Michael Carter of Visor Capital -

With inflation spiking to 19%, a residential real estate bubble unwinding, banks facing a very difficult funding environment, the government increasing the tax burden on the oil and gas and mining sectors, and the negotiations with foreign oil firms over the Kashagan field showing a more assertive state, one might assume the investment climate in Kazakhstan had taken a severe negative turn. But we believe that, on the contrary, the investment climate is improving: we believe that investors have more access, more investment opportunities and better investment return potential than one year ago.

To lay out the reasons behind our optimism, we look at the positives and negatives that investors saw in looking at Kazakhstan over the past years, and our view of how these have changed in the past months. First we look at some of the positive aspects:

Strong, diversified, resource-based economy: The economy has slowed down on the back of the construction and banking sector downturns, but is still at healthy levels. In the resource sector, commodity prices have continued to rise, and production volume increases are expected for most resources in the coming years.

Openness to foreign capital: While the Government has moved to increase its influence in the resource sector, it has done so in a way that has not had a negative impact on the value for asset owners. The pre-emptive rights that the government has in the resource sector give it the right to buy at a market price, with the transactions seen to date bearing this out. We have seen the government signalling its intentions to give it pre-emptive rights in infrastructure sectors that are key to the development of the economy, which could give some investors some concerns. In other sectors, we do not see any such measures, with recent international strategic investments into the banking sector being a good example. At the shareholder level, international minority investors have been able to successfully seek legal redress in the past year.

Proximity to other regional markets: Kazakhstan is seen by many international companies as a base for their Central Asian, or Eurasian, operations. This choice is due to the good business environment. Regulation, taxation and easy capital movement are some of the major elements in these decisions. The move to Kazakhstan was, in many cases, a move away from a country with a less supportive investment climate.

Regulatory environment favourable: The EBRD and World bank evaluate the business and investment climate in many emerging economies. Looking at the Eurasian region, one sees that Kazakhstan places better than its regional peers on issues such as regulation, shareholder rights, legal rights, government effectiveness and corruption. Essentially, doing business in the region is best done from Kazakhstan.

Tax burden reasonable: Corporate taxes are currently 30%, personal taxes 10%, and VAT has just declined to 13% from 14%. The tax code is in the process of being revised, with the stated intent of raising taxation for the resource sector, and lowering it for other sectors. In the resource sector, the tax take is below that of many countries in the world, even after the recent introduction of an export duty on oil. We believe that the tax burden under the new tax code next year will continue to make investment in the resource sector attractive, when compared to other jurisdictions.

Government spending under control: The government is channelling most of the income from royalties and taxation in the resource sector into the National Fund. This is done both to sterilize the impact of this inflow of foreign exchange, and to give the country a fund to weather difficult times and times when the resource economy no longer sustains the country. This means that the Government runs a balanced budget without counting this significant income. The balanced budget also means that government net debt is minimal.

What were the negatives that people considered?

Moderately high inflation: Even before the recent spike in inflation, inflation was one of the major concerns for the economy. Inflation was averaging 7.5% in the three years prior to 2007, and spiked to 18.8% in 2007. This spike was largely driven by food prices, which affect inflation in Kazakhstan more than in many other countries. We estimate that it accounted for almost 40% of the basket last year, and even more in 2008. The government has taken a number of measures to bring food inflation under control; the slow-down in the economy may well assist these efforts.

Shortage of skilled labour: A lack of skilled labour is one element that makes import substitution challenging and expensive. The government is focusing on developing the workforce necessary to diversify the economy over the long term. This issue has not been impacted by recent events.

Low population density Low population density, and a low population in general, is an issue to some investors. It makes logistics challenging, and limits the total potential of the market. In terms of limits to the market, one should not look at Kazakhstan alone: both local and international companies look at the neighbouring countries as natural markets.

Undeveloped capital markets: Capital markets are not very developed so far. This lack of development is, in part, due to the ease with which entrepreneurs had been able to borrow all necessary funds for their ventures from the commercial banks. Commercial banks made very good spreads on this business, and had few incentives to create an efficient capital market. This ease of access to debt made entrepreneurs' assessment of the value of their business out of line with international norms. The funding issues that the banks suffered in the past year have caused many businesses to suffer from a shortage of capital, which has led them to explore the possibilities of the capital markets. Bond and equity issues are not an overnight process. We are confident that the volumes of issues going forward will be greater than one might have forecasted a year ago. Valuations are getting more sensible, making both public securities and private equity investments more attractive. Many investors bought into the strong macroeconomic story, but found it difficult to buy anything. In the future, there should be more investable assets.

Over-reliance by banking sector on foreign capital: The banking regulator was worried about the sector's over-reliance on foreign funding. International credit markets took care of the problem before regulatory measures could have their desired (perhaps softer) impact. It is likely that future growth of the banking sector will be based on more balanced funding sources, and more discriminating lending policies. The global credit crunch has been painful for Kazakh banks, but not fatal. A number are ending up in the hands of foreign banks, which may well bring greater efficiency and sounder practices to a banking sector that already has better practices than banks in the region.

In conclusion, the macroeconomic story is still very strong. The recent downturn has lowered asset valuations, and made private equity transaction and bond and equity issues more likely. This is the time to be considering investing in Kazakhstan.

Michael Carter is head of research at Visor Capital

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