Having suffered three major crises - the break up of the CIS, the 1998 Russia Crisis, and the depressed oil prices of the same time - the Kazakh economy is now reaping the benefits of the liberalizing economic reform measures taken

Although oil prices remain depressed in real terms, Kazakhstan is enjoying positive results from massive increases in production. Exports doubled from 1999 to 2000, in part owing to improved access to international markets.

The benefits of oil are felt also through massive FDI, to build capacity, and also through taxes on companies and individuals employed in providing infrastructure and services

The public finances of Kazakhstan are in excellent condition at present, buoyed by vastly increased tax revenues and tightly controlled expenditure. The government ran a fiscal surplus of 12.9% of GDP in the first quarter of 2001. The morass of subsovereign indebtedness is being addressed through an interventionist scheme of fiscal transfers and limits on borrowings at the Oblast level

The external position of Kazakhstan is extremely robust. There is a huge balance of payments surplus, overseas borrowing is limited and for extended maturities. Domestic holdings of hard currencies are substantial, bolstered by multibillion dollar holdings in the pension funds and the petroleum fund, both increasing in size at a rapid pace.

The obverse of the oil success story is that Kazakhstan runs the risk of “Dutch Disease” whereby export revenues from commodities cause appreciation of the real exchange rate and render other sectors uncompetitive. The indirect income from employment in oil and other sectors combined with increased government largesse in social spending may combine to fuel inflation. So far the government has avoided this, in part through the petroleum fund, but poor social indicators and increased democratisation may create increased pressure for more spending.

Introduction
Kazakhstan is the 9th largest country in the world by territory (2,717mn km²), with only 14.95mn people. Its low density of population is determined by the preponderance of arid areas (some 60 % of territory) and dry steppe. Mountains cover about 10% of the total land mass. The country is located between Russia to the north, China to the east, the Caspian Sea to the west and three other ex-Soviet republics of Central Asia – the Kyrgyz Republic, Uzbekistan and Turkmenistan - to the south. The main cities are Almaty (1.2mn people, former capital, economic, financial and cultural centre, seat of the National Bank, leading private banks and corporations), Astana (0.34mn people, new capital), Karaganda (0.55mn people, heavy industrial hub of Central Kazakhstan) and Shymkent (0.45mn people).

Kazakhstan, one of the larger constituent parts of the former USSR, was one of the last of the 15 Soviet republics to declare independence in 1991. Kazakhstan entered independence challenged by a number of adverse factors: the extremely delicate ethnic balance (Kazakhs were only 44 % of population in 1989[1]); a strong dependence of the economy upon other parts of the former Soviet Union; not having its own armed forces at a time when bitter ethnic conflicts were already flaring up throughout the region, and a geopolitical position land-locked between Russia and China.

The subsequent ten years of independent Kazakhstan betray a history of a nation’s struggle, led by a shrewd and patriotic political elite, to preserve and develop a nation state. The political leadership faced formidable challenges: to preserve national sovereignty and territorial integrity, without antagonising powerful neighbours; to escape domination by one power by manoeuvring between Russia, China and the US; to reform the collapsing planned economy and introduce market forces; and to develop new transport routes for commodity exports.

Kazakhstan’s political establishment is built around one charismatic figure – that of the President Nursultan Nazarbaev, former Prime-Minister of Kazakhstan within the USSR. The existing political system is described as dirigiste and technocratic. Although some question the level of democracy relative to western standards, international organizations, such as the OSCE[2], highly praise Kazakhstan for its ethnic stability and constructive relations with neighbouring countries. International economic and financial bodies, such as the World Bank/IMF, EBRD, and the OECD often award Kazakhstan the status of economic reform leader in the CIS. The mass media of Almaty and Astana are free to criticize the Government, whereas those in the oblasts (provinces) are more restrained.

Kazakhstan is well endowed with mineral wealth – its reserves of oil, gas, coal, ferrous and non-ferrous metals are of world significance. Development of these resources is the mainstay of the local economy and will determine the nation’s economic prospects in the foreseeable future. Especially significant is the oil and gas sector, which has attracted foreign direct investment (FDI) in such amounts as to make Kazakhstan one of the leaders in the whole post-communist region in terms of FDI per capita.

Economic Review
During the early transition period of 1992-1995, the formerly planned economy was in free fall. Many enterprises, as was typical for the planned economy, produced substandard products with negative value added, and consequently went bust. This was especially the case in the sectors producing consumer goods and industrial equipment. The general economic malaise was exacerbated by a balance of payments crisis as well as the breakdown of technological and financial relationships with other former Soviet republics. Further disruption was brought about by the disintegration of the single currency zone (rouble zone). Even enterprises producing exportable basic commodities, such as metals and oil, were starved of capital. Inflation and unemployment were rampant. In these conditions the Government adopted a radical reform course aiming to introduce a national currency – the Tenge (November 1993), suppress inflation, privatise state enterprises and bring in foreign investment. By 1995 this policy had started to pay off. The economy stabilized, and massive foreign investment was attracted into the commodity sectors, reviving the enterprise sector sufficiently to compensate for weakness in other areas. By 1996 and 1997, the economy had returned to positive GDP growth, despite international oil and metal markets continuing to be depressed. Re-industrialization has started in the consumer goods sector, especially for food, beverage and tobacco. In 1998, first the Asian crisis and then the Russian crisis subjected the economy of Kazakhstan to severe shocks, the former by further depressing world demand for oil and metals, the latter through a catastrophic fourfold devaluation of the Russian rouble, which made Russian manufactured goods much more competitive. Due to the absence of trade barriers, this had a severe adverse effect on Kazakhstan’s manufacturing sector. After a 50% devaluation of the Kazakh Tenge, the economy showed significant resilience, returning to growth in 1999. Structural reforms were pursued with new vigour. It is widely agreed that the Government handled the consequences of the Russian crisis quite satisfactorily.

While the economy remains highly dependent upon the mining sector (with oil production representing around 12% of GDP and metallurgy a further 8%), in the absence of any sharp fall in oil prices, the potential risks to the fiscal stability of Kazakhstan are limited. The current international oil price of approximately $20 per barrel is understood to be consistent with government (and IMF) planning. Net indebtedness of the federal government is limited and declining with the government operating a surplus equal to 12.9% of GDP in the first quarter of 2001. The situation since then has become more complex, as since May 2001 surplus oil revenues are directed to the National Fund. However, the broad picture remains extremely positive. Furthermore, as the public debt is limited and maturities are long, there is minimal refinancing risk. As of the first quarter of 2000, two thirds of public sector foreign debt was owed to multilateral and bilateral, creditors with an average life for foreign debt of 9.8 years.

The dependence on oil revenues for a positive fiscal balance is accentuated by weaknesses in tax administration. At the end of 1998, tax arrears amounted to 6.8% of GDP and have not been materially reduced since. Low rates of tax collection are reflected in the fact that the average effective tax rate on personal income is over 10% while the tax yield is only 2% of GDP. Similarly the 26% payroll tax produces revenues of only 4% of GDP and the 20% VAT generates less than 5% of GDP[3]. These numbers indicate a large degree of tax evasion.

GDP Growth
In 2000 and 2001, world oil and metal prices increased substantially, and this, combined with increasing national production, produced extraordinary GNP growth for Kazakhstan (Table 1). This growth was reflected both in explosive capital investment and strong consumer demand, the latter giving a boost to national manufacturing, which now produces consumer goods of internationally competitive quality. Other sectors, notably banking/finance, construction and transport/communications have benefited accordingly.

Table 1. GDP Growth

For the first half of 2001, real GDP growth reached 14.1% versus the same period in 2000. This was one of the highest growth rates seen anywhere in the world.

The economy of Kazakhstan is strongly affected by external conditions (especially those on the international oil and metals markets). The country exports some 43% of its GDP and a significant part of total investment is of foreign origin. This makes economic forecasting a big challenge for the Government, which tends to be conservative in its predictions. Tellingly, the GDP forecast for the whole of 2001 was only 4% growth, while the outcome is likely to exceed 12%. The Ministry of Economy and Trade envisions 7% GDP growth and 10% growth in industrial production for 2002.

Oil and Gas
Energy continues to be of the utmost importance for the economy. Production of oil in 2001 is set to reach 311mn barrels, (259mn barrels in 2000). The potential production, around the year 2014, according to projections of the Ministry of Energy, Industry and Trade, may reach 0.9bn to 1.3bn barrels, most of which would be extracted on the Caspian Shelf, where the giant Kashagan oilfield, arguably the world’s largest oil find for the last 10 years, was recently discovered. Estimates of Kazakhstan’s oil wealth range between 10bn and 150bn barrels. Such a large discrepancy is explained by insufficient exploration of the potentially huge Caspian Shelf reserves.

Oil companies operating in Kazakhstan took advantage of the increase in oil prices on the world market to significantly increase exports of crude. In 2000, prices for fuel and energy resources in Kazakhstan grew 79% overall (against a fall of 9.4% in 1999), and oil producer prices grew 2.7 times. So much oil was exported that local refineries were starved of supplies (owing to higher overseas prices). This disparity between domestic and international prices for oil remains marked, but has declined modestly. For the period January to July 2001 the international oil price averaged $20.87 per barrel against $22.07 for the same period in 2000. Over the same time period the prices on the domestic market actually increased to give an average of $9.27 in 2001 against $6.40 in 2000.

On August 8, 2001, the strategy for gas industry development to 2015 was elaborated by the Ministry of Energy and Mineral Resources. Today's resources of natural gas in the country are estimated at over 2trn m³. Extraction of natural gas in 2005 may reach 34bn m³ (consumption – 7.84bn), in 2010 – 47bn m³ (consumption 11.15bn) and in 2015 – 52bn m³ (consumption 15.83bn).

International Reserves & Balance of Payments
Foreign exchange reserves declined in 1998 during the Russia Crisis, as the Government tried initially to defend the Tenge. Spending to maintain the high exchange rate of national currency led to a decrease in gold and currency reserves from $1.96bn at the end of 1998 to $1.60bn on 1 April 1999. Too high an exchange rate for the Tenge in comparison with the devalued currencies of other countries in the region - trade partners of Kazakhstan - caused a deterioration in the balance of trade for Kazakhstan (Table 2).

In the face of a drastically deteriorated (i.e. increased) terms of trade vis-à-vis the Russian manufacturing sector, and depleted foreign reserves, the Government and the National Bank agreed to adopt free currency flotation and a devaluation of the national currency at the beginning of 1999. The current account remained negative throughout 1999, however, and required further financing out of the foreign exchange reserves of the National Bank.

Table 2. Balance of Payments

Unfortunately, the Capital Account also experienced a marked deterioration at the same time. This was mainly caused by a general and drastic reassessment of risk by investors in emerging markets, following the Asian and Russian crises. Investors’ confidence in Kazakhstan was further shaken by the adoption of a freely floating exchange rate.

Foreign reserves started growing only from the very end of 1999 following strong growth in export and foreign investment. This trend has continued from that time (Table 3).

Table 3. International Reserves*

As of 15 October 2001, the international reserves of the National Bank have reached $2.45bn, total international reserves have reached $3.63bn, including $1.18bn in the National Fund.

As oil exports stand to grow significantly in coming years, the terms of trade are once again under threat from a real appreciation in the Tenge. There is a fundamental mismatch between exports of commodities, the prices of which are determined in volatile international markets[4], and imports which are largely for consumer, investment and intermediate products which typically reflect greater price stability. Exports of non-oil products have actually decreased in nominal terms since 1998. In the year 1999-2000 the terms of trade for Kazakhstan appreciated by over 30%[5]. Even excluding oil, there was an effective appreciation of 6.3%. A major challenge for Kazakhstan will be the prospect of “Dutch Disease” whereby buoyant exports of commodity goods cause a currency appreciation and render the non-oil economy uncompetitive. At present, a significant part of this problem is caused not only by the exports of oil products, but also the significant FDI to develop the oil industry and the commensurate indirect impact on the labour market. The sterilization of oil revenues into the National Fund goes some way to ameliorate this problem but implies that these revenues are not then available for much needed spending on social services and poverty alleviation.

Foreign and Domestic Debt
Kazakhstan’s foreign debt continues to rise, but the structure is developing favourably. Government and Government guaranteed debt has been slowly decreasing, starting from 1999. The rise in private sector debt rise is mainly associated with loans to subsidiaries by foreign parent companies, as the FDI boom continues. The Government boasts of the country’s unique position amongst CIS states, noting that Kazakhstan owes nothing to the IMF. With continued strong growth in international reserves, the Government should have little difficulty servicing its foreign debts.

Furthermore, domestic debt is quickly decreasing, as the Government has no need to finance the budget through domestic borrowing. Consequently, the yields on Kazakh T-bills are very low at present.

Table 4. Foreign and Domestic Debt

Exchange rate
In 2000 and 2001, the management of the Tenge was directed toward escaping major swings against the Dollar while not allowing the currency to appreciate sharply, in nominal terms, against the currencies of other trade zone partners (especially Russia). This exchange rate regime led to a significant increase in international reserves in 2000 and 2001, owing to the sharply increased value of exports of hydrocarbons and metals and corresponding massive balance of trade surplus. The National Bank is widely expected to start targeting price stability, rather than the exchange rate, as its main objective.

Table 5. Exchange Rate

The Government assumed an exchange rate of 153.9 per $1, and an annual average – 149.9 per $1 when making budget projections for 2002.

Monetary Policy and Inflation
Since 1995 the Government and the National Bank were actively pursuing a strict anti-inflation policy, following a broad set of recommendations on monetary policy from the IMF and the World Bank. The Russian rouble crash of 1998 caused massive imports of Russian manufactured goods, which sent prices for many consumables down. Annual changes in the CPI index in the late months of 1998 and early 1999 were into single digits (and even negative).

The strict monetary policy which was implemented until April 1999 ensured a decrease in inflation to 7.1% for the whole of 1998. However, the decrease in the rate of inflation was accompanied by an abrupt decline in money in circulation. This fall in liquidity served to further aggravate the internal crisis of commercial non-payment, as the National Bank’s policy of maintaining high interest rates kept money expensive and impeded credit to the real sector.

The appreciating real exchange rate and the lack of domestic liquidity caused the Government of Kazakhstan and the National Bank to depart from strict monetary policy and adopt a more stimulative monetary and credit policy while allowing the exchange rate to float. Consequently, annual inflation increased in 1999 to 18%. Inflation was back in single digits by the end of 2000. Producer prices duly followed developments in the international oil and metals markets. A sharp increase started in late 1999, and continued until mid-2000.

Throughout 2000, with the benefit of an improving economy and favourable inflation and exchange rate outlook, the National Bank continued to ease monetary policy, continuing this policy into 2001. Rapid expansion of the monetary base and especially broad money resulted from, and contributed to, fast economic growth. The process has not been accompanied by an upsurge in inflation.

Table 6.Money aggregates

On September 6, 2001, the National Bank reduced the rate of refinancing from 12% down to 11%, making the third reduction in 2001, prompted mainly by continuing favourable inflation dynamics. The National Bank expects this reduction to cause not only lower interest rates, but also higher business confidence. Expectations are that the easing trend will continue for the medium term without enhancing inflationary pressure.

By year-end 2001, inflation is forecast to be less than 7% per annum. In the 12 months to August 2002, inflation, as measured by the CPI has been 8.4%. The CPI also reflected zero inflation for the month of July. For 2002, inflation is expected to be in the range of 5-7 % and in the following 2-3 years it is expected to be within 4-6%.

Currently the National Bank is contemplating the introduction of a new model for inflation deterrence. It envisions that the National Bank together with the Government will state a maximum reasonable level of inflation for a year (or a longer period) and will keep inflation within the stated limit.

Table 7.Inflation

External Position
After a sharp setback in 1999, Kazakhstan’s external position improved significantly throughout 2000 and 2001. Following a stark improvement in terms of trade, shifts towards a positive trade balance and balance of payments, and larger international reserves (Tables 3,4), the country has seen its credit rating improving. Standard and Poors` long-term rating has reached BB+ for local currency and BB for foreign debt. The short-term rating is now B for both local and foreign currency, and both long-term and short-term outlooks are stable (Table 8). Of the CIS countries, only Kazakhstan and Russia have credit ratings, Kazakhstan being the stronger rated.

Table 8. Credit ratings history of Kazakhstan

Moody's Investors Service announced a credit upgrade for Kazakhstan on 20 June 2001. Thus, the republic's bonds in foreign currency shifted from B1 to Ba2, and bank deposits in foreign currencies moved up to Ba3 from the previous rating of B1. Long-term state securities issued in national currency were also upgraded – from B1 up to Ba1. The forecast for all ratings is positive. According to the agency, the development of hydrocarbon fields and also the start of construction of oil and gas pipelines are confirmation that, in the medium-term, Kazakhstan will be able to achieve significant economic growth. The creation of the National Fund, according to Moody’s, will reduce the influence of world prices on the country's economy and the dependence of the state budget on such prices. They also noted an improvement in the general state of the banking system.

After the Russian Crisis of 1998, Kazakhstan was the first CIS country able to issue a Eurobond (1999, $ 300mn), which was sold in the European and US capital markets.

Foreign Direct Investment
Kazakhstan is widely reputed to have created the most favourable regime in the CIS for foreign investment. Actively attracting FDI was considered crucial in overcoming post-Soviet economic deficiencies and easing the transition to a market economy. Furthermore, it was necessitated by the structure of Kazakhstan’s economy, which required capital-intensive development of energy and mineral resources, whilst there was no significant internal source of capital. The importance of foreign investors is emphasised by the fact that a Council of Foreign Investors has been organized, reporting directly to the President. It has adopted the plans of action developed by four joint groups of the Council that proposed a number of constructive measures directed to the improvement of the investment climate in the country.

Aggregate FDI in Kazakhstan's economy from 1993 to 2000 has exceeded $12bn. After some decline in FDI in 1999 ($1.5bn), it has started growing again from 2000 ($2.7bn). The stock of FDI is heavily concentrated in the oil and gas sectors (56%) and the non-ferrous metallurgy (22%) sector.

Foreign Trade
Radically improving terms of trade and increased production of exportables have sent Kazakhstan’s exports sky-rocketing. Imports, depressed after the 1999 devaluation, have also picked up. Overall, a massively positive trade balance was built up in 2000. In 2001 it will be less, reflecting sharply increased imports of capital goods, especially equipment for further developing oil and gas fields, and the renovation of industrial plant throughout the economy. Increased purchasing power on the part of consumers has also to increased import of consumer goods.

Table 9. Exports and Imports

Table 10. Structure of Exports

Table 11. Structure of Imports

Public Finances
Budget revenues and expenditures sharply increased in 2000 and 2001. 2000 ended with practically a zero fiscal deficit, although the budget was revised towards increased spending. Reflecting tax and non-tax windfalls from higher oil, gas and metals prices, as well as runaway economic growth, the state budgets for 2000 and 2001 were amended several times by Parliament. Higher than planned budget revenue in 2001 has allowed the Government to reduce the budget deficit by KZT 31.9bn down to KZT 27.3bn (approximately 0.9% of GDP). The Ministry of Finance is refraining from foreign borrowing, even though such important budget contributors as VAT and social taxes have been reduced. The privatisation programme is also being scaled down.

In contrast, after the last budget revision, expenditures are up only by KZT 19.6bn. Additionally, KZT 12.8bn will be contributed as charter capital for the newly created Development Bank of Kazakhstan. In the first quarter of 2001, the budget surplus reached the extraordinary level of 12.9% of GDP. Although an amendment to the budget duly followed, expenditures increased again and the share of Government revenue and expenditure in GDP shot up. Increasing the possibility for strong fiscal expansion without jeopardising the state budget, the Government has cut VAT from 20% to 16%, and social taxes from 26% to 21% (from 1 July 2001).

Table 12. National Budget

Banking Sector
Within the framework of the transition from a planned to a market economy, the reform of the banking sector started in 1990, before independence, with the adoption of the law “On banks and banking activity in the Kazakh Soviet Socialist Republic”. This law became a cornerstone of subsequent banking reform by establishing a definition for, and legalizing, commercial banking. The establishment of other credit institutions, such as credit co-operatives, pension and investment funds, and banks with foreign participation, was also now permitted. Previously the whole banking sector had consisted of five state “banks”: one “first tier” bank, State Bank (Gosbank), and four at the “second tier”, Bank for Foreign Trade (Vneshekonombank), Savings Bank (Sberbank), Agroprombank (Agricultural Bank), and Promstroybank (Bank for Industry and Construction).

The new law established the general functions of the National Bank of Kazakhstan, including managing monetary policy and credit regulation, and control of the list of operations permitted for Gosbank and the commercial banks. A regulatory environment was established for the first time for commercial banking.

Formally, a two-tier banking sector was established, with the National Bank of Kazakhstan (NBK, initially GosBank of Kazakhstan) representing the first tier, and the commercial banks comprising the second. Soon after independence, about 200 commercial banks were operating. Most were undercapitalised, as was the whole system, functioning in a weakly regulated, fraud-infested environment. In the decade to follow, the NBK made spectacular advances in terms of strengthening regulation and supervision, reducing the number of banks to 47 in 2001. Strict requirements to meet NBK-established international standards and higher capitalization were gradually applied to commercial banks.

The national currency – the Tenge – was introduced at the height of the transition crisis – in November 1993. The accompanying additional extended responsibilities for monetary policy and foreign exchange provided the NBK with the full powers and functions of a central bank.

The young banking system was severely tested during the Russia Crisis and the related transition to the free-floating Tenge regime (which was accompanied by abrupt devaluation of the national currency). Despite these challenges, the system showed significant stability, public confidence was not lost and the deposit base remained stable. The two main reasons for this were: the high levels of bank capitalization which had already been achieved; and the bold decision by the NBK to avert a run on deposits by publicly committing to convert Tenge deposits into Dollars at the pre-devaluation exchange rate of 88.3 KZT/$. All NBK obligations were fulfilled in an orderly and timely manner, which produced a sea change in depositor confidence.

A meltdown of the banking sector, as seen in Russia, was not experienced. Within 1999 total deposits increased by 58 % in nominal terms, whilst private deposits grew by 36%.

At the beginning of 2000, the Kazakhstan Deposit Guarantee Fund was established, with 16 leading banks taking part at the outset (representing 88% of all term deposits in the country). The Deposit Guarantee Fund was established as a Joint Stock Company with the ultimate aim of further boosting deposit inflow. With the same purpose, the “Law on Banking Secrecy in the Republic of Kazakhstan” was adopted in March 2000.

Continued strict and responsible regulation by the NBK has led public confidence to new heights. In 2000, private deposits, including those from non-residents, increased by 66.8% and reached KZT 91.7bn (about $635mn.)

The role of the 2nd tier banks in providing credit for the real economy has also substantially strengthened. Against a background of resumed economic growth, stable development of the financial sector, and the rapid growth of bank resources, the supply of credit to the real sector significantly expanded, further fuelling growth. By the end of 2000 the ratio of bank credit to GDP reached 11% (versus less than 8% in 1999). Nowadays more than 60% of bank resources are directed towards the real economy. In 2000, total bank assets reached KZT 527.9bn ($3.7bn), up from KZT 140.9bn ($1.9bn) in 1996. The share of non-performing loans has decreased to 2.0%, (24.3% in 1996). There are now 16 banks which are more than 50% foreign owned and their share of total banking sector capital is now 23.2%.

Non-bank financial services are also developing. In 2000, regulations were introduced in relation to financial leasing, and many leading banks have established their own leasing companies. In addition, the Government has launched its “Long-Term Programme for Financing Residential Construction and Development of Mortgaging” to promote the mortgage finance sector.

Among the measures for further strengthening banking sectors, the NBK has announced the following measures:

- introduction of “consolidated” supervision of banks, i.e. taking into account share cross-holdings within financial-industrial groups and various distortions in banks' performance resulting from affiliation with other entities, and the development of appropriate risk management recommendations;

- extension of regulations covering entities engaged in banking operations, including postal banking;

- support for the introduction of new financial instruments;

- continued development of the system for collective deposit insurance, (extending it to non-term deposits).

In general, at present the Kazakhstan banking sector is widely considered the most advanced and stable in the CIS. It demonstrates not only a quantitative increase in banking activities, but also improved quality of services. Its adherence to international standards for banking and General Principles of Bank Supervision (Basle Committee for Bank Supervision) allows it to support a high level of stability, and a rapid pace of development.

Table 13. Main Economic and Banking Indicators (NBK), 1995-2000

The latest available data, as of 1 September 2001, shows the number of banks at 44, including 1 bank with 100% state ownership, 1 inter-governmental bank, 16 banks with foreign participation, which include 12 subsidiaries of foreign banks. The total equity capital of the banking sector has reached KZT 114bn ($770mn), a 16.8% increase within the last 8 months.

Compared to the end of 2000, the share of the 3 leading banks, TuranAlem Bank, Kazkommertzbank, and Halyk Savings Bank, has grown from 35.5% to 47.9%. The share of foreign subsidiary banks has grown from 22.8% to 23.7 %.

Indicators of capital adequacy remain strong:

- tier one capital to total assets rate is 13% (versus a requirement of 6%);

- tier one capital to total risk assets is 18% (versus a requirement of 12%)

The current trend within the sector is towards a somewhat lower capitalization rate, explained by faster growth of assets outpacing growth in equity capital.

From the beginning of 2001, total assets have increased by KZT 155.1bn (29.4%) and reached KZT 683bn in September. The Dollar equivalent of total assets has reached $4,642mn, an increase of 27.1%, or $989mn.

Pension System
Within the existing framework, the state budget envisages minimum pensions to rise in 2002 and reach 45% above their 1999 level. Public employees are to see their wages rise by 25% in 2002. The President is opposed to lowering the pension age[6].

The total amount of funds accumulated by the pension system has reached KZT 161bn (66% up from KZT 97bn at the same date last year). A wide-scale state-sponsored advertising campaign is being run to increase public understanding and acceptance of the new pension system. However, private pension funds are reluctant to actively solicit business in rural areas, and even in smaller district centres. As a result almost half of the working age population remains outside the pension system. Official declarations, implying that pension reform (including the introduction of the “accumulating” (private) pension system instead of the “solidarity” (state) one) is close to being finalised, stand in marked contrast to the fact that the pension system nationwide covers only 4.3mn employees, compared with 8.6mn people of working age.

The pension system is dominated by the State Accumulating Pension Fund (SAPF), which was initially meant to serve as a default option for depositors, to ease their entry into the new pension system while they make their choice between many private funds. In reality, as of 1998, the SAPF accumulated 95% of all pension deposits, almost all of which were invested in low-income T-bills, starving the real economy of much needed capital. Effectively, in 1998-1999 the new pension system was continuing to play the same budget-plugging role as the old system, funding the government at low interest rates. The last two years have seen a stark re-distribution of pension assets in favour of private funds – SAPF`s share has declined to 39% in 2000 and 33% in 2001 (as has, coincidentally, the government’s funding requirement). In the near future, SAPF is scheduled to be equalized with private funds and probably privatised. However, there has not been much tangible improvement with regard to pension fund investment assets – more than 70% of funds are invested in Kazakhstan government eurobonds and T-bills. Only 16 % are invested in the bonds and shares of companies which have class a “A” listing on the Kazakhstan Stock Exchange (KSE). Reflecting underdevelopment of the national capital markets, and concern with low investment returns, the Government has allowed the pension funds to invest in shares and bonds abroad.

To date, the anticipated development of capital markets resulting from pension system reform has not occurred. Some 70% of private sector managed pension assets remain invested in Kazakhstan government debt. The overwhelming bulk of investments, around 90%, are invested in Dollar assets, creating the potential for losses from the foreign exchange mismatch and also the real appreciation of the Tenge. It is anticipated that the regulations governing investments overseas will soon be changed to allow for investment in a broader category of corporate and sovereign debt (Single ‘A’ as opposed to Double ‘A’ at present). More importantly, the new qualification for sovereign debt is rumoured to be lowered to a rating equivalent to that of Kazakhstan (now BB+), which will open significant new investment opportunities.

A greater problem, however, has been the lack of mobilization of resources for domestic corporations. Although, unusually, the capital markets in Kazakhstan rank ahead of the banking sector for provision of finance to the real sector, this has been concentrated almost entirely in the blue chip sector of predominantly state owned or controlled companies. The realization of the potential of investment from the pension sector will depend upon improvements in corporate governance and accounting transparency.

Conclusion
Against a backdrop of strong economic fundamentals, a stable political climate, strong currency reserves and great mineral wealth, Kazakhstan offers excellent investment opportunities to the international investor. Undoubtedly, much of its resurgence in fortunes has been won at the cost of an increased dependence on the hydrocarbon sector. Already, however, sufficient reserves have been built into the system that even substantial and prolonged weakness in the price of oil is unlikely to undermine sovereign debt servicing capacity, and the ability to support public interest entities.

While investor experience has undoubtedly improved since the tumultuous early years, lessons learnt in some sectors indicates caution is necessary. GML is well established in Kazakhstan and therefore favourably positioned to assist clients in identifying value in Kazakhstan and selecting suitable investments.

Furthermore, the returns now available from Kazakh sovereign instruments have been eroded by the significant investment form the pension sector. In consequence, GML focuses on value-added transactions providing pick-up versus mainstream sovereign and state-sector debt which can be achieved through the trade finance and à forfait markets.

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[1] Now 53.4%

[2] Organization for Security and Co-operation In Europe

[3] Source IMF

[4] 78% of exports were accounted for by oil and other commodity products

[5] i.e. the ratio of the index of export prices to the index of import prices

[6] At the Peoples Assembly of Kazakhstan last session, 24 October 2001, he said “If we lower the pension age, then in 5-7 years there will be one pensioner for each working person. To cover these colossal expenditures KZT 30-50bn will be needed. There is no such money in the budget. We will come again to pension crisis.