CIC Occasional Paper No. 2 - Banking on success: Kazakhstan set to become new ‘growth hub’

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Introduction

Kazakhstan, once an economic backwater, is set to become one of Asia’s new ‘growth hubs’, with strengthening economic links to the world’s major economic players. This is the conclusion of a CIC survey of research findings from the International Monetary Fund, EBRD, the Asian Development Bank and others sources.

The country’s economic growth, already outpacing Europe’s by more than five percentage points per year over the last five years, is set to continue growing at the same rate in the foreseeable future. This process will transform economic opportunities and produce a steady if necessarily uneven improvement in living standards. The CIC survey also concludes that economic performance is likely to be accompanied by population growth and increasing integration into the world economy; these developments are likely to provide further stimuli to competitiveness, growth and the diversification of the Kazakh economy. Such processes will be likely to entail transitional costs, but these are likely to be offset by corresponding benefits.

Since Independence in 1991, Kazakhstan’s progress has been dependent on dramatic increases in oil production and the development of the country’s energy resources. Since 1996, oil exports have increased five-fold. However, as the experience of other oil-rich states has shown, the possession of great mineral wealth is not in itself sufficient for sustained economic progress. The rapid growth of the country’s economy following Independence – running at 10 per cent a year over the last four years - points to the importance of other key factors; in our view these will continue to exercise a benign influence on the country’s economic development. A brief summary of these is set out below, followed by an examination of two factors that are helping to shape the country’s economic and political future and have not received the attention they deserve: the changing pattern of Kazakhstan’s external trade, and the significance of Kazakh banking reforms from which we believe other CIS and lesser developed countries have much to learn.



Growth factors

Factors contributing to growth include:

· High levels of inward investment running at four times the regional average in per capita terms, and eight times that of other CIS oil producers, such as Russia and Uzbekistan1;

· The development of a banking system approaching Western standards; as recent studies have shown, this is by far the most important financial sector in all transition economies;

· Ongoing structural reforms including privatisations of eight per cent of state-owned assets, the most recent of which has been land;

· Sound monetary and macro-economic policy, to which Horst Koehler, Managing Director of the IMF, paid tribute at a conference to mark the tenth anniversary of the tenge on 14th November 2003;

· The creation of a stabilisation fund modelled on the Norwegian Petroleum Fund – The National Fund - amounting to US$ 2.3 billion as of June 2003, set up with the aim of protecting the Kazakh economy from the impact of fluctuations in the oil price;

· Political stability – the sine qua non of economic progress in a region where stability cannot be taken for granted;

· An educated work force, with near 100 per cent literacy and an education system that does not discriminate on the grounds of gender, religion or race.


Future economic development is likely to be influenced by a number of additional factors:


· Continuing increases in oil exports, as high-quality crude comes on stream from Kashagan on the northern shore of the Caspian - the second largest oilfield in the world - and the construction of a complex network of pipelines stimulating the diversification of export markets;

· Further exploration of the North Caspian region for oil reserves possibly as extensive as those at Kashagan;

· The entry of Kazakhstan into the WTO, which will require a further round of trade liberalisation, including lowering of external tariffs (currently averaging 7.9 per cent) and the removal of non-tariff barriers;

· Economic diversification, with the ultimate goal of moving from extraction-based industries to a service and technology-based economy, in accordance with the three-stage Innovative Industrial Development Strategy (2003-2015) published by the Kazakhstan government in October 2003;

· Greater transparency in contractual relations with Western companies and greater understanding of multi-national firms whose needs and concerns are now better catered for by policymakers;

· Improvements to Kazakhstan’s road, rail and air transport infrastructure;

· An population that is expanding as the result of an increase in the birth-rate, improving standards of health, and Kazakhstan’s economic success, which draws population from neighbouring CIS countries and the return, mostly from Russia, of those who left in the 1990s;

· Aid programmes to tackle rural poverty and improve water supplies, such as the US$190 million package of measures announced by the Asian Development Bank in October 2003, and the US$164 million loan agreement with EBRD in December 2003 to improve roads and promote small business.



Trade relations

Trade is the primary means by which poor states may become rich ones and, to cite a recent IMF report, the growth of trade in Kazakhstan has been “remarkable.” Total exports of goods and services grew 14 per cent per annum during 1996-2002, while imports grew at 11 per cent. In 2002, exports of goods and services reached 48 per cent as a share of GDP, up from 33 per cent in 1996. Most of the trade expansion has occurred since 1998, accompanied by a rapid growth of GDP.

Inevitably, oil accounts for an increasing proportion of exports, with the total value of oil exports growing by 27 per cent per annum during 1996-2002, and exceeding non-oil exports for the first time in 2002. But, as IMF figures demonstrate, the non-oil economy has also grown strongly, at about 8 per cent on average between 2000 and 2002, with non-oil exports accelerating after 1998 and achieving an annual growth of 5 per cent. In 2002 they grew by 9 per cent. These gains - which suggest that the Government’s policy of promoting economic diversification is beginning to pay off - have been closely followed by rising wage levels which were up 10 per cent in 2002 and by growth in employment with unemployment falling to 9.25 per cent during the year after sharp increases in the late 1990s.6

However, the most noticeable feature of recent Kazakhstan economic development has been a change in its pattern of trade. In 1998, CIS countries still accounted for nearly 40 per cent of Kazakhstan’s total exports. By 2002, this share had almost halved. Although Russia (16 per cent) remains the country’s principal export destination, China (9 per cent) is chief among its non-CIS trading partners, ahead of Germany (8.8 per cent) and Italy (5.5 per cent). Kazakhstan’s imports are 37.1 per cent from Russia, 9.3 per cent from the US, 9.3 per cent from China and 9.1 per cent from Germany.

The changing pattern of Kazakhstan’s trade suggests that although the country remains formally committed to the goal of regional economic integration, this is a goal that is likely to be increasingly difficult to achieve. Wide divergences between the economic performance of CIS states, and particularly between Kazakhstan and its poorer and less well-developed neighbours, suggest that integration will remain a purely rhetorical objective. According to a perceptive article by Bruce Pannier posted on Eurasia Net on 26th December 2003, last year was the first since 1991 that there have been no bilateral meetings between any of the Central Asian presidents outside of a larger forum, such as the Shanghai Cooperation Organisation or the annual CIS summit, both held at the end of May. As Pannier points out, such meetings may have been largely symbolic, but until very recently they were regular features of life in Central Asia.

The importance of Kazakhstan’s links to its neighbours, Russia apart, is likely to diminish further with Kazakhstan’s entry to the WTO - on which negotiations have been taking place since 29th January 1996 - and the country’s wider integration into the world economy.

For Kazakhstan, the important economic partnerships are with Russia, China and the US, which is why President Nazarbayev has been active in putting good relations with the leaders of all three at the forefront of his agenda. While trade with the US is at more modest levels than with Russia, the US is by far the biggest investor in the country, accounting for US$10 billion since Independence. Moreover, the US has sought to use its economic ties and political and economic pre-eminence to promote a free market economy and civil society; notably by linking support for Kazakhstan’s political ambitions – for example its aim to chair the OCSE in 2009 - to continuing reform in the political and economic sphere.

In seeking to influence political and economic developments, the US is a dynamic influence in Kazakhstan and throughout the region, while in terms of trade, Russia remains the country’s most important partner as well as a major collaborator in the development and marketing of energy. The increasingly close economic ties between Kazakhstan and China reflect the latter’s dynamic economic growth as well as its deep concerns about the security of its oil supplies and its expressed preference for supply by land.

External trade tariffs now average around eight per cent. Were these to be reduced further following WTO entry, the trends described above would be further accentuated. The lowering of tariffs could also be expected to provide a spur to domestic competition. Several studies have demonstrated the link between greater openness and both economic growth and the reduction of poverty, although transitional costs might cause a temporary increase in the country’s presently falling unemployment rate. In this situation, the importance of regional economic ties is likely only to diminish as the country emerges fully as a global economic player.



Banking Reforms

Growing international interest in Kazakhstan is due almost exclusively to the development of its oil resources and its potential as a major player in the oil markets of the 21st century. The part played by its banking and financial sector in a remarkable record of sustained economic growth is relatively little known, but it is one that provides important lessons for other CIS and less developed countries.

As is made clear in an article in the December 2003 edition of the IMF publication, Finance and Development, the emergence of an efficient banking sector is vital to the process of economic development. Its authors state: “The banking sector is the most important financial sector in all transition economies. In most of them several elements of financial development are missing – namely, non-bank intermediaries and capital markets.”

The authors point to the record of the so-called CIS-7: Armenia, Azerbaijan, Georgia, the Kyrgyz Republic, Moldova, Tajikistan and Uzbekistan, all of which remain desperately poor. They ask: “Why are these countries lagging behind other transition economies? The root of the problem lies in weaknesses in their institutional infrastructure, which hamper their ability to intermediate savings between lenders and borrowers.”

In their view, “a deepening divide” has opened between transition economies where economic development has taken off – such as Kazakhstan - and those caught in ‘a vicious cycle of institutional backwardness and macroeconomic instability’- such as the CIS-7.

They conclude that the transition economies quickest to remove the impediments to banking development achieved the most rapid growth. Common barriers to growth include slowness in closing failed or unviable banks, poor financial sector supervision, weak accounting and auditing standards, inadequate governance in the sector and state ownership.

Kazakhstan moved swiftly to remove all such impediments – and unlike the transition countries of Central and Eastern Europe, which were obliged to carry out banking reform as a condition of EU membership, did it alone.

Although the number of banks has been drastically reduced – from more than 200 to around 35 - the sector has expanded exponentially. Financial services, which accounted for a negligible proportion of GDP at Independence, now account for approximately five per cent of national wealth. While the Kazakh energy sector is currently showing 15 per cent annual growth, the banking sector – the most modern and dynamic in the CIS - is showing 50 per cent annual growth.

While bank consolidation continues the three largest banks – Kazkommerts-bank (KKB), Bank Turan-Alem and Halyk Savings Bank - account for around 60 per cent of total banks assets. These provide facilities almost identical to those provided by Western banks – a welcome experience for Western businessmen who have met frustrations and bureaucratic delay in banks elsewhere in Central Asia.

Banking reform has led to regular upgrades in the country’s credit rating –Kazakhstan was first CIS country to obtain a S&P rating - which, in turn, has been a crucial factor in determining investor confidence. Announcing an upgrade to its rating in June 2003, a spokesman for S&P explained:

“The upgrade reflects the sustained strengthening of the Republic’s economic prospects, as well as prudent policies keeping the government’s deficit at low levels. Moreover, fiscal prudence is underpinned by the accumulation of oil and tax windfalls in the National Fund which will smooth impact of oil volatility.”

Thus, improvement to the banking sector has not only facilitated domestic trade and - along with new laws on banking confidentiality - discouraged capital flight, it has also proved a key factor in influencing the investment decisions of major oil companies and international consortia.

The issue of investor confidence helps explain the huge disparities between Kazakhstan and the other CIS states in the levels of foreign direct investment, and the still larger disparity between levels of FDI in Central, East European and Baltic states and the CIS. Many CIS states have rich mineral deposits, and several have substantial energy reserves. These include Russia, Azerbaijan, Uzbekistan and Turkmenistan; but the levels of FDI received by each in per capita terms is a small fraction of that received by Kazakhstan, and a still tinier fraction of that flowing to the states of Eastern and Central Europe and the Baltic.

Although the authors of the article quoted above do not make the connection, it is clear that a major difference between those states enjoying a high level of foreign investment and those - like Russia - that do not, lies in the efficiency and reliability of their banking sectors. The early decision of Kazakhstan’s political leadership to place bank reform high on the political agenda and to keep it there has therefore yielded rich dividends.

The overall capital of Kazakhstan banks reached almost US$1.4 billion with total assets of $10.5 billion, according to Grigory Marchenko, the outgoing National Bank chairman, who was named Central Banker of the Year for 2003 by Euromoney. Over the last ten years, Kazakhstan’s gold and currency reserves have grown ten times and now amount to nearly US$4.8 billion. Around a quarter of the economically active have credit cards – the highest proportion in the CIS.

On January 5th this year, Marchenko was rewarded for his contribution to the rebuilding of the country’s financial institutions by being appointed first deputy prime minister in charge of the financial sector. His appointment coincides with the restructuring of the National Bank, which will relinquish its regulatory function to a separate institution, and is likely to bolster Western confidence that the reform of the financial sector will continue.

The confidence of Kazakh citizens in the country’s financial institutions is evident in the rapid development of Kazakhstan’s pension saving scheme. Nearly six million people, accounting for almost 80 per cent of the country’s economically active population, now participate in the scheme - a fifty per cent increase since 1st January 2002. The extraordinary growth of the fund, amounting to US$2.3 billion (or 8 per cent of GDP), represents a major advance in the fight to reduce poverty, and to avoid the acute economic difficulties faced by Western European countries, such as Germany and Italy, which have un-funded pension liabilities. The growth of pension assets has provided an increasingly significant source of investment: 32 per cent are invested in securities of domestic companies and bank deposits.

A rather more controversial indicator of the public’s confidence in the country’s financial institutions was provided by its response to a capital amnesty in 2001, which enabled money illegally moved out of Kazakhstan to be returned without incurring punishment or tax penalties. This brought more than US$500 million of bank deposits back to Kazakhstan, increasing money supply for 2001 by a remarkable 40 per cent.

There is therefore good reason to think that the IMF was underestimating matters when it stated: “There are clear signs of growing trust in banks in Kazakhstan. Financial soundness indicators have improved, with adequate capitalisation, liquidity and profitability in place.”

When the first representatives of Western oil companies arrived in Kazakhstan following Independence, there were no banks or recognisable financial institutions. Today, in addition to a modern banking system, the institutions include the Kazakhstan Stock Exchange, the Centre for Inter-Bank Settlements, the Central Depository, the Banknote Factory, the Mint, and the Centre for Cash Operations and Valuable Storage – all created since the country ceased to be a member of the Soviet Union. The recent history of Kazakhstan demonstrates their crucial role in the development of transition economies.




© Caspian Information Centre, London, February 2004