakh monetary policy will bolster KZT over the next two years. After the NBK dropped its KZT peg and switched to inflation targeting, domestic confidence in KZT has improved, reflected in a rising share of domestic deposits held in tenge. Amid the NBK's new-found commitment to inflation targeting, we expect de-dollarisation to continue over the longer term, which will provide additional support for the tenge. Although we expect the NBK to progressively cut its policy rate from at current rate of 10.0% to 8.5% by end-2019, steady disinflation will keep real interest rates relatively high, offering further support.

KZT To Outperform RUB
RUB/KZT Exchange Rate, Weekly
Source: Bloomberg, BMI

Finally, from a valuation perspective, Kazakhstan's real and nominal effective exchange rate indices remain well below their long-term averages, suggesting scope for additional long-term appreciation. Although higher inflation in Kazakhstan relative to major trading partners such as China and Russia will play a role in driving the REER higher, inflation differentials are forecasted to narrow significantly from 2016-2019 and nominal appreciation can be a significant driver in our view, particularly against RUB.

With KZT now at its weakest against RUB since June 2014 in spot terms ( see chart above), we believe KZT is poised for period of outperformance, the latter of which we forecast to see modest depreciation versus USD over the coming years. In contrast to KZT, the RUB's REER has recovered to levels last seen since oil was over USD100 per barrel/bbl, and the government in Moscow is becoming increasingly uncomfortable with RUB strength. KZT outperformance versus RUB will furthermore be supported by a healthier growth outlook.

Risk To Outlook

Notwithstanding our core view of long-term KZT appreciation, downside risks to this forecast remain in the KZT's oil price dependency and potential political instability. To begin with, possible increases in US shale production and/or a breakdown of the OPEC production cut agreement pose a risk to our view of the global oil price recovery ( see 'Brent Supply Side-Pressures To Dampen Recovery', February 8). Under such a scenario, global oil prices could fall back to the low price levels recorded in 2014, which would conversely weigh on the growth prospects of Kazakhstan's hydrocarbon-dependent economy and thus dampen demand for tenge-denominated assets.

Additionally, uncertainty surrounding the eventual leadership transition could further weigh on KZT value. While our core view remains that the country will see a managed power transition in a post-Nazarbayev era ( see 'Long-Term Political Outlook - Post Nazarbayev Era: Managed Transition The Most Likely Scenario', August 3 2016), a potential power struggle, and/or greater public calls for political liberalisation in the event of Nazarbayev's passing cannot be ruled out. Such a case, could in our view, disincentivise FDI in the country and thus provide headwind to the tenge's long-term appreciatory trajectory.