Kazakhstan’s KASE stock market index has been one of the best performing in the world since early 2016, gaining almost 60% in each of 2016 and 2017. The debt market, although less spectacular, has also been a strong relative performer in this period. Part of the reason for the gains is because of the strong recovery in the economy, and in earnings, and also because investors have been positioning for structural changes in Kazakhstan’s capital markets that may both greatly expand the availability of instruments in, which to invest and also open up the markets to a larger foreign and domestic investor audience.
Amongst those initiatives is a new bourse is being set up in the newly established Astana International Financial Center. Local debt will be clearable by both Clearstream (expected from July this year) and Euroclear (later this year or early 2019) and that is expected to attract a lot of foreign investors to tenge-denominated debt. Currently foreign investors hold only 2% of local debt issues compared to over 35% in Russian ruble debt. The Finance Ministry also plans to soon issue a new tenge-denominated bond and will follow with expected Euro and Yuan issues later this year.
Privatization appears to be on track as the Finance Ministry is again aggressively pushing the programme, which aims to raise between $3.5bn and $5bn from IPOs in 2018 and 2019. Air Astana and Kazatomprom are slated for this year while NC KazMunaiGaz is expected to be the big listing for 2019. Talks are also underway to sell a 20% stake to Shell as part of the privatization.
But is the optimism and relatively high valuation ratings justified? Despite declaring last year that the country would prioritize the Nurly-Zhol (modernization) plan, the government appears to be much more focused on an expanded energy development strategy. The Oil & Gas Strategy 2025 is today clearly the greater priority as it will deliver economic recovery and growth over the medium term and, hopefully, provide the resources and time to allow the Nurly-Zhol plan to be developed. That’s the theory in any event.
Early last year President Nazarbayev sought to reinvigorate the Nurly-Zhol programme, which has the core ambition to transform the country’s economy from hydrocarbon dependency, and vulnerability, to a more diversified model by 2025. Included in the plan is a programme to boost non-oil & gas exports to 50% of the total by value and to emphasize technology and the agriculture plus food processing sectors in particular.
The economy certainly responded strongly last year, recording GDP growth at 4%. But it was not because of any progress in the modernization plan; it was due to the 10.5% growth in oil production and the steady rise in the price of crude oil. This combination almost entirely accounted for the boost to growth from the 1.0% GDP expansion recorded in 2016.
The oil output increase, which brought average daily output to 1.73mn bbl/d through 2017, almost all came from the ramp-up in the Kashagan oil field. This project is billions of dollars over budget (some $55bn cost to date) and years late. But it started to pump out oil in October 2016 and this rose steadily through 2017 to reach 300,000 bbl/d by the end of the year. It is expected to plateau at 370,000 bbl/d by mid-year. Phase 2, a planned $2bn gas-injection programme, is expected to bring that output up to a sustainable 450,000 bbl/d. Kazakhstan also gained from the oil price recovery. It had agreed to participate in the Russia-OPEC production deal, struck just as the Kashagan field started to produce oil, but quickly decided it was not in the country’s national interest to participate.
GDP expansion is expected to be nearly as strong this year, again primarily because of the increase in Kashagan output and the still rising oil price.
The bottom line is that despite the fanfare focus on Nurly-Zhol, Kazakhstan is becoming even more hydrocarbon dependent. The Oil & Gas Development Strategy 2025, published by the government earlier this year, expects oil production to reach 2.2mn bbl/d by early next decade and plans for more investments into oil processing and petro-chemicals, including a fourth oil refinery.
That is not to say that other industry sectors and projects are being neglected; it is just that hydrocarbons provide the easier route to economic well-being while other industries are improving more slowly.
What does this mean for the tenge?
Despite the strong economic gains from the oil sector and oil price recovery, the tenge is not a petro-currency. That is because the National Bank has to manage the tenge in line with the Kremlin’s ruble policy and that mandates that the ruble ignores the oil price rally and must stay weak relative to the dollar in order to help Russia’s economic recovery.
In reality, this is now also Kazakhstan’s policy because it has no other choice. In practical terms the policy appears to be to keep the tenge in the 5.3-5.6 range against the ruble and, with the current high oil price, this should mean keeping the rate closer to the upper end of the band.
Kazakhstan cannot afford to let the tenge strengthen against the ruble because the loss of competitiveness of domestic goods and services to Russian alternatives would be disastrous for some sectors of the economy. This was seen in 2015 and 2016 when Kazakhs crossed the border to Russia to buy vehicles. This almost destroyed the auto-manufacturing and durable-goods retail sector in Kazakhstan and was one of the reasons why the government had to let the tenge free-float. In reality that actually means creating a loose peg to the ruble. Kazakhstan cannot impose border controls or tariffs on imported Russian goods because both are (founding) members of the Eurasia Economic Union and this guarantees the free movement of goods, people, services, money, labour across internal borders.
One area of concern, also expressed by the international rating agencies, is that the government is still struggling to convince depositors to shift out of US dollar and Euro deposits and into tenge deposits. The rate of dollarization is still dangerously high at over 45% and it appears that people are very sceptical about government motives for persuading them to convert. Kazakhstan is processing a law, which will recognize all foreign company branches in the country as resident companies and will ban the use of foreign exchange in settlements between them and their Kazakh counterparties. The law is expected to come into force on July 1 2019. The new regulations are in line with WTO requirements and also the agreements supporting the A.I.F.C. and the Khorgos border centre.
Another question investors need to address is that of political oversight. President Nazarbayev has said he is planning for either a smooth succession of his choosing or, if he is paying attention to events in Malaysia these days, he may choose to remain for another term. He is using a number of strategies to ensure whatever course he chooses will be smooth. These includes;
The last presidential election was held one year early, in 2015. It means that the next scheduled election will take place in 2020. President Nazarbayev is entitled under the constitution to run for another term but he will be 80 years old. Two weeks ago that was probably considered too old for a national leader but the election of Mahathir Mohamad, a sprightly 92 year old, in Malaysia has at least opened the possibility of alternatives.
The main message from Mahatir's return? If you want something done right, keep doing it yourself.