Clare Nuttall in Almaty -

Building a successful business from scratch was difficult in Kazakhstan even during the boom years. As the economic slowdown becomes more severe, small businesses are struggling with falling demand and a lack of access to funding.

In an economy dominated by the extractive industries, the share of small and medium-sized enterprises (SMEs) in economic activity is relatively small - under 20% of GDP. While there are opportunities for smaller companies to grow as suppliers to the major natural resources companies, often the required technologies and skills are not available in Kazakhstan and are, therefore, sourced from abroad. It is too early to say to what extent the January devaluation, which saw the tenge fall 23% against the dollar, will change this situation.

In sectors such as manufacturing, textiles and food production, Kazakh companies face stiff competition with its neighbours - Uzbekistan, Kyrgyzstan and especially China - where manufacturing costs are considerably lower. For example, it costs around five times as much to produce a t-shirt in Kazakhstan than in China or Turkey. "In general a cheap labour force is a big competitive advantage for clothes manufacturing. Unfortunately we don't have this in Kazakhstan," says Inna Apenko, sales and marketing director at specialist clothing company Textiline. "We also have a shortage of specialists in this field, and had to conduct our own courses to train our workers."

Textiline has managed to carve out a niche by investing heavily in quality, high-tech garments, setting up a state-of-the-art factory in Talgar near Almaty. It produces sports clothes for export under a contract with Swiss cycling gear manufacturer ASSOS, workwear for major companies including Kazakhmys and TengizChevroil, and works on special projects including producing costumes and textiles for the film Nomad.

The Kazakh government has been keen to diversify the economy. The Kazyna sustainable development fund - now merged with state holding company Samruk - was set up to stimulate investment and innovation outside the extractive industries. Various Kazyna subsidiaries focus on different aspects of the process - including the Damu small business fund, the National Innovation Fund for high-tech companies, and the KazNex export development agency, which has studied the experience of extractive-turned-manufacturing economies such as Australia, Malaysia and South Korea to achieve the same thing in Kazakhstan.

As part of the government's anti-crisis programme, KZT117bn will be directed at the SME segment of the economy. Samruk-Kazyna and Damu signed agreements with 12 commercial banks to disburse the money in February 2009. The money is intended to finance SMEs' purchases of fixed assets, fund their operating costs and refinance existing loans. Loans are capped at KZT750m ($5m) per borrower, with a maximum loan period of seven years. 43% of the funding is expected to be directed at SMEs in Almaty, with a further 26% to Astana and the remaining 31% to other regions of Kazakhstan.

The previous round of funding through the Damu programme had been controversial; just KZT8bn the KZT50bn given to commercial banks in August went to SMEs. Banks blamed this on the terms set by Damu, which capped interest rates at 12.5%. For earlier rounds, banks had charged an average interest rate of 20%. In early November, Prime Minister Karim Massimov ordered that unused funds be returned to the state so that the money could be redistributed.

Buy small

The government is also mulling the idea of setting procurement quotas for small businesses for government contracts and infrastructure projects. These would help to solve the twin problems of demand and funding, identified as the biggest challenges facing SMEs.

Since the credit squeeze began in July 2007, banks have slashed their lending programmes, cutting off the cheap credit that fuelled many smaller companies' rise in the earlier part of this decade. Since people cut back their discretionary spending, and the larger businesses SMEs serve cut back their activities and investment programmes, SMEs are visibly struggling. Many have given up their office space and are either inactive or operating from their owners' apartments. "Small businesses have been hit indirectly by the spiral of falling commodities prices," says Greg Vojack, managing partner at law firm Bracewell & Giuliani's Kazakhstan practice. "Both big and small businesses will have to wait for demand to come back, which is most difficult for small and medium sized businesses. First, they need demand for their product. Second, if there is demand, they need to secure funding."

Textiline's Apenko says the company has had to adapt to falling demand. "Since all companies are reducing production and optimising their business, we have seen a reduction of approximately 30% of orders from our major customers," she says. "Under the circumstances, we intend to use our spare manufacturing capacity to launch new consumer products for the domestic market. We also plan to work actively towards exporting our products."

Bekker & Co., a Kazakh-German joint venture producing high-quality meat products and other foodstuffs, has also intensified its marketing efforts as the crisis has forced it to be more competitive. "The crisis has of course affected demand," says the company's general director Ivan Kravchenko. "For us, demand previously exceeded supply, so we plan to remain at our current output level and not reduce wages. However, since the crisis started we have paid more attention to marketing, which so far has been sufficient."

In addition to the crisis, Kazakh companies face a mixed situation regarding their legal and regulatory environment. In the World Bank's influential "Doing Business" ranking for 2008, Kazakhstan advanced 10 places to 70th out of 181 countries thanks to reforms in several areas.

The new tax code, which came into effect at the start of this year shifted the fiscal burden from the corporate to the natural resources sector. The corporate tax rate will be gradually lowered from 30% to 15% by 2011; it has already been brought down to 20%. The code also removed the obligation for micro businesses to make monthly tax pre-payments.

However, an apparently encouraging regime may conceal a more difficult situation in reality. "Some formal procedures look good, but the real situation is different. For example, it's possible to apply for and receive a certificate of origin in one day, but to obtain this, companies need 18 to 20 supporting documents," explains Saule Akhmetova, deputy chairwoman of KazNex. "The new tax code also looks good, since the rate is quite low. However, it does not encourage companies to invest in export development, since such activities are not taken out from the taxable base."

Akhmetova considers that these factors, combined with the relatively high costs of operating in Kazakhstan compared to its neighbours, continue to make starting up and growing a company outside the extractive sectors a difficult process. Those companies that have succeeded are those which have made a special effort to invest in high-quality production or service provision. "In sectors such as textiles, Kazakh companies can't compete with mass production in China or Turkey, and should focus on high-value production based on new technologies and intellectual property," Akhmetova says. "To compete effectively with international companies - both on the domestic and the export market - Kazakh companies need to focus on the quality and marketing of their products."

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