The wisdom of youth

Building diversified financial markets
A guiding hand from the central bank

THE YOUNG MEN, many less than 30 years old, who manage much of Kazakhstan's economic and banking sectors should be smiling. Wealth is pouring in from oil and mineral sales to an extent not seen in the country's 14-year history as an independent entity. This is reflected in growth in GDP – more than 10% over each of the past four years. But instead of joy, they exhibit an austerity and caution unusual in people of their age.

These bright but inexperienced operators are the heirs to the discredited communist managers who allowed their country to be treated as the granary of the Soviet Union. They have no wish to repeat the mistakes of the past and are determined to build a market-based economy free from dependence on one commodity.

The bright managers have another reason to be happy. The country has just been given an investment-grade rating by Standard & Poor's. This acknowledges their skill in managing an economy that could by now have been swept towards disaster on a tide of inflation and consumerism created by its oil wealth. In fact, the temptation to let things drift has been resisted and strict controls have been exercised on expenditure.

Nevertheless, the young managers have yet to pass their severest test. Two challenges will determine their economic maturity and judgement. The first is to diversify the economy and produce a hedge against the risk that oil will run out or become too expensive to extract. In 2003, oil exports were worth over $6.5 billion, more than half total exports of $12.9 billion. Oil exports contributed almost 22% of annual GDP of $29.7 billion. Kazakhstan has oil reserves estimated at 60 million barrels, ensuring a steady stream of oil revenues far into the future.

State intervention in the distribution of oil revenues, which is not universally welcome, will nevertheless protect the country against a slump in oil prices or a decline in oil production. Excess oil revenues are directed by the authorities to the state-controlled National Development Fund and National Oil Fund. More than $3.5 billion had been invested in the National Oil Fund by June 2004.

The second challenge is to deal with an inflationary problem that is surfacing as oil revenues buoy up a local economy and strengthen the currency to unsustainable levels. Kazakhstan's monetary authorities aim for an inflation rate of between 5% and 7% but Anvar Saidenov, governor of the National Bank of Kazakhstan, warns (see interview, Anvar Saidenov) that year-on-year inflation passed 7% in July and more sterilization measures are required.

Meruert Makhmutova, the director of Kazakhstan's Public Policy Research Centre, confirms the threats to inflation and currency stability. "The oil revenue puts pressure on the local currency," she says. "The National Bank has spent $12 billion in the local market trying to detach the value of the tenge from the foreign exchange inflows. The problem is that the tenge may become dependent on foreign exchange and is therefore buoyed up by foreign exchange inflows rather than by local earnings and international sales.'"

Kazakhstan's dynamism began to be acknowledged by the international financial community in 2000, when the country paid off its entire IMF debt seven years ahead of schedule. In 2002 Moody's Investors Service gave it an investment grade rating. Its progress was confirmed by a record current account surplus of $525 million in the first quarter of 2003. Later that year, gross official reserves at the National Bank of Kazakhstan reached $6.4 billion: in June 2004, equivalent to some nine months' imports of goods and services.

Foreign direct investment has followed the international enthusiasm for Kazakhstan. In 2003, FDI reached a record $2.2 billion. The country is now in a position to withdraw over-generous tax breaks to firms investing in the oil sector in a bid to redirect inward investment to other parts of the economy. Such investments will have to work much harder, as non-oil industries are embryonic in a country that is heavily weighted towards agriculture.

Timchenko: "The Development Bank keeps on issuing bonds and I don't know why, as they have so much cash"

This policy risks displacing the private sector, says Andrey Timchenko, the managing director of Kazkommertsbank, who is still only in his late 20s. "In the long term," he says, "everyone agrees that the best use of the money is for infrastructure. But so far, the state-owned development institutions have proved to be ineffective in financing the real economy. There is a widespread criticism that these bodies are over-liquid. They can't place the money and they are barely making money."

The government is also active in the banking sector, where it is represented by the Development Bank of Kazakhstan. The bank has invested little more than a third of its $400 million of deposits. Timchenko again questions state policy. "They keep on issuing bonds and I don't know why, as they have so much cash," he says. "This can damage the competitive environment as they are put into the same market as commercial banks. They are subsidized in terms of cost of capital and commercial banks find it difficult to compete."

The government's grip on oil revenues is strengthened by its control of Kazakhstan's main oil company, Kazmunaigaz. Oraz Jandosov, a former deputy prime minister and finance minister, who heads the Democratic Party of Kazakhstan, says: "As oil revenues have increased sharply over the past three to four years, government intervention has also increased. This is evident in two areas. First in the number and scale of government-financed institutions which substitute for lack of private-sector companies. Second, the government has used money from the budget to create and capitalize government-owned companies that are outside the oil sector."

Jandosov questions whether government-financed incentives are an effective way of developing a private-sector economy.

Impediments to infrastructural investment go wider than merely lack of viable financial assets. Frustration with bureaucracy is another complaint frequently aired by bankers. "Innovation can't be fostered unless problems of bureaucracy are addressed," Kazkommertsbank's Timchenko says. "You can create incentives, but unless bureaucracy problems are tackled, the innovation doesn't occur."