Some niches thrive as Kazakh economy falters

By bne IntelliNews June 19, 2008

Clare Nuttall in Almaty -

Kazakhstan's economy grew by an average of 10% a year for most of the past decade until the global liquidity crisis hit, which will likely slash growth over the next three years to barely half the previous levels. Sectors from financial services to construction to retail might have strong long-term growth prospects, but they are currently struggling. However, there are some parts of the economy that are even now flourishing.

GDP growth of 10.2% in the first half of 2007 plummeted to just 5.8% in the fourth quarter of last year, and is set to continue at a similarly low level through to 2011. Kazakh Economy Minister Bakhyt Sultanov said in May that the government had cut its 2008 economic growth forecast for Kazakhstan from between 5% and 7% to just 5.3%. It later lowered the GDP growth forecast for 2009 from 9.2% to 6%, and for 2010 from 8.6% to 5.6%.

The lowered forecasts are mainly due to the deceleration in industrial output since last summer. Average growth during the year was just 4.5% due to the slowdown in the latter part of the year, as cutbacks in bank lending slowed economic activity. Kazakhstan is now closer to the situation it was in five years ago, when oil exports were the main driver for growth. Oil and gas production is increasing, putting Kazakhstan in a position to benefit from record oil prices, which were hovering around $140 a barrel in mid-June. Kazakhstan is also a major exporter of both grain and numerous metals, for which prices are also at historic highs.

Outside the commodities sector, though, there are niches of the economy that are defying the downward trend.

Food for thought

High pent-up demand for services have caused this segment to grow by over 10% a year for several years running; it now accounts for more than 50% of the economy, and some service providers are continuing to see strong growth. "After the liquidity crisis, we actually got more clients," claims the director of one Kazakh IT services company. "Companies want to be more effective when the market starts to grow again. While they are waiting for this to happen, they are mobilizing themselves to work out the most effective ways to manage their business. This will give them a competitive edge, and put them in a good position for when the market recovers."

Kazakhstan's manufacturing sector is not expected to grow considerably. Most of the clothing and household goods bought here are cheap imports from China and to a lesser extent Turkey. Other manufactured goods are imported from South Korea, India, Russia and Europe. "Because of high oil prices, we have substantial inflation issues, which makes it difficult for us to be competitive in terms of production. Our labour costs are rising, so we will not be able to compete against China or even neighbouring Kyrgyzstan or Tajikistan in manufacturing," says Andrey Timchenko, managing director of Kazkommertsbank.

However, there are exceptions. Within manufacturing, demand for certain food products is growing strongly despite a slowdown in the entire sector as inflation dampens consumer spending. In fact, Kazakhstan is following a pattern very similar to Russia, where the emergence of a middle class with growing disposable income caused a boom in consumer-related sectors. Falling unemployment and wage increases have led to growing purchasing power in recent years. As a result, once the economy rallies and real wages start to increase again, sectors such as food, retail, consumer goods and leisure will boom. "We now see the rise of the consumption-driven sectors," says KKB's Timchenko. "They are still at a rudimentary stage, and require the construction of trading space, storage and logistics infrastructure. Inflation is also a problem at the moment, but a lot of people have been getting richer very quickly and relatively easier, and this will continue in future. This side of the economy is going to grow like crazy."

Food processing has also grown strongly, due in part to Kazakhstan's strong agricultural sector, as well as growing consumer spending power and the government's import substitution policy. Since mid-2007, growth slowed with rising inflation. However, this has not been uniform across the sector, as it has tended to affect impulse purchases rather than planned grocery shopping. "We have seen the market for carbonated water, for example, stagnate because purchasing power has decreased. However, demand for milk is growing because this is a commodity product that is consumed every day," says the head of an Almaty-based soft drinks manufacturer.

Numerous new companies have emerged in this sector, and new brands have been launched on the market. The quality of products offered to Kazakh consumers has also increased considerably. As with other consumer-driven sectors, it is set to rally when the economy resumes its long-term growth trajectory.

Real pain

Nowhere was the boom and bust of the Kazakh economy more extreme than in the real estate sector. But while residential property was at the epicentre of the economic crisis and correspondingly suffered a major setback, prices for commercial property have continued to rise.

The construction boom originated from a genuine need for new housing, especially in Astana and Almaty. However, with an inefficient capital markets and few other places for either banks or individuals to direct their surplus cash, the boom rapidly turned into a bubble. Residential projects - the easy money in the real estate sector - were badly planned and over-leveraged. After July, when the cheap debt needed to finance these projects suddenly disappeared in a sub-prime puff of smoke, the sector juddered to a halt. Many projects have now been abandoned, and prices for residential real estate have slumped. In Almaty, the most overheated market, prices have dropped from their peak of $3,400 per square metre (sqm) in July to just under $2,200 in May. They could fall as low as $1,200 per sqm before the market starts to recover.

That a recovery will happen isn't really in doubt. An overall shortage of housing in Kazakhstan and the need to replace the outdated Soviet housing stock means there are strong long-term drivers for growth in the residential sector. Future growth in the residential property market is set to go ahead, but in a more considered manner. "I think this crisis has been good for the industry, because it has forced developers to meet the needs of the market," says Charles Raether, head of Jones Lang LaSalle's Kazakhstan team. "Previously they just built whatever they felt like building. Now developers understand that if they want to attract international investors, they need to build quality accommodation that will meet investors' needs and be attractive to good tenants."

In the commercial real estate market, the need for new office, retail and warehouse space is even more apparent. In the last nine months, prices for commercial real estate have continued to rise, albeit at a slower rate than previously. In Almaty alone, it is forecast that 1.5m sqm of office space must be constructed by 2012.

Infrastructure projects are also continuing apace. Kazakhstan's inadequate and outdated infrastructure for oil and gas, electricity generation and transmission, and transport will all enjoy massive amounts of investment over the coming decades, which will ensure a long-term demand for construction.

With some 70% of all bank loans estimated to be directly or indirectly connected to the real estate sector, it's no wonder the banking sector also faltered after the credit crunch. There were even fears for a while that some of Kazakhstan's banks would collapse.

Up until then, the banking sector had been the main agent for growth in Kazakhstan, borrowing money on international capital markets that it then fed into the economy in the form of loans to local businesses and individuals. Kazakhstan's banking sector developed into the most sophisticated in the CIS. However, the shutdown of international capital markets in July dealt a heavy blow to the sector. Worst hit by the crisis were the banks with high exposure - in some cases up to 70% of a bank's liabilities - to international capital markets, as well as the overheated domestic real estate sector.

The only bank to emerge unscathed from the crisis was Halyk Bank, which had relied on retail deposits rather than international borrowing. Thanks to the farsighted policy of its chairman and CEO, Grigoriy Marchenko, Halyk continued to grow its deposit base during 2007 while other banks were losing deposits. Other Kazakh banks have seen a shrinking of their assets and loan books. 2008 is set to be another difficult year for the sector - Alliance Bank, for example, warned in March that its assets would shrink by 7-9% by the end of this year. However, the annual results issued by Kazakh banks this spring were, by and large, more positive than expected. All the major players were sufficiently prepared for there to have been no bank failures. And as banks tighten their lending requirements, they are set to emerge from the crisis leaner, but in better shape.

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