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While Kazakhstan has long been on the radar of Western decision-makers, it evidently took a character called Borat to attract the attention of a broader public to the largest country in Central Asia.

Kazakhstan’s large neighbour, Russia, has considered this country a serious partner for years on account of its energy resources, even though relations between the two have not always been that cordial: at the end of the 19th century the Russian Empire annexed its smaller neighbour to the south and wasted no time in declaring the grasslands of the nomadic population to be state property, paying no regard to the nomads’ centuries-old traditions. Starvation and the emigration of around three million people following the forced collectivisation of agriculture under Stalin created room in a tragic way for entire nations to be banished to the Kazakh steppes in later times. Concurrently, during World War II much of the Soviet Union’s heavy industry was relocated to the east of the Ural Mountains. Kazakhstan was already known as a raw materials supplier during the Soviet era.

Today, the country is home not only to over 3.3% of the world’s oil and 1.7% of its natural gas reserves. The fact that it has nearly the same amounts of oil and gas in deposits that cannot be tapped yet for technical reasons or for reasons of commercial viability bears witness to the huge potential of the Kazakh energy sector. Rising oil prices have also shifted the overall economy of the former Soviet Republic into high gear: besides export income, the steady inflow of petrodollars is now boosting investment and consumption too. This has enabled Kazakhstan to post GDP growth of roughly 10% every year since 2000. At the same time, the constant uptrend is treating the finance minister to what Germans would consider utopian budget surpluses that are helping to keep public debt at less than 10% of GDP. For years now, foreign investors have also been seeking to participate in the booming economy in the land of the steppes. By the end of 2006 they had poured in USD 32.5 billion in direct investments; in terms of FDI per capita Kazakhstan has assumed a leading position in the Commonwealth of Independent States (CIS).

However, the boom has its price.

The cost of success

The influx of capital is driving up inflation and exerting upside pressure on the Kazakh currency. Since 2002, prices have climbed relentlessly and gradually fuelled inflation rates approaching the double digits. The Kazakh currency, the tenge, has appreciated 20% vis-à-vis the US dollar over the past five years. "Dutch disease" has long become a familiar story in Kazakhstan – increasing price levels alongside the appreciating tenge are jeopardising the competitiveness of the economy and placing heavy demands on the central bank’s ability to steer monetary policy. Last year, undeterred by all the signs of a strengthening currency the central bank drove down the value of the tenge for several months through forex interventions in order to curb disproportionately strong inflows of speculative capital.

A second side-effect of the economic upswing has further serious drawbacks: An increasing number of Kazakhs are borrowing money to finance consumption and construction projects; in 2006, lending to the private sector was up by about 80% on the year-earlier figure. This has raised the vulnerability of the banking system, a fact regarded by the International Monetary Fund as one of the biggest risks threatening the stability of the Kazakh economy. At the same time, the robust demand for real estate is being exacerbated by the increase in borrowing, raising the spectre of a price bubble. To be able to finance the credit growth the banks have boosted their foreign debt exposure. This has made their refinancing largely dependent on the state of the international financial markets.

Aware of these risks, the central bank has already stepped on the brake: more stringent rules for the banks’ foreign-denominated debts are meant to temper their appetite for foreign capital. Other measures aim concurrently to prevent the private sector from amassing excessive debt. The central bank’s handling of the situation underscores Kazakhstan’s leading role in the CIS in the fields of financial supervision and banking regulation.

The local capital market still has catch-up potential since it has failed so far to keep pace with the rapid growth of the banking sector: it is hoped that the Regional Financial Center currently under development in Almaty will help get the market off the ground. The Center has the ambitious target of promoting the non-bank financial sector and whetting the appetite of foreign investors, for instance by offering simplified visa conditions and tax incentives. Existing problems with transparency are also gradually being eliminated, one example being the launch of the KazPrime-Index in March 2007. Much like the Euribor in Frankfurt and the MosPrime in Moscow it reflects interest rates in the local interbank market and thus helps to raise transparency in the pricing of bonds and mortgage loans.

All in all, the Kazakh government’s prudent fiscal policy deserves praise: a stabilisation fund was set up in 2001 to absorb a share of the profits from energy exports so future generations can benefit from them as well. This fund was instrumental in amassing total assets of over USD 14 billion, or 18% of GDP, by the end of 2006. Account is also being taken of the demographic development: back in 1998, Kazakhstan was one of the first countries in the post-Soviet world to start adjusting its pension system for the ageing of society that has been predicted for the decades ahead. With nearly ten years having passed since then, Kazakhstan’s record is quite impressive – to date, savings totalling 8% of GDP have been channelled into private pension funds. Furthermore, various government programmes are in progress to help develop the infrastructure, promote new industries and push ahead with privatisation with the aim of gradually diversifying the economy and lowering its dependence on the energy sector.

Unfortunately, the reform activity has not been entirely positive in all areas. Even though the World Bank says that the quality of governance has improved slightly since 2002, its progress has slowed, especially in 2006. The fact that in May 2007 President Nursultan Nazarbayev had the Kazakh parliament grant him the right to stay in office for an unlimited number of terms could, theoretically, have positive implications for political stability in the country; however, the fact itself has drawn criticism from some Western observers.

Given these developments there is still some controversy internationally over Kazakhstan’s bid to chair the OSCE in 2009. If the parliamentary elections that were called two years early and held this past Saturday prove free and fair, they could no doubt open a further door to the West for the Kazakhs. However, this former transit country on the Silk Road that functioned for centuries as a link between the Orient and Occident has refrained from positioning itself clearly between East and West: while Kazakhstan’s OSCE ambitions may be viewed as a sign of its orientation towards the West, its membership of the Shanghai Cooperation Organisation and various CIS organisations sends an equally clear message.

Vice versa, at least the level of pragmatic interest is easier to recognise: investors from China, Europe and the US are participating in the Kazakh upswing by means of, for instance, direct investments in the energy sector. Lately, possibilities for private investors have also started to emerge. Investors can move into the equity market by purchasing Global Depository Receipts; these are mainly traded on the London Stock Exchange. Anyone who finds this type of individual financial investment overly risky or complicated may opt instead for the equity certificates now being offered by various banks. However, considering that the Kazakh equity market is still relatively illiquid it has to be borne in mind that in times of unfavourable market conditions it may prove difficult to find a buyer for such securities. In contrast to equities, it is much more difficult to purchase fixed-income securities: there is a very high minimum investment requirement for eurobonds and this may be a major hurdle for private investors. Smaller amounts may be invested indirectly, though, via investment funds with a focus on Eastern Europe.

This article first appeared in Borsen-Zeitung

DB Research is the think-tank of Deutsche Bank Group

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