Graham Stack in Berlin -
A backwater in an otherwise vibrant economy, Kazakh equities have taken off in the last two years and are outperforming Russia's RTS so far this year. Some local companies have finally seen the value of listing their shares and improving corporate governance, but there is still a long way to go.
A growing number of large public offerings and M&A deals have seen investors buy more than $6.5bn worth of Kazakhstan-related equities between 2005 and 2007. These included high-profile placements of natural resources producers - KazMunaiGaz E&P, Kazakhmys and KazakhGold - as well as banks Kazkommertsbank and Halyk Bank.
This year looks set to deliver a new wave of IPOs and secondary offerings, especially among Kazakh banks: surging loan growth has made them thirsty for capital to satisfy regulatory requirements. And the acquisitions of such companies as PetroKazakhstan, Nelson Resources and UrAsia Energy have underlined the strategic interest in Kazakh assets and confirmed valuations, which have soared as foreign direct investment (FDI) reached $12bn in 2006.
The interest in Kazakh equity is underpinned by the booming economy and a set of sparkling numbers. According to the most recent data, released in the middle of June, real GDP growth will hit a whopping 9.7% by the end of this year, inflation will come in at a respectable 8-8.5%, and the budget deficit is forecast to be a manageable $1bn, or only 2.2% of GDP.
The growth of the equity market has got to the point where investment banks in Moscow have started to track it. And Moscow-based Aton Capital is the first with an index, the Aton Kazakhstan Equity Index, which was launched in April.
"We believe that natural resource wealth, rapid economic growth, and political stability have earned Kazakhstan a permanent place on the radar screens of major emerging market investors globally," declares Aton's Julia Bushueva.
Aton's Kazakhstan Equity Index tracks the performance of the top-10 stocks of Kazakh-related companies, currently with an aggregate market capitalization in excess of $38.1bn. And as of April, the index is proudly outperforming Russia's RTS Index. The Kazakh index's stronger performance is related to the smaller weighting it gives to oil stocks, Bushueva explains. Oil and gas stocks constitute only 23% of the Kazakhstan index, but 50% of RTS, so negative tendencies in the sector have had a smaller impact on the performance of the index. Instead, the index has gained substantial support from copper giant Kazakhmys (up 14% in the year to date, constituting 30% of the index) and Kazakhtelecom (up 16%, 10% of the index).
The investment case
"The key to the Kazakh investment case is that oil output is set to double or triple in the next 10 years, far outstripping production growth in Russia, where reserves are far less easily accessible," says Alfa Bank's Rinat Gainoulline.
In contrast to Russia, the development of Kazakhstan's massive reserves of oil, gas, gold and other commodities is only just beginning. That makes it both a natural resource play and a growth story. The country's long reserve life for key commodities suggests a strong forward growth outlook, but also implies continued need for outside investment.
Kazakhstan has a second advantage over Russia: "A number of reform initiatives in the banking sector, pension system and other key policy areas, were implemented well ahead of Russia and thus laid the foundation for sustained economic growth," says Aton's Bushueva.
Alfa's Gainoulline agrees. "At an early stage, international experts were engaged to create a new streamlined financial system for Kazakhstan. This means that windfall revenues from oil are now being channelled mostly by private banks operating more efficiently than the state banks that dominate in Russia. And sweeping early reform of the pension system has resulted in $9bn now under private management," he says.
Gainouilline reckons Kazakh banks are now set to "globalise:" increasing domestic demand for consumer crediting is being met by aggressive foreign borrowing. This could constitute a risk, but an important factor in the success of the Kazakh financial system to date has been, "the intelligent and farsighted financial supervision that has ratcheted up reserve requirements to keep pace with banking growth."
An efficient financial sector bodes well for diversification away from a commodities economy. But Gainouilline sees two main threats on the horizon.
One is political: cracks appearing in Kazakhstan's elite could lead to political instability. Hikes in government spending, especially on infrastructural spending, could fuel corruption and wastefulness, and threaten macroeconomic stability.
The second threat is the lack of people in this nation of only 15m souls. Kazakhstan might lack the human resources to diversify successfully. The obvious answer is to invest windfall revenues in education, but the time lag for investment in education to mature demands political foresight, which corruption and populism could undermine.
The great unknown is what impact its vast neighbour China will have on Kazakhstan's development. China has very concrete plans: to use Kazakhstan as node in the transport corridor planned to shorten routes to Europe. This promises large-scale investments in road and rail. Transforming transit routes on this scale could help accelerate Kazakhstan towards its destination of diversification in a very real sense.
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