Will Central Asia's commodity boom pave way for new Silk Road?

By bne IntelliNews May 13, 2008

Clare Nuttall in Almaty -

Central Asia, remote and mysterious, vast and landlocked, has long stirred imaginations in the West. As a crossroads for the movement of people, goods, and ideas, the region is exposed to a broad swathe of cultural and economic influences. The fabled Silk Road, dating back over 2,000 years, is the prototypical example of early globalization. But the region is more than a transit route, having long been valued for the indigenous riches that lie below ground.

Today, however, it's not the salt that captivated Marco Polo that's creating the most excitement, but energy and minerals. And this time round, the post-Soviet sovereign states of Kazakhstan, Uzbekistan, Turkmenistan, Tajikistan and Kyrgyzstan have a real chance to leverage their resources for lasting economic benefit.

Not only is the Central Asian resource endowment vast, but a relatively small population would share in the proceeds. To put this in context, Central Asia's land area, at 4m square kilometres, is only marginally smaller than that of all 27 member states of the EU combined, yet more than eight times fewer people live there.

Oil (especially in Kazakhstan) and gas (predominantly in Turkmenistan and Uzbekistan) are the most valuable natural assets in this vast region. Overall, Central Asia's hydrocarbons deposits are modest by global standards, amounting to just over 3% of the world's proven reserves for both oil and natural gas. The region's population, however, is even smaller in relative terms (1% of world population), which suggests that sustained high energy prices should provide an excellent springboard to prosperity.

Kyrgyzstan, where gold is a dominant export, and Tajikistan (cotton, minerals and aluminum), have drawn the short straws. Having missed out on the hydrocarbons boom, they remain relative economic backwaters, despite the dynamism of recent years.

Even so, growth across the region is robust, averaging between 5% per year in Kyrgyzstan and almost 10% per year in Kazakhstan over the past five years. Improved terms of trade lie at the heart of this growth, generating domestic demand among consumers and business communities, and investment has reached unprecedented levels.

If this all sounds too good to be true, that's because it is. Despite the recent boom, policymakers face tough conditions that will endure for years to come.

Tough decisions

Standard & Poor's Ratings Services believes it will take more than the good luck of rising export prices to firmly root sustainable growth and development in what remains an environment characterized by weak institutions, sub-par governance structures, social problems, a worsening income distribution, and a land-locked location far from the major markets for Central Asia's exports.

Vast resource endowments are a necessary, but not sufficient, condition for economic advancement; the real test is to get the products to the markets. In Kazakhstan, where there are plans for large capacity increases in hydrocarbon production, the country will have to make major investments toward developing new oil and gas fields and creating the corresponding pipeline infrastructure. Developing the extra capacity is often fraught with cost overruns and delays, as experienced on the giant Kashagan oil field project.

Oil exports from Kazakhstan depend heavily on transit across Russia. Kazakhstan's strategy seems to focus on further diversification of its export routes. Although some investment has been made in new pipelines, the existing network remains inadequate for the planned expansion to markets in Europe and China.

In the meantime, gas producers in Kazakhstan, Turkmenistan, and Uzbekistan are in a weak bargaining position regarding exports destined for Ukraine and markets in the West, largely because Russian giant Gazprom operates the gas supply network and acts as the de facto monopsonist of Central Asian gas exports.

If Central Asia's location is an inconvenience for pipeline-bound companies, it's a much bigger problem for their metal and mining counterparts. Again, Russia dominates the transportation network, while bottlenecks limit exports to the expanding Chinese market. Increasing energy costs will further disadvantage these producers.

However, Kazakhstan's high share of easy-to-recover reserves, as well as lax environmental regulations, will keep the metals and mining sector primed for expansion, although polluting practices will hamper growth in the longer term.

The region's poor institutional infrastructure may compromise its huge investment needs and complicate the task of raising the private funds necessary to complete all the projects. The economic free-fall following independence has been deeper and more drawn out than in other former Soviet republics. This is partly because of the new nation's unfavourable trade and production specialization, but incompetent economic management has exacerbated matters.

Affairs have greatly improved in certain countries; in Kazakhstan, for example, support for a market-oriented policy approach has gained ground on a broad basis. Nevertheless, the region remains hopelessly behind its peers in perceptions about regulatory quality, government effectiveness, the rule of law, and other governance indicators. Perceptions of corruption are among the highest in the world.

Not surprisingly, this environment adversely affects the business and investment climate. It's particularly noticeable in the resource sector, which is considered strategic and where government interference can add to the business risks. As in Russia, Central Asian governments feel the need to build national resource champions, if necessary at the cost of foreign or local partners.

While the political environment is superficially stable, the prevalent political system is one of extreme concentration of power. As a consequence, there are minimal checks and balances, and presidential successions carry risks. This may make investors - foreign and domestic - more reluctant to commit the necessary resources to fund the countries' development once the good times are over.

In the near term, the largest threats to stability and prosperity arise from the consequences of irrational exuberance during the resource boom. They are most evident in Kazakhstan, where rampant credit growth and an unprecedented construction bonanza have created serious economic imbalances.

Other nations in the region demonstrate extreme megalomania and wasteful excess, as a stroll along the streets of Turkmenistan's capital, Ashgabat, with its heroic monuments and opulent palaces, will testify. And as regional populations know, there is no more powerful reminder of the wanton destruction wrought by central planning than in the disaster that has struck the Aral Sea. Opening up political and economic processes in Central Asia will help minimize the risk of repeating similar mistakes.

It's important not to lose sight of the untapped potential this region still offers over the longer term. With commodity prices set to remain at lofty levels for the foreseeable future, Central Asia's leaders have a golden opportunity to lay the foundations for a brighter future for their populations. But to achieve this, they will have to consistently improve the quality of the business environment and prepare their countries for the inevitable transition of leadership. It will take courage and determination to modernize institutions and economies, and to allow a higher degree of transparency and accountability. Having enjoyed the resource boom, the hard work is still ahead.

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