Chris Weafer of Macro Advisory -
Turkmenistan is still some way off from opening up to portfolio investors, although this country of almost 5.5mn people with a PPP-based GDP per capita of almost $13,000 has been on the radar of many of the world’s major corporations for some time. And now the winds of change are building in Central Asia’s last closed economy.
A number of economic and geopolitical events are making it less easy, and much less comfortable, for the government in Ashgabat to remain as isolated as it has been in the past. The mixture of energy price weakness, contagion from the Russian ruble’s weakness and the possible rehabilitation of Iran is starting to have an uncomfortable impact on Turkmenistan.
Turkmenistan has been able to sustain double-digit headline growth for many years and has a macroeconomic profile that compares favourably with others in the region and amongst other emerging or frontier economies. That growth, and the relative stability in the economy, has mostly come from the steady increase in revenue generated from the country’s vast gas reserves. Initially, this started when the country was able to extract a higher price from Gazprom, while in recent years this has come from the growth in gas exports to China.
However, despite the relatively closed nature of Turkmenistan, it is now also feeling the chilling effect of both lower gas and oil prices, and the contagion from the near 50% devaluation in the Russian ruble’s exchange rate during the last quarter of 2014. The value of gas export revenues is expected to fall by approximately 25% this year, as both Russia and Iran cut back further on purchases and China pays a lower price even as it raises import volumes.
That loss in revenue directly impacts the budget and has forced the government to rethink its spending plans. The president has ordered a 10% cut in spending for this year with particular emphasis on cancelling, delaying or stretching the time-line on large infrastructure projects. At the same time, the government took the surprising step of devaluing the manat by 19% against the US dollar on January 1 in order to force a reduction in imports and to help limit the loss of domestic competitiveness against ruble-priced imports.
The two areas that appear exempt from spending cuts are in the social and security categories. State sector wages, pensions and some social programmes will see a 10% increase in expenditure this year as the government tries to protect people from the impact of higher inflation and to limit the risk of protests if the economy deteriorates and inflation accelerates. Security spending is also expected to rise (no public data) as the country responds to the heightened concerns over radical Islamism, such as IS and the Taliban, which is threatening the Central Asia region.
In terms of hard numbers, the economy is still expected to expand by 9.5% this year, down marginally from the 10.3% growth reported for last year. Retail sales may again see double-digit growth (base effect and higher salaries/pensions) and the industrial sector is expected to post above 10% expansion. Inflation will be higher this year due to the currency devaluation and social spending programmes. However, the expected 7.5% increase is still modest in regional terms. Ending fuel and energy subsidies for the general population is also a factor, and is another reason for concerns over social unrest and, hence, another factor pushing up security costs in the budget.
The country’s balance sheet is in relatively good shape: sovereign debt/GDP is around 20% and financial reserves are sufficient for approximately 22 months, according to a recent state report. The fact that exports are expected to decline faster than imports is one reason why the current account deficit is expected to nearly double to 7.5% of GDP this year. The budget reported a surplus equal to 0.8% of GDP last year, but despite the president’s order to achieve a balance in 2015, we are factoring in a deficit equal to 2% of GDP. Nevertheless, in general the country is in good financial shape, and ready to ride out the external energy and ruble contagion for several years.
Reliance on the energy sector for future growth and financial stability carries clear risks, which are amplified by the country now heading towards an almost exclusive gas export arrangement with China that holds obvious dangers in terms of future pricing. Russia is rapidly winding down gas imports and has said it will need to import only 4bn cubic metres (cm) this year, down from 10bn cm in 2014. Iran, which imported over 10bn cm last year, has also been cutting back on purchases as it grows its domestic production. That leaves only China: both countries have signed new contracts to boost export volumes from under 30bn cm last year to 80bn cm by 2020, which is forecast to represent 40% of China’s gas demand in that year.
Fearful of reliance on only one customer, Turkmenistan has been trying to find a way to start exporting gas to Turkey and the EU, as well as to Pakistan and India. At the same time, the EU has launched an initiative to secure Central Asian gas as it tries to reduce reliance on Russia; however, there is no physical route for that gas unless Russia and Iran agree to either a new legal status for the Caspian Sea or a land-based pipeline can be constructed across Iran. Russia has no incentive to allow that because Central Asian gas would cut into Gazprom’s exports, and Iran has even less incentive as it looks past the sanctions period at a possible gas pipeline of its own to the EU market.
The planned gas route across Afghanistan (TAPI) is still deemed too dangerous for investors or energy companies to fund the $10bn cost. If the current framework nuclear deal with Iran results in a final, binding deal, then post-sanctions Iran will be a safer and cheaper alternative for gas heading south. Turkmenistan will again lose, leaving it with only one export option – east to China.
One area where Turkmenistan is very favourably placed is actually its geographic location for transport. It is a key route for planned rail transport links from Kazakhstan to the Gulf of Oman – the first part of which is now operational and, eventually, will be part of China’s planned transport links to the Arabian Sea. Turkmenistan provides the only safe route for China to the coast circumventing Afghanistan, and is a much easier and cheaper alternative than via Pakistan.
Being the key part of the transport corridor clearly offers investment and diversification opportunities. It is planned that the rail projects will eventually open up to carry passengers and that is one reason why some of Turkmenistan’s big tourist-orientated projects are likely to be exempt from major spending cuts. Ashgabat is set to host the 2017 Asian Indoor and Martial Arts Games, and plans to use this as a showcase for tourism.
To that extent, the country is both economically and geographically at a crossroads. It can benefit from the latter, but clearly needs to try and move beyond hydrocarbon and China dependency in terms of the former. The dangers from a worsening trend in the economy are obvious in terms of governance and domestic stability risks.
Chris Weafer is Senior Partner at Macro Advisory, which offers bespoke Russia-CIS consulting.
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