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Kazakhstan does its own bailing

Kazakhstan, whose economy has endured a switchback progress since independence from the Kremlin in 1991, is discovering the benefits of salting away wealth in the good times as it seeks to survive the global downturn without recourse to foreign aid.

For over a decade the landlocked and oil-rich country has been touted as the poster child for successful privatization (or at least de-statification) and marketization of a former centrally planned economy. Now the strength of those changes is being tested as Kazakhstani share prices tumble and bank earnings collapse amid the global financial crisis.

Profits of Kazakhstani banks declined 61% from January through September, because of the need to conserve liquidity in light of bad loans, 36% of which are secured on real estate. Lenders are also facing increasing competition from foreign banks setting up offices in the country, and it is likely that consolidation and internationalization will continue.

Ratings companies Fitch and Standard & Poor's have revised credit ratings downward for a number of Kazakhstani banks, and Fitch has done the same for sovereign debt.

In response, the Kazakhstan government intends to raise US$5 billion through bond issues and take $1 billion out of the budget so as to buy $6 billion in bad loans from domestic banks. It will be able to purchase up to 10% of traded shares and mandate personnel and financial measures to be taken by the banks. These measures will obviate the need to follow Iceland and Ukraine in seeking recourse to the International Monetary Fund (see Ukraine goes from orange to red).

Standing as a bulwark for the country against the global downturn is the National Oil Fund of Kazakhstan (NOFK), set up in 2000. As of last month, the fund held $22.6 billion in the National Bank of Kazakhstan (NBK).

That is more than the central bank's foreign exchange reserves, which amount to about $19 billion, while gross external debt at the end of 2007 was $96.3 billion. A total of $13 billion will be necessary to refinance debt. A foreign bank's estimate for November sets the NOFK holdings at $27.6 billion and NBK holdings at $21.9 billion, for a total of almost $50 billion.

The NOFK is similar to a fund established by Norway in 1990 so as to buffer variations in oil revenues and fund domestic pensions. The declared goals of the NOFK are to ensure stable socio-economic development, accumulate financial resources, and reduce the economy's susceptibility to external shocks. Thus the government intends to spend up to $10 billion out of the NOFK to promote agriculture and other non-energy economic development.

The country has done much to recover from the early days of independence from the Kremlin in 1991, when GDP declined. Additional hardship followed in the late 1990s with the Asian and Russian crises and a drop in world energy prices. After late 1999, economic performance improved, with GDP expanding at a 9% to 10% pace from 2000 through 2005, thanks to professional macroeconomic management, increased world energy prices, and spillover effects from energy-sector growth to other sectors of the domestic economy.

Now, with energy prices again tumbling, growth in gross domestic product (GDP), until recently among the world's fastest growing, may drop to between 5% and 6% this year from 8.5% in 2007 and a spike of 10.7% in 2006.

Reflecting the global downturn, the Kazakhstan Stock Exchange (KASE) index has crashed to 800 from 2,700 five months ago, in spite of this market tending largely to be patronized by local insiders. Kazakhstani companies of global significance have international listings, usually in London. Being concentrated in the energy and natural resources sector, they have fared as poorly as other major companies.

Other economic indicators are similarly gloomy. Inflation is picking up pace after holding at a steady 6% to 7% from the beginning of the decade through 2004. Last year, prices climbed at a 10.8% rate, up from 8.4% in 2006 and 7.5% in 2005. It is now set to equal or surpass last year's rate by the end of December.

Even so, the country's currency, the tenge, which is convertible and administered by the government under a "managed float" regime, has held steady around 120 to the US dollar, varying less than 1% from that target over the past year after strengthening from 150 in 2003.

Ratings changes by Fitch and Standard & Poor's have left the important energy sector largely unaffected, but a changed regulatory environment may have more impact on this vital source of government cash: at the start of 2008, hydrocarbon revenues accounted for one-third of the state's total budget. Late last year, President Nursultan Nazarbaev approved during re-negotiations with the consortium developing the offshore Kashagan oil deposit restrictive amendments to the Law on the Subsurface and Subsurface Use, which governs energy exploration and development. (See Kazakhstan announces new energy directions.)

Kazakhstan's favorable track record mean these changes will not cause current Western investors in the energy sector, especially those with sunk costs, to flee the country. However, the new policy on foreign direct investment, together with the significant decline in world energy prices, represents a severe disincentive to new foreign investment, even if Kazakhstan does not intend to follow a Russian pattern of "resource nationalism".

Fitch estimated earlier this year that the imposition of new energy duties would not affect ratings of Kazakhstani companies or the state as a whole. Standard & Poor's this month confirmed its long-term corporate credit rating of the national oil pipeline operator KazTransOil at BB+, just below that of its parent company KazMunaiGaz and the Republic of Kazakhstan itself (both rated at BBB-).

One measure of Kazakhstan's ability to survive the present crisis is the cost of credit default swaps, an indicator of the risk of a country not paying its debts. These have declined for Kazakhstan in the past week and rate the country alongside Russia and Indonesia and a better bet than Pakistan, Ukraine and even resource-rich Venezuela. The decision to buildup its oil fund over the course of the decade is standing the country in good stead.

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URL:  http://www.robertcutler.org/blog/2008/10/kazakhstan_does_its_own_bailin.html
First published in Asia Times Online, 30 October 2008.

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