What's Wrong with Inflation?

What's Wrong with Inflation?

If you pull a blanket in opposite directions, you will most likely stay where you are, or inch toward whoever is stronger. The same thing happens in the economy. Any macroeconomist will tell you that inflation cannot be beaten without reducing consumer demand, and that the economy will slow as a result. Our situation is paradoxical, and all the international financial institutions, local economists and others have said as much: we cannot defeat inflation because we cannot suppress consumer demand, which is being fuelled by growing government spending and uncontrolled consumer lending (which must also include car loans and mortgages).

Inflation is bad because it widens the gap between people's incomes: the poor become even poorer, and the rich even richer. The reason is that inflation increases the nominal growth of company revenues, which in turn raises the incomes of business owners and top managers. Wage increases, meanwhile, do not happen automatically, and pay rises generally lag behind prices, especially in the public sector, where the decision-making mechanism is far more complicated than in the private sector. So average real incomes may appear to rise, but in periods of inflation the growth typically accrues to the wealthy, while the incomes of the poor decline.

High inflation also prevents sustainable economic growth, because inflation is always followed by devaluation and higher interest rates. Borrowed capital becomes unaffordable. The government tries to keep lending going at non-market rates, which means inflation keeps rising.

We are seeing this in 2025, and we must admit that without a comprehensive plan to fight inflation from the Government and the National Bank, the actions of the National Bank alone will not be enough to fully suppress inflation in the country.

Let's look at which factors are affecting inflation, and will continue to do so in the near future, and what must be done to reduce their impact:

Growth in government spending, including state lending programs. Here we can see that the state is already taking certain steps, but they are very, very small and cannot change the situation radically. For instance, interest rate subsidies have finally been abandoned, but a large volume of liquidity has been offered at a reduced rate of 12.6%. On the whole, this is a big step in the fight against non-market rates, but it must be understood that a large number of state cheap-lending programs still remain in agriculture, mortgage lending and car lending. The volume of cheap state lending needs to be cut back more actively.

Consumer lending. The ARDFM is trying in various ways to restrict consumer lending, but in practice we see little success, because the main driver of consumer and car lending is installment programs. These affect not only demand, but also prices, since the interest is built straight into the price of the goods. Everything from trips to cafés to apartments and cars is now sold on installment, and most people, unfortunately, cannot calculate the real cost of what they are buying. Worse still, consumers have no choice: the price with and without installments is the same, since banks often forbid cash discounts. For the seller, the priority is to make the sale, and if the product is more sensitive to credit availability than to price, the seller can easily add 10% to the price to pay that amount to the bank. For example, a seller sells 100 units of a product a month at KZT 100,000 and earns a profit of KZT 30,000 on each. In total he earns KZT 3 million a month. If he raises the price by 10%, but without credit leverage for now, he sells 70 units, but with a margin of KZT 40,000, and his total margin comes to KZT 2.8 million. That is unprofitable, but then the bank comes along and says: I will give you a 12-month installment plan, and you will pay me 12% on every item sold on credit. A 12% kickback amounts to an effective rate of 24%, and when late payments and transfers to ordinary loans are added, the effective rate rises to 40–50%. Meanwhile, the seller's sales double, and another KZT 1.8 million of margin is added to his KZT 2.8 million, so total margin rises to KZT 4.6 million, while the price rises by only 10%. Quite a business, wouldn't you agree? And this is what happens across all product groups with this kind of sensitivity. If the state regulated installment sales, at least in terms of disclosure, and gave buyers the choice to "buy at the real price, or at a higher price but on installment," this would substantially curb consumer lending, and people would start to think twice about buying on credit.

Lending to the real sector. One of the most practical ways to reduce inflation is to increase the supply of goods, works and services. In other words, lending should go not toward increasing demand, but toward creating supply. For this, second-tier banks need to be encouraged to lend specifically to the real sector of the economy. Unfortunately, regulatory arbitrage (the ban on current accounts and the restrictions on foreign-currency deposits) completely discourages second-tier banks from lending to the real sector. I have written about regulatory arbitrage many times, and unfortunately we can state that the government is unable to do anything about it, and the banks will continue to earn trillions of tenge from it, far more than any state assistance provided to banks over the last 10 years. Banks that profit from these bans and restrictions do not increase lending to the real sector, but concentrate only on higher-yielding segments such as short-term consumer lending, whereas only by expanding supply can the gap between demand and supply be narrowed. Eliminating regulatory arbitrage would significantly reduce the profitability of the banking sector, and banks, seeking to restore their returns, would begin to expand lending in unserved niches.

Unfortunately, without a comprehensive plan it is extremely difficult to beat inflation. Annual inflation this month has already exceeded 11%, and once the low-inflation months of last year drop out of the calculation (last June inflation was 0.4%), within a couple of months we will reach inflation of 12% or higher. Since the beginning of the year, inflation has held at around 1.1% per month, and in May we saw slight signs of a decline to 0.9%, but in any case, inflation this year will be around 11–12%, reflecting the effect of higher tariffs and rising prices for services. Next year we will see the effect of VAT, so in reality, under the current approach, a decline in inflation can only be expected in 2027. And that is assuming there are no other pro-inflationary factors, and provided the current inflation cycle does not turn into a spiral.