Surviving the resource curse

IN THE 1970s, Venezuelan oil minister Juan Pablo Pérez Alfonso put the dubious advantages of large oil reserves in colourful terms. The mineral was, he said, “the devil’s excrement”. Kazakhstan, which has bigger reserves than Kuwait and ambitions to be the world’s fifth-largest oil exporter by 2025, is up to its neck in the stuff. Black gold, of course, is the cliché more commonly applied to the highly prized commodity which, if properly exploited, can transform the economic and social fortunes of a country.

The challenge facing Kazakhstan, which is ranked number six globally in terms of mineralization, is how to avoid the fate of the less-favoured oil producers. In Iraq, Nigeria and Venezuela, for example, a toxic combination of political strife and widespread corruption has meant that the general population faces falling rather than rising standards of living.

Xavier Sala-i-Martin, professor of economics at Columbia University, noted in a recent report: “Based on evidence from a cross-section of countries, natural resources such as oil and minerals do seem to be a curse rather than a blessing, as they impose a heavy drag on long-run economic growth. But the real curse of possessing oil is not so much that it incites the infamous Dutch Disease – the misallocation of resources away from tradable sectors – or that it generates uncertainty because of oil’s price volatility.

“Rather the main problem with oil booms is that they give rise to a series of pathologies – rent seeking, patronage, corruption, plunder – that corrode vital domestic institutions and undermine domestic public institutions and undermine governance.”

The authorities in Kazakhstan insist that they are well aware of the pitfalls. “If we don’t diversify our economy away from oil and gas in 15 years or so we will face serious problems,” says Grigori Marchenko, who as well as being governor of the National Bank of Kazakhstan (and Euromoney’s central bank governor of the year 2003) is special economic adviser to president Nursultan Nazarbayev.

Less-known face of economy Marchenko says that the central Asian republic’s economic fortunes are not solely based on oil and gas and that this is not well understood outside Kazakhstan. “Oil and gas is seen as a sexy sector by journalists and so inevitably it attracts a lot of attention from the international media, which overshadows developments in the rest of the economy,” he says.

According to Marchenko, recent statistics indicate that oil and gas have generated 18% of GDP, 30% of budget revenues and an average of 45% of foreign direct investment over the past five years. In his judgement that means energy’s contribution is important, but not overly so.

Yerzhan Tatishev, chairman of Bank TuranAlem, agrees that the role of oil and gas in the Kazakh economy is often exaggerated outside the country. “The degree of economic dependency on oil and gas is far less than for other countries such as Russia and Venezuela, for example,” he says. “Everybody understands that it is necessary for us to diversify our economy, but it will take time before we will see the results of our efforts. Kazakhstan is not limited to oil and gas development, but oil and gas is a major economic driver and so it would be stupid not to take advantage of that fact.”

Economic performance since 2000 has been impressive. GDP growth has averaged more than 10%, inflation has been trimmed to less than 6% from over 13%, and the government’s fiscal balance as a percentage of GDP has gone from a 1% deficit in 2000 to a bare surplus of 0.003% last year.

Reza Ghaffari, head of Citibank Kazakhstan, says that the government, having managed the transition from a centrally planned to a market economy well, now needs to think hard about the formulation of economic policy to ensure that the benefits of oil and gas wealth are not wasted and are evenly distributed.

“Everybody agrees on the need for economic diversification, but nobody agrees on how best to do it,” he says. “I don’t believe that the non-oil and gas sectors of the economy can grow on the basis of local demand. It has to grow on the back of export demand. Hence the government needs to develop policies which help to promote exports while at the same time encouraging accommodating foreign direct investment into the country.”

Nurlan Talkenov, chairman of investment banking boutique Bridge Fund, agrees that creating the right environment for domestic and foreign direct investment will be vital if the country is to attain its economic potential. “In the past 10 years Kazakhstan has attracted around $20 billion of investment, but wants to attract $60 billion in the next 10 years. It can’t generate all of that amount domestically and so it needs to be attractive to investment from abroad as well.”

The good news from the capital and bank markets is that the appetite for Kazakh risk is extremely strong at the moment.

Bank TuranAlem, for example, recently secured a $245 million dual-tranche term loan via mandated lead arrangers Citigroup and Deutsche Bank – the largest ever syndicated loan for a Kazakh bank, indeed for any privately owned bank from the Commonwealth of Independent States. “There’s a very positive story surrounding Kazakh banks over the last 12 months,” says Ben Dobson, vice-president in the global trade finance department at Deutsche Bank in London.

He adds that as a result of Kazakhstan’s positive credit story – last year Moody’s Investors Service raised the country to its investment grade Baa3 level which had a big effect on the number of banks able and willing to lend – the leading Kazakh banks have been able to raise larger amounts over longer maturities at tighter pricing.

On the back of commitments from 49 banks from the Americas, Asia, Europe and the Middle East – a new record for a Kazakh bank syndication – BTA was able to price the $134.75 million 12-month element of the transaction at a tight margin of 215 basis points over Libor, while the $110.25 million 18-month portion was the first time a Kazakh bank had been able to secure such a tenor in the international syndicated loan markets. Dobson says that the use of the proceeds – the export of commodities and the import of capital equipment – is easily understandable and “is genuine banking business with which lenders are comfortable”.

In April, the country’s leading financial institution, Kazkommertsbank, was able to secure $500 million of 10-year funding in the Eurobond markets.

Growing needs of small firms Increased access to funding from both the private and public sectors will prove vital if the banking sector is to sustain the growing funding needs of the small and medium-size enterprises (SMEs). According to Serik Turzhanov, director of the small business department for Almaty, some 28% of the financial capital’s population is now employed by SMEs. As a result SMEs are now a major source of new business for many of the country’s banks.

“Loans to SMEs have more than doubled in the past two years,” says Tatishev at Bank TuranAlem. Given that SMEs are the driving force behind most western-style economies, maintaining an economic environment in which banks are comfortable lending to new start-up enterprises will be a key challenge for the Kazakh government.

One non-oil and gas related sector that has strong economic and investment potential is metals and mining, which was the pillar of the country’s economy before the discovery and exploitation of hydrocarbon reserves. According to Daniel Tine, a specialist in natural resources and energy at Massachusetts Institute of Technology, at independence in 1991 Kazakhstan’s mineral reserves included 90% of the world’s chromium ore, 26% of copper, 33% of lead, 33% of zinc, and 38% of tungsten.

The country was soon able to attract foreign direct investment into the sector: UK company Trans World Metals bought the country’s largest chromium plant and mine in October 1995, paying $65 million upfront and committing a further $400 million for development.

Korean company Samsung purchased the Zhezkazgan Copper Plant in May 1996 for $49 million, and committed another $300 million. Despite weak world copper prices the plant has remained profitable because of the low operating costs in Kazakhstan.

As well as these large-scale investments several small-scale operators have prospered through their involvement in metals and mining. Celtic Resources Holdings, for example, which is listed on small-cap market AIM in London, has seen its market capitalization soar from £300,000 to £95 million in the past few years on the strength of its gold mining activities in Kazakhstan. Celtic’s key asset there is the 100% owned Suzdal gold mine, containing 1.5 million ounces of gold in reserves, with a projected production of 100,000 ounces by 2004. This asset has been enhanced with the 75% acquisition of the nearby Zherek mine, where production is expected to reach 20,000 ounces by 2004.

Celtic was one of the first foreign companies to invest in the developing Kazakhstan gold mining industry in 1992. “After the collapse of the Soviet Union, issues such as closure of large enterprises, unemployment, heavy bureaucracy, corruption and the absence of a stable currency caused significant hardship to Kazakhstan. Despite this, Celtic decided to invest because we saw great potential and the country was fast becoming stabilized under the leadership of president Nursultan Nazarbayev,” says Celtic managing director Kevin Foo. “We wouldn’t hesitate to invest in Kazakhstan again.”

To date the company has invested $10 million in its Kazakh operations, with a further $21 million to come in the next year. “It’s big money to us, but it’s safe money,” says Foo. Celtic has also created 300 jobs in Kazakhstan and Foo says that it has been pleased with the quality of the staff it has been able to find. “Kazakhstan has an excellent workforce, with literacy rates running at around 98% and more than 30% of the population under 40 having university degrees. The standard of engineering expertise in Kazakhstan is superb – we build all our own equipment using local labour and companies.”

Although acknowledging that there is political risk attached to operating in Kazakhstan, Foo says that Celtic’s experience of dealing with the authorities has been overwhelmingly positive. “Kazakhstan has come a long way in terms of cutting bureaucracy. The Kazakhs are smart enough to know that if they charge too high taxes or introduce punitive laws then investors will walk away from the country.” He adds: “The substantial development and growth in Kazakhstan is clear and many political and economic decisions made since independence have proved to be sound. For some time now the geopolitical axis has been moving east with the emergence of the Russian and Chinese economies and Kazakhstan is at the very centre of this active growth.”

There is also strong interest in coal mining, with Kazakhstan holding 12% of the former USSR’s deposits, for example. In 1996 US firm Access bought the Bogytr coal mine and 66% of the Stepnoy coal mine in Kazakhstan, for more than $40 million, pledging another $550 million in upgrades in the following years.

Agriculture is also set to be of key strategic importance. “The government is very conscious of the need to develop agriculture,” says Raymond Webber, head of HSBC Kazakhstan. “Although in terms of dollar revenues its contribution to GDP is dwarfed by oil and gas, in terms of employment it is of paramount importance.”

Investing in the countryside Citibank’s Ghaffari agrees that to ensure socioeconomic stability the government “needs to be able to create jobs for the poor in the countryside”.

President Nazarbayev certainly thinks so. In his annual address to the nation in April he announced that the revitalization and development of agriculture and the rural areas would be a key social priority, with KT150 billion (roughly $1 billion) of investment earmarked for 2003/05. An additional KT45 billion has been allocated to improve rural healthcare and social services and there are plans for a rural development programme that will promote a combination of rehabilitating rural communities or assistance in the redeployment and re-employment of the rural population from depressed areas.

A key element of agrarian policy is the reform of land laws, which will allow for the private ownership of land. This will in turn allow farmers to pledge their farmland as collateral for loans.

Among the commercial banks there is a strong belief that with appropriate government and multilateral support Kazakhstan can improve on its ranking as one of the world’s top-five grain exporters. “We have good farmers who understand that the more they invest in their businesses, the better the returns,” says Nurdin Damitov, deputy chairman of Nauryz Bank, the successor organization to the Soviet-era Agroprombank. He adds that Kazakhstan is well placed to take advantage of the opening up of new markets in the region such as Afghanistan and Iran.

Askar Yelemessov, president of Deutsche Bank’s Kazakh investment banking unit, DB Securities Kazakhstan, says that because of the large amount of cultivatable land available there is strong potential for viable organic food production that could generate extra export revenues.

Alongside the promotion of the agricultural sector, president Nazarbayev has announced several important initiatives this year to encourage the development of a larger manufacturing base.

These include the establishment of an innovation fund responsible for funding new technology enterprises and a Kazakh investment fund, which will stimulate the creation and expansion of firms producing high-value-added goods. As well as providing working capital the fund will take stakes in the companies it finances. Finally, Nazarbayev also announced plans to create an export insurance corporation, which will provide political risk insurance to help boost international trade.

The government’s initial investment in these new institutions will total just under KT34 billion. They are designed to complement the activities of the Development Bank of Kazakhstan, which was established in 2001 to provide funds for manufacturing and production companies. To date the DBK has provided KT23 billion of loans, a figure that is set to increase significantly, following a government decree authorizing an increase in DBK’s charter capital to $500 million from an initial equivalent of $250 million. “We expect our loan portfolio to increase by around $120 million to $140 million a year,” says Kambar Shalgimbayev, DBK’s president. “So the extra funding is vital as we are only allowed to lend on a 1:1 basis with our charter capital.”

Shalgimbayev says that the new government team appointed at the end of June wants the DBK to be a prime participant in the development of key areas: the agricultural and food processing industries; chemicals and petrochemicals companies; the promotion of hi-tech manufacturing; and infrastructure development relating to the country’s Caspian shelf oilfield programme, which envisages the sale of exploration and development licences for around 120 offshore blocks in 2003/04.

“The goal of the country and of DBK is to solve the problem of potential over-reliance on oil and gas. The oil and gas developments in Kazakhstan are very good, but we need to be independent of the sector as well,” says Shalgimbayev. He adds that because of its geographical position, with sufficient investment in road, rail, sea and air links there is an opportunity for Kazakhstan to become the key transit country between Asia and Europe. “There’s a good chance to recreate the old Silk Route, but in a hi-tech format.”

Is a public sector development bank needed? “Many of the infrastructure projects financed by the DBK could just as easily be funded by the commercial banking sector,” says Bank TuranAlem’s Tatishev. “The idea behind the DBK is good but commercial banks can fulfil most of the role anyway.” Shalgimbayev, however, says that DBK’s position as a government agency enables it to borrow and then on-lend at a more competitive rate than private-sector institutions.

Ghaffari at Citibank says that the danger of having a government institution with a conservative lending policy is that it risks passing up on the more speculative type of investment opportunities that are at the very heart of a successful development agency.

Away from the manufacturing/production sectors, the services sector has the most immediate development potential, notably financial services. Although with a population of just 17 million Kazakhstan is dwarfed by both its northern and southern neighbours Russia and China, in terms of financial sector development it is widely regarded as having overtaken both of them.

“Thanks to the progressive policies of the National Bank of Kazakhstan [the central bank] Kazakhstan has been very good at taking on board financial sector infrastructure,” says Citibank’s Ghaffari.

Much still remains to be done domestically in terms of deploying bank funds. Despite growing by an annual average of 30% to 40% in the past three years, banking assets as a proportion of GDP remain a lowly 31.6%, compared with 200% to 300% in the west. However, this has not stopped the leading banks from already looking to expand abroad. “Kazakhstan is not the world’s biggest economy and so it’s a natural step for us to begin exporting our financial expertise to the rest of the CIS,” says Tatishev at Bank TuranAlem, one of the leading banks looking to establish a foothold in Kyrgyzstan and Russia.

At home, the introduction of innovative consumer and mortgage finance products by fast-growing retail banking specialists such as Alliance Bank is having a dramatic effect on sales of cars, electrical goods and property, which in turn is helping to boost the fortunes of the retail and real estate services sectors.

A great private-equity play Even the imperfections in Kazakhstan’s financial system have created opportunities for new players. Since the majority of the largest corporates are either in state or foreign hands, the development of equity capital markets infrastructure has been stunted, with the KASE bourse in Almaty perennially plagued by the poor liquidity of the small-cap stocks listed on it. This has created a business opportunity for a new generation of investment banking boutiques such as Visor Investment Solutions and Bridge Fund which, as their names suggest, are looking to act as intermediaries between holders of assets and potential investors.

“The stock market in Kazakhstan is almost non-existent and is very illiquid, and that has created a tremendous opportunity for private-equity investment,” says Nurlan Talkenov, founder and chairman of Bridge Fund.

Talkenov believes that there is a good chance of attracting new capital through private-equity investment. “There are still assets to be bought in Kazakhstan, with lots of mergers and acquisition potential across different sectors of the economy,” he says. “The upward pricing trend we are seeing here is also strongly reminiscent of the bull run we saw in the US market in the 1980s and 1990s.” He highlights the brewing sector as one with strong FDI potential, especially since the recent acquisitions by Carlsberg and Heineken.

Bridge Fund is also looking to list Kazakh assets in New York. It intends to buy oil and gas licences in Kazakhstan and then float a shell company in the US to raise money to fund production. Talkenov believes that real-estate development also has strong investment potential, given that land prices have doubled in the past 12 months and the potential profit margins on luxury housing or business centre developments are running at upwards of 40%. He acknowledges, however, that the recent boom in real-estate prices – parts of Almaty have seen tenfold increases in the value of residential property in recent years – may be vulnerable to any fall in oil prices, which could dispel the feel-good factor in the city.

Talkenov believes that Kazakhstan has strong potential as the prime conduit for investment in the rest of central Asia. Kyrgyzstan, which is slowly opening up its economy, is seen as a natural investment destination for the excess liquidity available in Kazakhstan. Talkenov highlights the recent acquisition of Kyrgyztelecom by Swedtel as evidence that Kyrgyzstan can be attractive to foreign investors.

As the most populous country in central Asia, with around 40 million inhabitants, Uzbekistan could be an even bigger draw. Talkenov says: “It’s a natural market for Kazakh capital and asset prices are still very low.” Given the current investor-unfriendly regime of Uzbek president Islam Karimov, however, Bridge Fund’s strategy for Uzbekistan is centred on sourcing suitable co-investment projects with international financing institutions such as the European Bank for Reconstruction & Development and the International Finance Corporation to help mitigate political risk.

Although there is also potential for Kazakh companies to expand into Russia, the bigger number and size of Russian companies means it is more likely that the Russians will be buyers of Kazakh assets rather than sellers of Russian ones.

Indeed, perhaps the cruellest irony should an independent Kazakhstan succeed in developing a truly open, diversified economy is that it will open itself to a potential economic takeover bid by its one-time imperial master.

Kazakhstan, the ultimate bolt-on acquisition for an overly oil-dependent Russia? Stranger things have happened.