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Monday, August 18, 2008

Kazakhstan's "Sudden Stop"

I couldn't help having my attention drawn earlier this summer by the news that the European Bank for Reconstruction and Development (EBRD) had cut its 2008 growth forecasts for a number of emerging transition economies - Ukraine, Kazakhstan, and Romania to be precise. More than the cut itself - since I was already pretty much aware of the situtaion in Romania and Ukraine - what I perhaps found more significant were the reasons given. In particular the EBRD issued a warning that Kazakhstan was suffering from 'the impact of inflation and credit stagnation' and a as a result reduced expected gross domestic product growth for 2008 from an annual 8.5 to 5.1 per cent (the IMF forecast is something similar).

In Romania's case the growth forecast was cut from 6.5 to 5 per cent (this view is not shared by the Romanian government who have declared that they expect growth in 2008 to be a record 7%) citing the present 'rapid monetary tightening'. In fact the Romanian central bank has been vigorously raising interest rates to try to get a grip on inflation, which hit 9% in July. In the case of Ukraine, the growth forecast was reduced from 6 to 5.5 per cent, as the EBRD warned of the impact of inflation which has been hitting an annual rate of over 30 per cent, the highest in Europe and indeed among the highest globally at this point.

What stands out in all this are two factors, the increasing importance of inflation and growing credit restrictions. But while I cannot reasonably claim to have been that well informed about what had been happening to the Kazakhstan economy, I have been following both Ukraine and Romania quite closely. But being struck by the dramatic character of what seemed to have happened in Kazakhstan, and by how it seemed, somehow or another, to be intimately connected with the global credit crunch, I thought that perhaps this would be a good moment to remedy that long-standing deficiency on my part. So I decided to try to find out for myself what it is that had actually been happening in Kazakhstan. What follows is a summary of what I found.

Kazakhstan The Country

Kazakhstan, officially known as the Republic of Kazakhstan, could with some accuracy be described as "no mans land" since it actually lies between two worlds, straddling as it does both Central Asia and Europe. It could also be described as a form of no-mans land in another sense, since a large part of its historic population has been nomadic, and rural, and up to very recently the majority of the countries urban population have been migrants who have arrived from "elsewhere".

Ranked as the ninth largest country in the world by size, it is also the world's largest landlocked country, with a territory of some 2,727,300 km² (which is greater than the whole of Western Europe). It is bordered by Russia, Kyrgyzstan, Turkmenistan, Uzbekistan and China. On the other hand, and despite its enormous size, Kazakhstan has a comparatively small population. No one actually has an exact idea of the current size of the Kazakhstan population (not to mention the thorny issue of just how many foreign migrants live and work there), but the US Census Bureau International Database list the current population of Kazakhstan as 16.763 million, while sources drawing their data from the United Nations (like the IMF which I have relied on for the chart below) give a 2008 estimate of 15.135 million. In any event the current population level, after falling in the early 1990s as ethnic Russians left, has now stabilised, and is virtually stationary. This virtually stagnant population constitutes, as we will see, a major problem for a country with such a massive potential resource base, and such enormous economic and development potential as Kazakhstan would seem to have.

Substantial Resource Potential

Kazakhstan is the biggest energy producer in Central Asia and the country's $100 billion economy has in fact grown at an average of 10 percent a year rate since 2000 (see chart below) and in particular as the price of oil has surged. This rapid GDP growth produced a rapid increase in per capita income as well as national creditworthiness, and these in turn sparked in their wake a substantial construction boom. Indeed it was precisely the bursting of this boom in the autumn of 2007 - on the back of the seize-up in global wholesale money markets which followed August's financial turmoil in the USA - which is at the heart of Kazakhstan's current growth slowdown. Kazakhstan's economy expanded at a 'mere' 5.3 percent rate in the first quarter of 2008, half the pace in the same period a year earlier, following a dramatic curtailment in bank lending, and if Kazakhstan is still able, despite all the problems we will see below, to maintain some sort of growth momentum at this point it is undoubtedly the result of the oil and other commodity resources which the country has at its disposal, and indeed as part of its response to the crisis the country increased crude production by an annual 6.3 percent in the first four months of the year, according to official government data.

Now one of the curious features about the present slowdown in Kazakhstan, has been the fact that at the very same time as the economy started to lose velocity the central bank was struggling to curb inflation which was shooting upwards as revenue from record oil prices pushed, and a domestic construction and consumption boom had been pushing up wages (remember, there are not THAT many people in the country, and much of the population is rural and unskilled in relation to the needs of a modern technological and services economy) - and these had hit nominal year on year rates of increase of over 30% in the autumn of last year: see chart below).

So, as well as containing the property bust, the Kazakh authorities have also had to conduct an inflation fight (more details below) and thus far from lowering rates like the US Federal Reserve has been able to do, Karakhstan's central bank was forced to raise the key interest rate to 11 percent in December 2007, at a time when annual inflation was riding at almost 19 percent, the highest for the country in over eight years. The refinancing rate was then maintained at the 11% level until it was finally lowered to 10.5% at the last central bank meeting in July.

Resource Potential

The fact that Kazakhstan's industrial output growth has steadily lost momentum in 2008 as the slowdown in the building industry prompted a slump in cement and other materials production should note take our minds too far from the fact that the underlying potential in Kazakhstan is enormous. In fact industrial production rose only 3.8 percent in the January-June period when compared with a year earlier, according to the most recent data from Astana-based State Statistics Agency.

Cement production was down 26 percent year on year in January , the most in five years, as growth in the construction industry stalled, brought to a halt by the fact that the Kazakh banks, who had been struggling to borrow from abroad following the collapse of the U.S. subprime mortgage market, virtually stopped lending to homebuyers and builders.

Copper and rolled iron output declined an annual 13 percent in January while output from refineries and manufacturers decreased an annual 2.9 percent. Thus there is evidence of a very sharp shock hitting the local economy. On the other hand, since the country is resource rich and the first half of 2008 was witness to a very significant global commodities boom, there were other economic sectors to fall back on, and mining production was up 6 percent from a year earlier in the first quarter, bolstered by an increase in natural gas and coal output, which climbed 15 percent and 11 percent respectively. At the same time Kazakhstan, which is the biggest energy producer in the former Soviet Union after Russia, increased crude oil production by an annual 5.4 percent.

Apart from oil and gas Kazakhstan has a huge array of potential resource reserves just waiting to be tapped. Among these there is copper. London-listed Kazakhmys accounts for the bulk of Kazakh copper output - and this was down 17.5 percent year-on-year in January-April. Industrial output in Karaganda region, home to Kazakhmys and Arcelor Mittal mines and smelters, declined 5.5 percent year-on-year in January-April.

Kazakhmys said first-quarter output fell 9.9 percent on ``severe winter weather'' and repairs at its Balkhash smelter.Production of finished copper plates, or cathodes, from the company's ore fell to 75,500 metric tons, from 83,800 tons a year earlier. These drops in output are, in the main not directly associated with the credit crunch, but they do give an idea of the challenging environment in which the mining and extraction industries work in Kazakhstan. Realistically speaking it seems quite likely that output in these sectors will return to more normal levels during the second-half of 2008, rebounding significantly from the low point reached in the first-quarter.

On the other hand industrial output in capital Astana and commercial hub Almaty, where most construction activities are based, was down 13.2 percent and 8.6 percent, respectively, in January-April, and this activity may well take much longer to recover.

Kazakhstan has also cut its 2008 oil production forecast to 67.6 million tonnes (1.35 million barrels per day) from a previous estimate of 70 million tonnes citing maintenance works and transport bottlenecks. This means output is likely to remain roughly stationary since the country produced 67.5 million metric tons of oil and gas condensate in 2007. Kazakhstan has 3.3 percent of the world's proven oil reserves and 1.7 percent of its gas, according to BP's Statistical Review of World Energy.

Kazakhstan also has around 15 percent of world's uranium, most of which is processed at the Ulba Metallurgical Plant in Oskemen, a formerly secret city south of Siberia known in Russian as Ust Kamenogorsk. Management at the Ulba plant are currently planning to invest $850 million, 6.5 times the plant's projected annual cash flow - and offering to trade domestic mineral rights to joint-venture partners in China, Japan and Russia in return for the technology they need in a bid to make Kazakhstan the world's biggest supplier of atomic fuel for civilian nuclear reactors. If successful, Kazatomprom would consolidate the market for its 983 million pounds of recoverable uranium deposits, second in importance only to Australia's, and become less reliant on the raw ore's spot-market price by supplying higher-value products needed to fuel the next generation of reactors.

However one more time let us not forget the natural environment in which all this is situated, since Kazatomprom's East Mynkuduk mines, which are 1,180 kilometers (733 miles) west of Almaty, lie beneath a semi-desert, with camels grazing and temperatures which range from minus 30 degrees Celsius (minus 22 Fahrenheit) in winter to 60 degrees Celsius (140 degrees Fahrenheit) in summer. Kazakhstan is currently uranium ore's third-largest producer, behind Canada and Australia, both of which it plans to surpass by 2010.

On top of oil and uranium Kazakhstan also has 38 percent of the global supply of chromites, used to produce corrosion-resistant steel; 22 percent of all lead; and 16 percent of known silver reserves, according to Renaissance Capital, a Moscow-based investment bank. And on top of all that there is its bauxite, copper, iron and gold. Indeed, while it is not exactly true that Kazakhstan is home to 95% of the elements in the periodic table of elements, the statement isn't that much of an exaggeration.

But what is obvious if we look at the large swings in output which followed the financial shock of last autumn is that the institutional environment is all important here. Simply gung-ho "you've got the reources, we've got the money" investment plans won't work on their own, as we have been seeing. Kazakhstan needs the skilled labour force to leverage these resources and it needs to management and infrastructural support to make things work.

There has however, been no shortage of "ready, willing and able" funding, and foreign investment flooded the country after the discovery of the Kashagan oil field in 2000. At the time of discovery it was the largest new field unearthed in 30 years, containing 13 billion barrels of recoverable crude, according to Rome-based Eni, Italy's largest oil company, which is currently contracted to develop the Kashagan field along with Exxon Mobil and Royal Dutch Shell .

Buoyed by surging commodities prices, Kazakhstan's National Oil Fund is soaking up the government's share of the new petroleum revenue. As of November 2007, it had amassed $20.1 billion, according to central bank data.

Kazakhstan is also the world's fifth-largest wheat exporter, and even though on April 15 the government placed a temporary ban on wheat exports in an attempt to control inflation, it has made clear that it will once more allow unlimited grain exports after the ban expires in September.

Apart from manpower all these resources also need, as I have been saying, infrastructure, and Kazakhstan is keeping itself busy building roads. The Kazakh government are currently out looking for investors to build or maintain 1,000 kilometers (620 miles) of roads at a projected cost of 541 billion tenge ($4.5 billion) in exchange for operating concessions. One of the roads will connect the capital Astana with the regional mining center Karaganda to the southeast. Two more roads will run from the financial capital Almaty to Kapchagai Lake and Khorgos on the Chinese border. The government also plans to build a ring road around Almaty. The state may build a fifth road from Astana to the Borovoye forest in the north and seek an investor to maintain the road in exchange for operation concessions.

The government also plans to upgrade 2,552 kilometers of roads at a cost of 900 billion tenge to create a highway that would allow freight from Chinese manufacturers to be delivered directly to European markets. The first phase of the upgrade will cost 789.3 billion tenge and is scheduled for completion by 2013. A second phase will be finished in 2016. Kazakhstan has announced it already has agreed finance of 472 billion tenge ($3.93 billion) from banks to start the works.

The Financial Sector

Banks dominate the financial system in Kazakhstan, accounting for 80 percent of total assets. They are mostly locally and privately owned, although foreign participation has increased recently. The system is highly concentrated, with the largest five banks accounting for 78 percent of market share. Banks are very reliant on external financing, with external liabilities making up about 45 percent of the aggregate balance sheet. Easy access to external funding fueled very rapid domestic credit growth, which expanded at an annual average rate of 70 percent from end-2004 to August 2007, bringing bank credit to around 75 percent of GDP by end-2007. Lending was mainly to the household, trade, and construction sectors (the oil sector is not reliant on domestic banks for its financing).

Then came the "sudden stop" and confidence in Kazakhstan's banks plumetted, with the consequence that household deposits contracted sharply during the August–October period while nonresidents sold about $4 billion worth of tenge assets — mostly held in central bank notes — putting in the process significant downward pressure on the value of the tenge.


Kazakh inflation accelerated in July and reached an annual rate 20 percent, its highest level since March 2000. Food prices, which as in so many other places are one of the key drivers of the inflation, were up by a monthly 1.8 percent in June and by 8.1% since the end of December 2007.

The recent surge in inflation is all the more significant since inflation had been kept pretty tightly under control since the recent growth spurt started in 2000. Kazakhstan's central bank left its benchmark interest rate unchanged at 11 percent until its July meeting in a battle to keep inflation at bay following a 2% rate increase in December.

Credit Downgrades

As I have said the root of the present slowdown in Kasakhstan growth is to be found in the construction slump which followed the imposition of a credit crunch last autumn. However the origins of the country's problems go back a little further than last August. Concern about the rate of expansion in domestic credit in Kazakhstan in fact goes back to an IMF report in October 2006 which said the pace of credit growth and external borrowing in Kazakhstan was making lenders more vulnerable to external shocks such as a reduction in the availability of financing.

These warnings were not heeded, indeed quite the contrary, and when the crunch itself came the consequences were pretty severe. Basically the European wholesale money markets, which had, for a number of years, looked so favourably on each and every project which could be dreamed up in Kazakhstan suddenly slammed their doors closed, and a number of local banks, who found themselves increasingly struggling to borrow from overseas financial institutions, had little alternative but to effectively cease lending to homebuyers and builders in September 2007.

Obviously the blame here can be shared out around a number of parties. Domestic authorities who did little to restrain the property and lending boom, and international investion who only upon hearing the list of Kazakhstan's natural resources were prepared to put their money on the table without due reflection over the infrastructural and instititional problems the country was almost bound to have.

And when the stop came, it came abruptly. Kazakhstan bank sales of Eurobonds and syndicated loans, which had totaled $8.63 billion during the first eight months of 2007, suddenly plummeted to an estimated $300 million in the three months from October to December. Hence my reference in the title of this post to Kazakhstan's "sudden stop".

And the list of those who had previously been busying themselves arranging the deals for Kazakhstan's banks looks just like a who's who of international finance: New York-based Citigroup Inc., the largest U.S. bank by assets, edged out Amsterdam-based ING Groep NV, the largest Dutch lender, as the top underwriter. New York-based JPMorgan Chase & Co., the third-largest U.S. bank; Frankfurt-based Deutsche Bank AG, Germany's largest lender; and Zurich-based Credit Suisse Group, Switzerland's second-biggest, round out the top five.

Kazakhstan banks also attracted international equity investors. In November 2006, JSC Kazkommertsbank, Kazakhstan's biggest bank by assets, sold $846 million of global depositary receipts in London. JSC Halyk Savings Bank, majority owned by President Nazarbayev's daughter Dinara and her husband, followed in December with a $748 million sale. JSC Alliance Bank, the country's largest consumer lender, sold $704 million of global depositary receipts in July 2007. All three are based in Almaty, the country's financial center.

The outside money helped the country's banks grow their assets 10-fold between 2002 and 2007, to $94.7 billion as of Nov. 1 2007. It also left the banks vulnerable when investors began retrenching.

From August through October 2007, $6.8 billion in foreign currency flowed out of the country - 28 percent of the central bank's total reserves. With the country's banks largely shut off from international borrowing, the ratings agencies started to get nervous. Standard and Poor's started the ball rolling by lowering Kazakhstan' foreign currency rating in October. By November the cracks were becoming visible, with the construction industry slowing rapidly.

The evolving situation lead to an ongoing series of "reappraisals" of Kazakh bank creditworthiness on the part of the ratings agencies, with Standard and Poor's following its initial October downgrade of the country's foreign currency-denominated debt rating (by one level to BBB-) by a revision on the outlook on Kazakh banks to negative in December. Fitch Ratings also changed its outlook on Kazakhstan's long-term issuer default ratings to negative in December, and even the Kazahstan sovereign rating outlook was revised to negative by S&P in late April 2008.

Moody's Investors Service joined the act, and reduced the credit ratings of six Kazakh banks, including TuranAlem, in November because of concerns they wouldn't be able to refinance about $40 billion of international debt. Kazkommertsbank and Bank TuranAlem were cut to Ba1, one step below investment grade. Halyk was lowered to Baa3, the lowest investment grade, while TemirBank dropped to Ba2 from Ba1.

In an attempt to stop the haemorrage the government stepped in and provided lenders with almost $11 billion of emergency cash, reducing in the process central bank reserves by almost a quarter. The government has also moved to place new limits on local banks' foreign debt (they can now accumulate up to a maximum of four times their capital base - beginning July 1, 2009). This move is expected to cut dependence on borrowing from abroad, although as a result commercial lending growth may slow to 13 percent this year according to central bank estimates, possibly reaching as much as 8.22 trillion tenge ($68.4 billion) this year, compared with 7.26 trillion tenge in 2007. Lending may rise further to 9.85 trillion tenge in 2009. However - in a "worst-case-scenario" - the central bank warned that banks may post a 9.5 percent drop in commercial lending in the country this year, should access to foreign capital markets not be made available again.

At the same time the Kazakhstan government has indicated it will lend $4 billion to banks to ensure liquidity. The banks also were expected to get "about 300 billion tenge ($2.48 billion) of free money" due to a decision to reduce the size of bank reserve holdings with the central bank. The government has also said it will continue to purchase shares of Kazakh companies listed on foreign exchanges until their reach pre-August 2007 levels.

Kazakhstan banks' foreign liabilities rose 490 percent in dollar terms between 2004 and the start of 2008 - to $13.5 billion - as they used their investment-grade ratings to borrow abroad and lend to consumers and real-estate developers, according to CreditSights. This debt has now become impossibly difficult to refinance because of investor wariness about all but the highest-rated debt. Kazakhstan's central bank holds about $20 billion of reserves and the country's oil fund has about $15 billion, so if push comes to shove they should be able to ensure Kazakh banks have sufficient funds to meet their obligations.

Credit-default swaps on Kazkommertsbank surged in June to 694 basis points from an earlier 225 basis points, according to CMA DataVision. CDS contracts, which are used to speculate on a company or country's ability to repay debt, increase when perceptions of credit quality worsen. Contracts on the country's debt cost 148 basis points, compared with 34 basis points at the end of May. The current level is twice that of Russia's debt, which has similar ratings.

As indicated by the chart below, during the current crisis the increase in EMBI spread has been much higher recently for non-EU member states (except Bulgaria) than for the EU member countries. In addition, the increase in the spread is higher for countries running high inflation and balance of payments deficits, i.e. countries more vulnerable to external shocks. The largest increase in the EMBI spread from June 2007 to January 2008 was recorded for Kazakhstan and Bulgaria (140%), followed by Serbia (118%) and Ukraine (106%). Far lower increase was recorded for more developed Central European countries and EU member states - Poland (67%) and Hungary (49%).

(please click on image for better viewing)

All kinds of assets and revenue flows have been used as collateral in a desparate attempt to secure refinance for the debt, and one of the most innovative examples of this is the package that Bank TuranAlem JSC, Kazakhstan's second-largest lender, put together last October - via ABM Amro and Standard Chartered - to sell $750 million of bonds in a DPR (diversified payment rights) securitisation scheme backed by foreign currency remittances from migrants. The deal is the largest bond sale of its kind ever by a Kazakh bank. The bonds were sold in four portions. Three were guaranteed by bond insurers and carry top ratings from Moody's Investors Service and Standard & Poor's. The other bond, which isn't guaranteed, is rated Baa3 by Moody's, the lowest level of investment grade, and an equivalent BBB- by S&P.

Construction Slump

After several years of rapid rises, Kazakhstan property prices are now declining, most notably in Almaty where the prices of existing homes are reportedly down by 40 percent from their peak. This decline has partly corrected previous overvaluation, although the price adjustment may have further to go, particularly if credit availability and household incomes continue to weaken.

As well as the banks, Kazakh homebuyers also found themselves suddenly left out in the cold by the global credit shortage. In Almaty, the Kazakhstan's biggest city, about 30 people were to be seen on March 18 in protest at the hole in the ground which was to be found where their new apartments were supposed to have been. Work stopped on the project after builder AO Corporation Kuat declared it was unable to get further funding.

About 29,000 people had prepaid for apartments which were uncompleted when the September squeeze arrived, and credit for Kazakh builders suddenly dried up. More than 140 housing projects were halted in Almaty alone, forcing the government to say it was going to provide $4 billion of emergency funding to get contractors working again. Kazakh construction companies had sold 280 billion tenge ($2.32 billion) of unfinished apartments by September, including 170 billion tenge financed by mortgages, according to government statistics.

Homebuyers have been receiving some help from the government, which in March 13 agreed to provide $500 million to help banks finance loans to builders in Almaty, although many are vociferous in saying that the money has not been arriving to them as promised. The governments announced $4 billion emergency investment program also includes funds to purchase 6,000 uncompleted apartments in Astana, the capital.

Prices for residential property last year soared 30.2 percent, reaching a record average high of 161,300 tenge ($1,338) per square meter, up from 123,900 tenge in 2006, according to the Astana-based state statistics agency. In the financial capital, Almaty, the average price was 345,200 tenge.

Bank TuranAlem, Kazakhstan's second-biggest bank by assets, received $81.2 million last December from the state emergency investment program to finance the completion of construction projects. London-listed AO Kazkommertsbank, the country's biggest bank by assets, is among six lenders that receive money from the program as seven-year loans and three-year deposits.

The government bailout was announced two weeks before celebrations of Nazarbayev's 68th birthday and the 10th anniversary of Astana on July 6. A group representing people who purchased apartments in the unfinished buildings had planned a 5,000-strong protest march in Astana during official festivities.

The Industry and Trade Ministry have said that 939 residential buildings, with 45,130 apartments pre-paid by homebuyers, were under construction last January. Mamytbekov said that the cases of 4,558 homebuyers in 18 buildings "remain problematic'' because the builders have been "charged with crimes.'' The Kazakh Prosecutor General's Office said 123 construction companies that received 104 billion tenge ($865 million) in pre-payments from homebuyers are behind schedule or haven't even begun work on new apartment buildings.
Assets of "careless construction companies,'' including buildings and vehicles, have been seized to compensate lost investments of homebuyers and the government, according to the Prosecutor General's Office. Criminal investigations have been opened into eight companies. A total of 285 companies are building 407 residential projects in Kazakhstan and have received 231 billion tenge in pre-payments from more than 50,000 individuals and companies, prosecutors said.
Of 200 ``problem'' projects delayed by at least six months, 110 are located in the capital Astana and 42 in Almaty.

The Kazakh government has spent 51 billion tenge to complete stalled residential projects, a fraction of bailouts promised by Prime Minister Karim Masimov last year, according to data from the Ministry of Industry and Trade released on June 23. The government said on Nov. 14 that it would spend $1 billion by the end of 2007 and another $3 billion in 2008 to "provide economic stability and growth'' by supporting the real estate market and small and medium-sized businesses. Masimov said two weeks later that this emergency investment program could be expanded.

The government plans to spend 17.2 billion tenge to complete residential projects in Astana. President Nursultan Nazarbayev ordered the state to step in and finish the projects, ``which have no source of financing,'' to ``help to reduce social tension,'' according to Edil Mamytbekov, a deputy minister of industry and trade, on June 20. President Nursultan Nazarbayev ordered the state to step in and finish the projects, ``which have no source of financing,'' and to take ``tough measures against careless builders". Another 46.4 billion tenge will be spent to support residential projects in Almaty, the mayor's office said on July 26. The state has already invested 22.4 billion tenge and will spend the remaining 24 billion tenge by year's end, it said.

The government in April said that state development holding Kazyna would distribute 59 billion tenge to commercial banks this year to finish 131 buildings in Almaty. Sergei Kuyanov, a spokesman for Almaty Mayor Akhmetzhan Yesimov, when question by journalists declined to comment on the discrepancy between the level of funding announced in April and the city's lower figure.

The central bank (NBK) provided large-scale liquidity support to banks during August–October through repurchase agreements, foreign exchange swaps, early redemption of NBK notes, and the easing of reserve requirements. It also intervened heavily in the foreign exchange market, using $6 billion (25 percent) of its reserves (15 percent of total official foreign currency assets) during August–October, and has since effectively pegged the tenge to the U.S. dollar. NBK reserves have recovered this year, rising by $4 billion through early June. The government directed $1 billion to support ongoing construction and investment projects in November 2007 (another $3 billion is slated for this year, although only $130 million is additional spending). After initially spiking, interbank interest rates have eased.

Kazakhstan has large financial resources to help weather the current situation. Official foreign currency assets totaled $46 billion in early June, comprising NBK reserves of $21 billion and oil fund (NFRK) assets of $25 billion. Commercial banks also have foreign assets of which about $3.5 billion are thought to be liquid. Total foreign assets broadly match foreign liabilities when the intracompany debt of the oil sector is excluded, while liquid foreign currency assets comfortably cover potential short-term foreign currency drains.

Favourable Demographics But Migrants Needed, Together With Modern Citizenship Rights

The chart you will find below is known as a “heat chart”. It depicts the ongoing changes in Kazakhstan's age structure. Each dot represents the number of people in any given age group at any given point in time. A dark red dot represents the largest concentration of people, by age, in a particular year while deep blue dots show the lowest concentrations. A single dark red dot is the equivalent of almost 406,000 people while each deep blue dot represents nearly 23,000 people.

In the upper left-hand corner of the chart the bright reds and yellow areas depicts the population boom that started in the mid 1970s and lasted until the late 1990s. The remnants of that boom extend downward from left to right across the chart. The band also narrows as this population segment ages. This feature reflects a reduction in the total number involved in the population bulge – a consequence of immigration.

Many ethnic Germans and Russians, for example, left Kazakhstan during the years following the end of the Cold War. In the lower left-hand side of the chart there is a preponderance of dark blue dots, indicating a relatively small number of people over the age of 60 years. Over time these dark blue dots are replaced by light blues and greens, a pattern reflecting a gradual but steady increase in the number of elderly people.

Kazakhstan’s population has fluctuated notably over time, rising during the 1980s and then declining during the 1990s (mainly due to outward migration). A low point occurred in 2001 but population has been rising since, with the upward trend expected to continue through 2020 when total population is projected to reach an all-time high of 16.7 million – reflecting a natural increase of 1.8 million between 1980 and 2020 - before the long run impact of below replacement fertility locks-in, and the population starts to decline.

The number of potential workers (those between 15 and 64 years of age) will gradually "peak" - having increased by a total of 1.9 million over the four-decade period, while the number of those over 60 will nearly double between 1980-2020, growing by more than 1 million in absolute terms.

The Kazazh government, being aware of the country's enormous resource wealth and the need for a labour force large enough to exploit it, wants to see the population rise to around 20 million by 2015. Clearly given the fact that Kazakh fertility (1.89 tfr 2007) is already below replacement, heading downwards this target is only achievable via significant inward migration flows. Much of Kazakhstan is desolate and uninhabitable while many of the populated areas lack the physical and social infrastructure necessary to accommodate any large-scale increase in numbers. So the country needs both a positive migration policy and infrastructural development in order to be able to adequately accommodate the new population.

Kazakhstan’s location has meant that it has long been a transit point on the migration route of people back and forth between Asia and Europe. Its importance was only added to by the fact that historically it was used by Moscow as destination point to which colonists, dissidents, and other minority groups could be sent. Such groups included Volga Germans, Poles, Ukrainians, Crimean Tartars and Kalmyks.

Soviet-era policies were also designed to encourage the movement of ethnic Russians to the periphery of the Soviet Union. As a result, Russians were the largest nationality (exceeding even the Kazakh population) in 1980, making up slightly more than two-fifths of the total.

After the fall of the Soviet Union, Kazakhstan's German population emigrated en masse, lured by better economic prospects, ethnic ties to their original homeland and Berlin’s generous programmes for resettlement. More than a quarter of Kazakhstan's ethnic Russian population returned to Russia during the 1990s, and the departure of such a large number of Russians had a particularly dramatic impact owing to their concentration in key urban areas (particularly in the then capital Almaty) and in specific occupations. In Almaty and a few other cities, Russians significantly outnumbered ethnic Kazakhs; they had their own cultural life, spoke their language freely and never had to learn the local language. They also enjoyed a privileged occupational status, accounting for a disproportionate number of managers, scientists, professors, engineering-technical specialists, and other high-wage, high prestige professions.

In order for the population to grow, the Government of Kazakhstan has set targets that the population should increase from 15 million in 2005 to 20 million in 2015, including introducing programs for the migration of 4.5 million ethnic Kazakhs - so called "oralmans" - from neighbouring countries of Central Asia, Turkey, Mongolia, and China. Although 374,000 oralmans have returned to Kazakhstan in recent years, the bulk of Kazakhstan’s population growth is currently the result of illegal migration fromother countries in Central Asia.

At the present time the majority of migrant workers in Kazakhstan are Uzbeks and Kyrgyz nationals. The number of Tajik migrants working in Kazakhstan compared to Russia is small. Since the mid-1990s, Tajiks have fled their country in significant numbers and have entered Kazakhstan either as refugees or externally displaced persons. The number of Tajiks who have entered Kazakhstan in this way is estimated as around 400,000. Although Kazakhstan acceded to the UN Refugee Convention and Protocol in 1999, it has effectively continued to deny official refugee recognition to many Tajiks.

Tajik migrant workers in Kazakhstan are engaged mainly in seasonal agricultural employment. Many of them often work irregularly. According to some sources around 12,000 Tajik citizens were residing illegally in Almaty in 2006. Many Tajiks are working as traders in markets, selling agricultural products.

Large numbers of migrants from the other Central Asian countries are drawn to Kazakhstan because it is easier to move there than to Russia; xenophobia is much less rife; and the rhythm of economic development makes it very attractive in salary terms. According to official estimates, about 500,000 migrants from other Central Asian Republics work in Kazakhstan. At the CIS summit in October 2007, the Kazakh government distinguished itself by moving to have adopted a resolution on a series of legally and socially protective measures for migrants.

According to a recent study by Marlène Laruelle of the Central-Asia Caucasus institute, more than half of Kazakhstan’s Central Asian migrants are comprised of Uzbeks, while around 200,000 are Kyrgyz and around 50,000 Tajiks. The majority of migrants are concentrated in four regions: Almaty, Astana, Atyrau and southern Kazakhstan. In the first two regions, migrants are chiefly employed in the construction industry, while in Atyrau, several tens of thousands of workers (according to some sources, at least 30,000 Uzbeks) work in the oil industry. In southern Kazakhstan, predominantly Uzbek migrants are employed in the agriculture, especially in cotton fields. In Kazakhstan, a kilogram of cotton pays US$0.40 compared with only US$0.05 in Uzbekistan. As for the Kyrgyz, a large number of them work on tobacco plantations.

According to Laruelle, nearly a third of the migrantswork in the construction industry, another third in convenience services (the food service industry, small business, home repairs services), and the other third in agriculture. The highest salaries are in the construction sector (about US$200 per month), whereas those in agriculture earn a lot less (about US$80 per month). Although the overwhelming majority of migrants are male, there are now an increasing number of female migrants: in 2002, women made up only 15 percent of Uzbek migrants to Kazakhstan, but by 2004 they were nearly a quarter. Kazakhstan has had labour shortages in sectors largely staffed by women, such as agriculture, the tertiary sector of the food service industry, and domestic services.

Central Asian migrations to Kazakhstan can be divided into three categories: daily, temporary, and permanent. The first takes place notably in the border regions of southern Kazakhstan, where an increasing number of Uzbeks commute to work on the Kazakh side of the border during the day, and return home at evening. Regular border closures and administrative complications at customs often trigger tensions among villagers who have become economically dependent on being able to cross the border.

The border post at Zhybek Zholy, for instance, is crossed by more than 4,000 Uzbek migrants every day. But for the majority of migrants, leaving for Kazakhstan is temporary. The length of stays thus vary largely depending on available opportunities: mostly they last between two and eight months, with construction work being seasonal, mainly in spring and summer, and work in the fields taking place in the fall. Many hope to return to their own countries after accumulating sufficient capital to construct a house or start up a small business. However, there are a growing number of migrants who decide to stay on a permanent basis. Between 1999 and 2004, more than 130,000 Uzbeks, drawn by higher living standards (an average Uzbek salary is around US$40 dollars, compared to 250 in Kazakhstan), moved to Kazakhstan permanently.

The Kazakh authorities are fully aware of the size of the migratory phenomenon and do not wish to resist it. On several occasions, the government has even stated that its citizens are not in competition for work with migrants because the latter fill a specific social niche, as they take the poor paying jobs refused by Kazakhstani citizens. The authorities nevertheless are seeking to reduce illegal immigration and to encourage legal migration, which is better controlled both judicially and socially.

Thus, in 2006, the Minister of the Interior legalized 164,000 migrants from other CIS countries, despite having initially announced a figure of only 100,000. Out of these, nearly 120,000 were from Uzbekistan, 23,000 from Kyrgyzstan, 10,000 from Russia and nearly 5,000 from Tajikistan. Astana’s open policy on migration has also led to the naturalization of many migrants: in 2005, more than 20,000 persons were granted Kazakhstani citizenship, three-quarters of these from Uzbekistan, 10 percent from Kyrgyzstan, and 5 percent from Tajikistan.

Although migratory relations between Kazakhstan and Kyrgyzstan are good, managing migratory flows between Kazakhstan and Uzbekistan has proved more difficult. Tashkent refuses to acknowledge the scale of the phenomenon. The Uzbek state has a monopoly on the legal dispatching of workers abroad, meaning each migrant is obliged to obtain official authorization from the Uzbek Agency of Work Migration. Since 2006-2007, the Uzbek government has also sought to hive off some of the financial flows of its “Gastarbeiters”. According to a government resolution “On registration of citizens seeking employment abroad”, Uzbek labor migrants have to come back to Uzbekistan, go through registration and pay customs dues before returning to work abroad. As a result, the majority of Uzbeks leave without legal permission and thereafter are unable to seek protection from their home state. This situation promotes human trafficking and the organization of mafia networks by recruiters who go from door to door asking for volunteers to work in Kazakhstan.

Working conditions for Central Asian migrants in Kazakhstan are still very poor. Legislation dealing with immigration continues to be largely insufficient, failing to penalize abusive employers and to guarantee minimum of social rights for migrants. The Kazakh police force does not seem in any hurry to denounce companies that employ migrants illegally. So, the very size of illegal migration tends to reinforce corruption in the police, the administration, and the customs services. A massive legalization is thus in the public interest, since it would enable these populations, services and money flows to become official, and therefore controllable.

Main Risk Factors

Returning now to the economic front, the principal short term risks to Kazakhstan's slow landing are threefold: a prolonged period of tight conditions in global financial markets, a substantial drop in oil prices, and/or a domestic event that triggered a loss of confidence in the banks. All or any of these could easily cause a process which was now largely under control to become much less so.

Looking forward, growth is expected to remain relatively subdued. Assuming limited bank access to external financing and only modest deposit growth, credit within the economy is likely to decline in real terms. Nonoil GDP growth is forecast by the IMF to slow to 4.7 percent this year, from 9.2 percent in 2007, with spillovers from the oil sector partly mitigating the impact of the credit crunch. Oil output should support somewhat stronger overall growth of close to 5 percent in 2008. A strengthening in growth to 6.25 percent is projected next year assuming global financial conditions improve and pressures on bank balance sheets are reduced. The current account is even projected to move into surplus in 2008, following the large deficit last year, due to higher oil and commodity prices and much slower import growth. With banks repaying debt, the external debt/GDP ratio is projected to fall sharply this year, and appears to be on a sustainable path under a range of scenarios, while the overall government budget surplus is projected to increase to 6.75 percent of GDP in 2008 due to strong oil revenue growth.
Exchange rate stability is a central policy objective of the NBK. At present, exchange rate stability is viewed as essential for maintaining depositor confidence, limiting the risks from the large foreign currency exposure of the corporate sector, and helping reduce inflation. The central bank noted that downward pressures on the exchange rate had abated since the turn of the year, and its foreign currency reserves have been rising, in part due to the decision to delay the automatic conversion of oil fund revenues into foreign currency assets. The country’s official foreign assets (NBK reserves and NFRK assets) are now well above the level reached prior to the onset of market volatility in August 2007. Intervention in the foreign exchange market has been substantially scaled back (as a share of total transactions) in recent months, although the NBK stands ready to intervene in the market if downward pressures on the exchange rate re-emerge. The authorities continue to view the exchange rate regime as a "managed float with no predetermined path for the exchange rate."

The NFRK continues to be managed prudently, and the government does not
expect to draw on the Fund beyond the amount of the guaranteed annual transfer to the
budget. The assets of NFRK consist of a stabilization portfolio of about $5 billion (invested in short-term debt securities) and an investment portfolio (invested in longer-term debt and equity securities). While the NFRK fulfils both a stabilization and savings role, at present the government has no intention to use the Fund’s assets to help cushion the downturn. Indeed, the government spent only 86 percent of the guaranteed transfer from the NFRK last year, and expects the mandated transfer to be adequate to meet spending needs this year.

The exchange rate regime in Kazakhstan has been reclassified from a managed
float to a conventional peg under the IMF’s de facto classification system. This is due to the very limited movement of the tenge against the U.S. dollar since last October. At present, the IMF take the view that there is no clear evidence of either over or undervaluation of Kazakhstan’s real exchange rate when compared to its estimated equilibrium level.

The fiscal position in Kazakhstan is very strong, with a large budget surplus and
low public debt. External debt has been reduced from 92.8% of GDP in 2007 to an estimated 67.9% in 2008. The IMF forecast a further reduction to 59.6% in 2009.

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