EURASIA 2011: Slower rising commodity prices to determine 2011

By bne IntelliNews December 17, 2010

Clare Nuttall in Almaty -

The strong rise in commodity prices in 2010 allowed the Eurasia region's hydrocarbon-rich states to emerge from the global economic slowdown. A slight slowdown in growth is forecast for 2011.

Even though a number of crisis related issues remain - notably Kazakhstan's backlog of non-performing loans (NPLs) and relative lack of activity outside the natural resources sector - the strong performance of the hydrocarbons and mining sectors in Kazakhstan, Azerbaijan and Turkmenistan in particular resulted in stronger-than-expected growth in 2010. The catch-up effect was also a factor, contributing to positive growth across the region. Smaller economies such as Tajikistan and Armenia benefited from the revival of the Russian economy and the consequent increase in migrant remittances. The only Eurasian state not to perform well was Kyrgyzstan, where political turmoil and the continuing failure to form a government look set to result in negative growth.

Commodity prices will determine 2011's growth rates in the largest regional economies, and a slight slowdown in growth is forecast according to most estimates, since the sharp rise in prices for commodities including oil, copper and uranium is unlikely to be repeated. After a strong 2010, the "catch-up" effect has also to a large extent been used up already.

More of the same in Kazakhstan

Kazakhstan's economy will grow by 6.5% in 2010, according to Visor Capital. Forecasts for the country's GDP growth in 2011 are in the 4-5% range. Troika Dialog forecasts 5% growth in 2011, and Renaissance Capital between 4.5% and 5%. Inflation is expected to be 7-8%, according to Renaissance Capital. The tenge is expected to remain relatively stable against the dollar throughout 2011, though there may be some slight appreciation.

Essentially, 2011 will be a continuation of 2010, with strong commodity prices driving growth and a smaller catch-up effect than in 2010. But since Kazakhstan is slightly behind countries such as Russia and China - where growth is expected to slow - its 2011 expansion will keep pace with the previous year's. "GDP was up more than we expected in 2010, due to the recovery in prices for commodities including oil, gold, copper and uranium," says Jean-Christophe Lermisaux.

However, he adds that there are disparities between the natural resources sector and other sectors of the economy, in particular the banking sector, which is "still convalescing."

Milena Ivanova-Venturini, head of research, Central Asia at Renaissance Capital, says: "In 2009, many metals companies had been producing at only around half capacity. Now they are at full capacity, so there is less opportunity to increase production. Future growth will depend on commodity prices. Can we double commodity prices again? Absolutely not."

With the opening of the Central Asia-China gas pipeline and new oil pipelines linking the West Kazakhstan oilfields to China, Kazakhstan's eastern neighbour remains the primary - and increasingly important - market for its raw materials. As well as underpinning global commodities demand, China accounts for 30-40% of Kazakhstan's exports. Construction of the Western Europe-Western China highway and the planned rail link from Zhetigen near Almaty to the Chinese border will allow Kazakhstan to further increase its exports.

The strong performance of the natural resources sector in 2010 has not been matched by an expansion across the board. There are no indications that Kazakhstan will return to the kind of consumer boom seen in the run-up to the crisis. Banks have remained cautious when making loan decisions, and the backlog of unfinished real estate projects from before the crisis is only now nearing completion, helped by the government funds allocated through the anti-crisis programme. Property developers are likely to start considering the first post-crisis projects in 2011.

The situation in the banking sector is gradually returning to normal after the agreements on debt restructuring for BTA Bank, Alliance Bank and TemirBank. However, this does not mean an end to the challenges faced by the banking sector, which has lagged well behind early 2010 forecasts for a resumption of lending. In fact, loan growth is expected to decline in 2010. The total of NPLs and write-offs amounted to 38% of banks' total loan portfolios as of November 2010, according to Visor Capital. Analysts estimate it will take around another two years for the problems of non performing loans to be worked out. "We expect banks to finally restart lending next year, but loan growth is likely to be well below nominal GDP growth," says Ivanova-Venturini. "While we don't expect any more shocks in the banking sector, some banks can remain in a zombie state for a while. The bad loan problem has not gone away, and its resolution will partly depend on what the government does."

The Kazakh government is currently working with an International Monetary Fund (IMF) advisory team, and may change the rules for banks pursuing unpaid loans through the court system. Currently, banks have to pay a commission to the courts, which is non-refundable whatever the outcome of the case. The government is also believed to be considering dealing with unpaid loans on a centralised level, for example by creating a national "bad bank" as some other countries have done in the past.

As Kazakhstan leaves the crisis behind, important future developments some coming into clearer focus. As of late 2010, there were more questions than answers - the answers are expected in 2011. "2010 was a transition year for Kazakhstan; 2011 will be the year of big decisions," says Visor Capital's Lermisaux.

In July 2010, the Customs Union comprising Kazakhstan, Russia and Belarus was formally launched. Towards the end of the year, signs that the three countries planned to push ahead towards a single economic space emerged.

The launch of the first phase of Kashagan - the world's largest offshore oil and gas project - is expected on, or possibly ahead of, schedule. The expected launch date is either late 2012 or in the first half of 2013. More important than whether the first phase starts a few months earlier or later, says Lermisaux, is what is decided between the Kazakh government and the international consortiums developing the field on the second phase of the project. "The government wants to benefit more from large assets, both in increasing taxation income and in increasing the state share in Kazakhstan's big oil and gas fields. Negotiations are ongoing at the three mega fields, Kashagan, Karachaganak and Tengiz Chevron. While questions about the finalization of those negotiations remain open, this may affect the timing of investment decisions," says Lermisaux. "Investment plans for 2011-2012 have more or less been decided, but the uncertainty on long-term investments (such as Kashagan phase 2) could have an impact on midterm production. There is also uncertainty in the area of taxation - which tax rates will be set, when, and how often they will be changed in the coming years. More specifically, there are ongoing negotiations on [production sharing agreements] PSAs, the reintroduction of export duty for the majority of producers and about local contents."

Decisions on the hotly anticipated IPOs of a number of companies from within the Samruk-Kazyna state holding company are expected in early 2011. Assets that the Samruk-Kazyna has already indicated it may float include National Company KazMunaiGas, national rail operator Kazakhstan Temir Zholy and the Development Bank of Kazakhstan. So far, the government and Samruk-Kazyna have been tight-lipped about the plans. The government understood to be initially drawing up a list of companies of strategic importance to Kazakhstan, that will not be floated. A list of those that will list shares is likely to be released early in 2011. "The government has a very low level of debt. Investors are looking at quasi-sovereign companies and anything owned by the state, as these look virtually risk-free and are quite interesting yield wise," says Ivanova-Venturini.

The main purpose of the IPOs will be to raise money for capital expenditure, and only minority stakes are expected to be floated. Visor Capital estimates that to carry out all its mid-term plans, NC KazMunaiGas alone needs to raise around $10bn. This would cover building refineries, expanding Kazakhstan's network of pipelines, increasing production at existing fields, and possibly buying additional stakes in Karachaganak and other projects. "This would cover building refineries, expanding Kazakhstan's network of pipelines, increasing production at existing fields, and possibly buying additional stakes in Karachaganak and other projects. KMG's balance sheet is already stretched, though it is backed by fantastic assets. If the company wants to carry out all its plans in the next four years, it needs to decide in 2011 how it is going to fund them," says Lermisaux.

The other question is where the Samruk-Kazyna companies will be listed. The Kazakh government - urged on by the Kazakhstan Stock Exchange and the RFCA (Regional Financial Centre of Almaty) - has indicated at least part of the offerings will be on the domestic stock exchange. Analysts expect dual listings, with an offering on the KASE and in either London or the Hong Kong. Since China is the primary consumer of Kazakh raw materials, investor interest in Hong Kong is high, while London remains the international hub of emerging markets investment.

Samruk-Kazyna will be the major source of IPOs in 2011, but a handful of independent companies may also decide to list. Potash miner Santimola said in October that it is considering a $100m IPO in London in 2011. Lermisaux says it is likely several mining companies may decide to list on AIM, while companies in sectors such as agriculture and real estate, and "natural champions" in other sectors may also decide to go for an IPO.

The final question for Kazakhstan concerns the leadership succession. Kazakhstan's next presidential elections are coming up in 2012, and speculation about whether Nursultan Nazarbayev will decide to extend his two decades in power by standing for election for another term is already raging. In May, the parliament adopted a law bestowing upon Nazarbayev the status of leader of the nation - similar to that given to Ataturk in Turkey or Gandhi in India. This also gave Nazarbayev and his family immunity from prosecution. While this was a strong hint that 70-year-old Nazarbayev was planning to stand down in 2012, in September his spokesman Yermukhamet Yertsbayev claimed the president was planning to stand again. While some bona fide opposition parties are already gearing up for the 2012 elections, Nazarbayev's successor will come from within government ranks.

Mongolian attraction

Next to Kazakhstan, Mongolia attracted the most attention among the Eurasian countries. The country's rich and virtually untapped natural resources combined with its proximity to China aroused a high level of interest among investors. At a conference in September 2010, Roland Nash, then head of research at Renaissance Capital, said he expected Mongolia would be the best performing market for the next decade.

The country's largest development - the massive Oyu Tolgoi copper-gold mine - moved a step forward in December when Ivanhoe Mines and Rio Tinto agreed on a new financing plan. Rio Tinto will provide up to $1.8bn for the $6bn project, and buy out 20m Ivanhoe shares.

Eurasia Capital forecasts a wave of Mongolian IPOs on the Hong Kong stock exchanges. Mongolia Mining Corporation (MMC) held a highly successful IPO on the Hong Kong stock exchange, raising $651m through the same of 20% of its shares, valuing the company at $3.2bn. L Enebish, general director of Erdenes MGL, has announced that Erdenes Tavan Tolgoi, which holds the license for the Tavan Tolgoi coal deposit, is likely to hold an IPO in late 2011, offering an expected 30% of its shares. Since Tavan Tolgoi is at least 10 times larger than MMC's reserves, Erdenes Tavan Tolgoi is likely to become the largest listed Mongolian company.

Russia is also competing for a share of Mongolian resources, stepping up its cooperation in the uranium mining sector, and in October opened a new rail link to transport Mongolian coal. But despite the excitement over Mongolia's natural resources, alarm bells sounded for potential investors in November when the government announced it would cancel more natural resources licences.

Best of the rest

Among other Central Asian economies, Uzbekistan's economy grew by a healthy 8% in 2010, according to the IMF, thanks both to its relative isolation from the crisis and the high prices for its main exports, gas, gold and cotton.

Despite the country's obvious potential, investors still face a frustrating and difficult environment. After a brief period in 2007-08 when it seemed the Uzbek economy was opening up, things went downhill in early 2010 when several prominent businesspeople were arrested. The perennial problem of currency convertibility has not been solved, and Uzbek banks appear increasingly focused on shoring up the country's large stock of bankrupt industrial enterprises. Several investment houses which previously had a strong focus on Uzbekistan have increasingly turned elsewhere, with one former investor saying the climate this year was the worst it had ever been.

In December, however, President Islam Karimov's address to the parliament focused heavily on plans for reforms to the business environment. Karimov stressed the importance of obtaining a sovereign credit rating from international ratings agencies. It is too early, however, to say how seriously reforms will be pursued.

Kyrgyzstan was the only one of the Commonwealth of Independent States (CIS) to see its economy contract in 2010, with tourism and agriculture especially hard hit by the year of political turbulence. Mass protests across the country in early spring led to the April revolution that ousted the unpopular president Kurmanbek Bakiyev from power. The revolution was considerably more bloody that the 2005 revolution, with the deaths of over 80 people. Worse was to come: in June, a clash between Kyrgyz and Uzbek youths in Kyrgyzstan's second city Osh escalated into mass ethnic violence and spread to Jalal-Abad and other southern towns. More than 400 people - and according to unofficial estimates up to 2,000 people - were killed in four days of rioting and ethnic cleansing in the south. Some 400,000 Uzbek refugees fled across the border to Uzbekistan. Bishkek and north Kyrgyzstan have returned to normality, and the south is gradually being rebuilt, although the situation remains tense. The population has also acquired a taste for civil action, and there are fears of continuing instability.

On a more positive note, the referendum on Kyrgyzstan's new constitution - replacing the presidential model with a parliamentary democracy - and the October general election took place peacefully and was assessed by the Organisation for Security and Cooperation in Europe as largely free and fair. Less positively, more than two months after the general election, a coalition government still had not been formed. Observers expect the horse-trading to end before long and a prime minister to be selected, allowing the country to return to normal. The IMF takes a positive outlook for 2011, forecasting growth of 7%. Until the government is formed, new investment will remain on hold. This includes anticipated investments by China of up to $1bn into infrastructure projects, as well as smaller investments in the mining sector.

Although Tajikistan remains the poorest country in the CIS, growth is relatively rapid. GDP increased by 5.5% in 2010, according to the European Bank for Reconstruction and Development (EBRD), and is expected to accelerate in 2010. The recovery of migrant remittances from Russia were important contributory factors.

Tajikistan is pushing ahead with the construction of the Roghun dam, a massive hydropower project that, Dushanbe hopes, will not only solve the country's domestic energy problems, but allow it to earn much-needed revenues by increasing its exports to neighbouring countries. However, the project is strongly opposed by Uzbekistan, which lies downstream from the dam, and fears disruptions to its supplies of water from the Amu Darya river, which are needed for irrigation. Relations between the two countries worsened considerably in 2010.

Another issue Dushanbe has to deal with is the terrorist insurgency in the Rasht Valley, after a group of prisoners staged a mass breakout from a high-security prison in August. The government has launched a counter-insurgency operation in the Rasht Valley, the main stronghold of the Islamist opposition. A virtual media blackout has made it hard to track progress. There are also fears that President Imomali Rakhmon's increasing reluctance to share power with the opposition could be leading to a breakdown of the power sharing agreement that has endured since the end of the Tajik civil war in 1997. While Tajikistan is keen to attract foreign companies to develop its hydropower and mineral resources, fears of rising instability may deter investment.

Turkmenistan has been one of the "stars" of the Eurasia region. Its lack of integration with international markets has meant that, despite a dip in demand for oil and gas exports in the depths of the crisis, it has largely managed to avoid any adverse impact. According to the IMF, Turkmenistan grew by 6.1% in 2009 (down from 10.5% in 2008), making it the fastest growing economy in the CIS after Azerbaijan. It is set to pass into first place in 2010, with growth of 9.4% forecast, rising to 11.5% in 2011.

Relations between Turkmenistan and Russia have been strained since April 2009, when Gazprom abruptly stopped imports along the main pipeline between the two countries, but they had warmed somewhat by the autumn of 2010. Ashgabat is continuing to look at alternatives to Russia for its export. The biggest development which happened in late 2009 was the opening of the Central Asia-China pipeline, which will carry mainly Turkmen gas to China. In December, an agreement on the TAPI (Turkmenistan - Afghanistan-Pakistan-India) pipeline was signed between the four countries, bringing the $3.5bn project a step closer to realisation, though the constant instability in Afghanistan remains a problem. Turkmenistan also increased its gas exports to Iran with the opening of a new pipeline, and remains in discussions with EU countries over Nabucco.

Outside the oil and gas sector, construction has attracted funds from the government, which in 2010 announced plans for a $1.9bn Olympic stadium, and is believed to be planning to spend up to $5bn on a probably futile Olympic bid. Ashgabat also initiated changes to its archaic banking legislation in mid-2010, and is planning to re-launch its privatisation programme.

Azerbaijan maintained strong growth through the crisis, and is expected to grow by 4% in 2010. However, the EBRD forecasts a gradual decline in the country's growth rate in the near term - from 10.9% in 2008 and 9.3% in 2009 to just 2.5% in 2011.

Azerbaijan remains a major recipient of foreign investment, with $5.36bn invested in the first nine months of the year, up 48% compared with the same period of 2009, according to the State Statistical Committee. The government is also considering a debut sovereign Eurobond in 2010. The government spent heavily on the infrastructure construction sector during the crisis, and the holding companies that dominate the country's economy are active in sectors from retail to construction to agriculture.

However, hydrocarbons remains the main driver of the economy. Gas production is expected to increase by 5% during the next three years, and will get a major boost when the first phase of the massive offshore Shah Deniz gasfield begins. BP-Azerbaijan's President Rashid Javanshir said in November that $20bn would be spent on the project. Azerbaijan also made several steps towards signing new gas export contracts in 2010. A Nabucco spokesman said in November that the first gas supply contracts for the Nabucco pipeline should be sealed by mid-2011. Azerbaijan is highly likely to be the first country to sign a supply deal for the pipeline, which is intended to export Caspian gas to Europe, bypassing Russia. Azerbaijan is also expected to sign a gas deal with Turkey in the first quarter of 2011. On the back of the country's oil and gas revenues, consumption in Azerbaijan has remained strong, although there are strong disparities between the oil rich elite in Baku and residents of the poorer, mainly agricultural regions.

A report published by the International Crisis Group in August/September warns that Azerbaijan's political stability will become increasingly at risk in the longer-term as its revenues start to decline. While the country's economic prosperity has helped, President Ilham Aliyev's government to maintain a stable regime, frustration with the country's lack of political freedoms and high level corruption is likely to increase when economic growth starts to tail off.

Armenia is expected to return to growth in 2010 after seeing a contraction in 2009. Growth of 4% is forecast for Armenia in 2010 and 4-5% in 2011, according to the IMF. The EBRD also forecasts growth of 4% in Armenia in 2010.

In 2009, the economy experienced a sharp contraction with GDP plummeting by around 15%. The faster than expected upturn in 2010 is due both to increasing prices for metals - Armenia's main export - and to the revival in remittances from migrant workers, mainly in Russia. According the Armenian Central Bank remittances were up more than 10% to around $490m in the first half of 2010. However, foreign direct investment in Armenia fell again in 2010. Armenia received FDI worth just under $349m in the first nine months of 2010, 9.5% lower than in the same period of 2009. This follows a substantial drop in foreign investment in 2009 - down 33.5% compared to 2008 to $732m, according to the National Statistical Service.

According to government figures, Georgia's GDP increased by 6.6% on year in the first half of 2010. However, according to a report from VTB Capital issued in October, "we expect a slowdown in growth dynamics in the second half of 2010, the overall GDP growth in 2010 is likely to be close to 5.0% on year, prodded on by growth in household and government consumption as well as inventory rebuilding and investment activity."

The main factor causing a decline in GDP growth will be Georgia's negative net exports. "Two key concerns at the moment are the persisting current account deficit and the recent surge in inflation. Authorities expect the former to reach 11.2% of GDP in 2010," says VTB.

Georgia's Prime Minister Nika Gilauri said in October/November that the country plans to return to public debt markets in 2011 with a Eurobond issue. Further details on size and timing have not been disclosed. "IFI lending has traditionally been the country's key source of patching its fiscal shortfall, but we believe the government will increasingly rely on market debt instruments in the future," BG Capital says in a note.

Another important event in 2011 will be the IPO of Georgian Railway Construction (GRC), a fully-owned subsidiary of Georgian Railway (GRAIL), which plans to conduct an IPO and raise $500m to finance the construction of a hydropower plant (HPP). Georgia expects to receive just $700m-800m in FDI in 2010, according to the head of the country's investment agency, Irakli Matkava. This is 33.3% below an earlier forecast by the Georgian government which expected to see $1.2bn in FDI. Gilauri announced in December that the government expects FDI to amount to about $1bn in 2011.

Georgia also hopes to develop the country's hydropower potential, thereby reducing its dependence on oil and gas imports. However, it may take some time for to raise the $6bn needed to fulfil all the government's plans.

Georgian President Mikheil Saakashvili announced in December plans for a "new economic course" for the country, aimed at creating a better business climate. Speaking on December 3, Saakashvili said this will include the introduction of a new tax code that will reduce administrative pressure on businesses, and reforms to customs procedures. Georgia's tax ombudsman will also start work.

In October, the Georgian parliament adopted changes to the country's constitution. A key amendment is the strengthening of the office of Prime Minister, which opposition figures suspect is intended to allow Saakashvili to continue in power after his term as president comes to an end in 2013.

Signs are there that Georgia may be seeking to repair its troubled relations with Russia - Tbilisi said it would not oppose Russia's attempt to enter the WTO, and in December Saakashvili has officially sent Georgia's peace initiatives for Abkhazia and South Ossetia to the UN and other international organisations.

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