Inflation as a Vicious Circle

The current inflation situation looks to me like a vicious circle that has to be broken somehow. It is obvious that a high base rate is no longer enough to stop inflation: in March 2026 (in three months) it will be exactly four years since we began living with a high base rate, which has done nothing but boost bank incomes, as I have written many times before.

On 1 January 2026 the new Tax Code comes into force. By raising the VAT rate, it will add a couple of percentage points to the inflationary background. For that reason, we will not see the base rate come down to an acceptable 9–10% per annum before 2027, and if nothing is done, not before 2028.

In August 2015 we switched to inflation targeting, and after that the tenge became freely floating. It was the right decision, but it works as intended only if every aspect of monetary policy operates in a free market, without restrictions, bans or other imbalances that can affect the tenge exchange rate. We have plenty of those.

I decided to test the hypothesis that the tenge exchange rate affects inflation in the country. In the long term, the exchange rate is always a consequence of inflation, but in the short term the exchange rate also affects inflation.

If we calculate the correlation between the monthly change in the tenge exchange rate against the US dollar and inflation, using different lags from August 2015 onward, a surprising picture emerges. A change in the exchange rate with a one-month lag gives the maximum correlation, 0.47. In statistical terms this is a moderate relationship, and the effect on inflation is roughly 22%. In other words, a 1% change in the exchange rate adds 0.22% to inflation the following month. A 5% change in the rate adds 1.1% to inflation the following month. That is exactly what we saw this summer, when the tenge weakened by almost 5%.

Looking at this year's monthly inflation figures, the highest inflation came in the first three months of the year, which is the result of two factors:

• a seasonal rise in food prices, since prices usually go up in the first three months, as has happened in all previous years;

• tariff increases at the start of the year.

Inflation has been declining since April 2025, followed by a sharp rise in August and September, which corresponds to the tenge's depreciation of 2.71% in July and 1.99% in August (4.75% over the two months).

In September and October 2025 the exchange rate stabilized and inflation slowed to 0.5% and 0.8%, respectively. December is traditionally an inflationary month, but I expect the significant strengthening of the tenge and the freeze on tariffs to curb the rate of inflation.

Eliminating the factors that weaken the tenge should therefore be one of the additional tools in the fight against inflation in the current situation.

I would single out the following factors that affect the exchange rate and need to be addressed:

Consumer lending. Besides affecting prices, since interest costs are built into them, it also strongly stimulates imports, which weigh on the tenge. Credit growth raises demand for consumer goods, and a large share of these are imported. This puts pressure on the exchange rate, which pushes up the prices of imports and, in turn, inflation. Current consumer loan rates are not very sensitive to the base rate: at 30–35% per annum, it makes little difference whether the base rate is 16% or 18%. Here the emphasis should be on disclosure requirements, financial literacy and tighter prudential standards. A good deal is in fact being done in this direction now; the main thing is that the measures already begun are carried through to their logical conclusion.

Outflow of foreign currency deposits due to rate caps. The 1% cap introduced when the Fed's rate was at zero was justified at the time. But when the Fed rate rose to 5% while our rates stayed at 1%, an arbitrage opened up. It did prompt part of the population to move their savings into tenge, but it did more harm by driving capital out of the country and giving banks windfall profits, because holders of foreign currency deposits began looking for returns in securities. When US Treasury bonds yield 4% and our banks pay 1%, it is obvious that people will move their money abroad. This led to a capital outflow, which began to affect the balance of payments and the tenge exchange rate. To partly address the windfall profits, a higher minimum reserve requirement was introduced, but it does nothing to solve the capital outflow and has created an additional imbalance in the market. It pushes second-tier banks to cut dollar deposits even further, and these will undoubtedly continue to flow abroad.

Investment spending by the public and private sectors without external funding. The state and, to a degree, the private sector spend trillions of tenge on investment programs, most of which are imported (machinery and equipment). The funding comes mainly from the Ministry of Finance's domestic borrowing, taxes and bank loans. These are mostly tenge funds, which are then converted into foreign currency and leave the country as payment for imported machinery and equipment. At a stage of economic growth, importing fixed assets is the right and necessary thing to do. From a macro perspective, however, foreign currency is being bought with domestically borrowed funds, which then affects the tenge exchange rate and, through it, inflation. This is why developed countries actively encourage foreign investment, and the fact that the Ministry of Finance has begun to attract external funding again is quite logical. Banks must also be involved, but current regulation continues to favor tenge lending. Banks will not bring foreign currency into the economy, because they cannot then deploy it further as loans within the economy. Sensible liberalization of foreign currency lending would allow an increase in foreign currency loans and encourage second-tier banks to raise foreign currency borrowings abroad, thereby supporting the balance of payments and, with it, the tenge.

So, it seems to me that in the short term, eliminating the imbalances in monetary policy would allow us to support the tenge by market methods and, accordingly, bring inflation down, which in the future would allow the base rate to be cut faster. Naturally, this does not remove the need for other measures, such as cutting government spending, saturating the domestic market with domestically produced goods, removing trade barriers within the country, sensible regulation of natural monopolies, and so on.