KAZAKHSTAN: MERMOUD DISCUSSES PUBLIC-PRIVATE

C O N F I D E N T I A L SECTION 01 OF 06 ASTANA 001243

SIPDIS

NOFORN
SIPDIS

DEPT FOR EB/ESC; SCA/CEN (O'MARA)

E.O. 12958: DECL: 03/15/2017
TAGS: ECON EPET ETRD PGOV KZ
SUBJECT: KAZAKHSTAN: MERMOUD DISCUSSES PUBLIC-PRIVATE
PARTNERSHIP AND ASTANA,S PUSH FOR DIVERSIFICATION

REF: A. A) ASTANA 1240

B. B) ASTANA 1122

C. C) 06 ASTANA 150

D. D) ASTANA 753

Classified By: CDA Kevin Milas; reasons 1.4 (b) and (d).


1. (C) Summary. In April 24-26 meetings with Prime Minister
Masimov, other Kazakhstani government officials, and private
sector representatives, Special Representative for Commercial
and Business Affairs J. Frank Mermoud discussed the
Kazakhstani government,s fast-evolving approach to economic
diversification and opportunities for bilateral engagement in
the framework of the Public-Private Partnership Initiative.
Masimov outlined the GOK,s latest plans to shift its focus
away from further development of the oil sector toward
domestically-driven diversification. He presented the new
&30 corporate leaders of Kazakhstan8 strategy, the GOK,s
own public-private initiative, and expressed interest in
exploring ways to create links with the proposed U.S.
initiative. Representatives of the private sector emphasized
tax and customs administration, along with a rule of law
deficit, as key obstacles to sustainable business and
economic development. They expressed hope that the
Public-Private Partnership Initiative can become a vehicle
for addressing these concerns. Ref A reports Masimov,s and
Sagadiyev,s remarks on the GOK,s current plans for the oil
sector. Please see action request in paragraph 25. End
summary.


2. (SBU) Special Representative Mermoud met the following
representatives of the Kazakhstani government and the
business sector:

April 24:
-- Raimbek Batalov, President of the Forum of Entrepreneurs
-- Arman Moldakhmetov, Vice President of the National
Innovation Fund
-- Courtney Fowler, Partner - Pricewater House Cooper
-- Kenneth Mack, Partner - Chadbourne & Parke, President of
the American Chamber of Commerce

April 25:
-- Serik Akhmetov, Chairman of the Association of Financiers
of Kazakhstan
-- Yerlan Sagadiyev, Advisor to the Prime Minister
-- Nurlan Kapparov, President of KazInvest Bank

April 26:
-- Azat Peruashev, President of the &Atameken8 Union of
Entrepreneurs
-- Ulf Wokurka, Deputy Chairman & CFO of Samruk State Holding
Co.
-- Karim Masimov, Prime Minister
-- Alikhan Smailov, Chairman of Managing Board ) &KazAgro8
National Holding Co.
-- Askar Batalov, Vice Minister of Industry & Trade
-- Serik Akhmetov, Minister of Transport & Communications

Shifting Focus Away from Oil(
--------------


3. (C) On April 26, Prime Minister Masimov provided Special
Representative Mermoud and the Ambassador with some
background on the GOK,s current economic thinking.
President Nazarbayev, Masimov said, attached a lot of
importance to economic diversification even in the early days
of Kazakhstani independence. &Back then,8 Masimov mused,
&we were hoping for a Marshall Plan.8 &Unfortunately,8
he continued, Kazakhstan is &most interesting8 to foreign
investors as a supplier of oil, not &other things.8 Now,
the Prime Minister stated, the government has decided to take
action into its own hands. &Before, we focused on selling
natural resources. Now we want to sell products.8


4. (C) In an earlier meeting, Masimov,s Advisor Yerlan
Sagadiyev expressed the view that the GOK,s spending of its
oil windfall is crowding out the desired private investment
in the non-extractive sector. Kazakhstan,s corporations, he
said, are directing their investment abroad as they flee the
uncertainty created by the GOK,s heavy-handed involvement in
a wide range of sectors. He explained that the challenge is
to delineate the separation of the government,s and the
private sector,s roles in the economy. The idea, Sagadiyev
stated, is for the state to inform the private sector what it
will do and what the state expects from the private sector.

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And Toward a New Vision: the Thirty Corporate Leaders
-------------- --------------


5. (C) The new plan, Masimov explained, rests on a
Kazakhstani-driven pursuit of diversification. The idea is
to appoint 30 domestic corporations as &corporate leaders8
or &national champions8 and entrust them with large-scale
investment projects. &Our financial system is strong and
lets us take much of the risk ourselves,8 Masimov stated,
&(what we need (from abroad) is the know-how.8 The three
areas of focus, he said, are education, healthcare, and
transportation infrastructure.


6. (C) Sagadiyev provided some of the practical details. On
April 20, President Nazarbayev met with some of the top
representatives of the Kazakhstani business world (Ref B).
The meeting was a prelude to the identification of 30
large-scale investment projects to be assigned to these
corporate leaders. &Thirty,8 explained Masimov to S/R
Mermoud and the Ambassador, &is because twenty is too few,
and forty is too many.8 Vice Minister of Industry and Trade
Askar Batalov told S/R Mermoud that each project will range
in size from $500 million to $1 billion. (Note: According
to a posting on the Presidential Administration website, each
project will have a minimum implementation cost of $100
million. End note.)


7. (C) The next steps, Sagadiyev explained, are for the
government to identify the 30 corporate leaders and have
relevant ministries sign memoranda of understanding with
them. &Not all ministries,8 Sagadiyev remarked, &are
sincere in pursuing in this.8 The plan, then, is to start
with two: Industry and Trade, and Agriculture. Sagadiyev
added that it was his job to find the corporate champions:
&it has been five days, and we have been traveling
heavily.8 He alluded repeatedly to using Britain,s
privatization experience as a guide in pursuing this vision
and, particularly, in drafting the MOUs: &we have a sample
from Britain signed by Thatcher during energy
privatization.8 The first MOU is to be signed in about a
month. U.S. consultants, Sagadiyev added, are being used
extensively in implementing this vision, including on the
issue of the public-private partnership.

A Role for Foreign Investors?
--------------


8. (C) While presenting his government,s new economic plan
as partly a reaction to the failure of foreign investors to
sufficiently embrace opportunities existing in Kazakhstan,s
non-extractive sector, Masimov stressed the vision,s
welcoming orientation toward foreign participation. &We
will have open, clean tenders,8 he assured S/R Mermoud and
the Ambassador. &If foreign investors are interested, they
are more than welcome,8 continued Masimov, and &if not,
that,s okay.8 But, he concluded, &conferences and good
economic relations are not enough.8 Sagadiyev took the
same results-oriented approach: &We are seeking specific
projects. We have passed the stage of understanding; we need
to do things.8 Masimov cited GE,s locomotive-building
operation near Astana and the Fed Ex operations in Almaty as
the kind of &good projects8 the GOK is seeking.


9. (C) Both Masimov and Sagadiyev expressed appreciation for
the potential role that the U.S. technical expertise could
play. &We do not have enough experience and technology;
this is where we are looking for Western participation,8
stated Masimov. He called the U.S. &number one8 in
technology and economic development and pointed out two
specific areas with particular promise for collaboration:
agriculture (&very good discussions with Secretary
Johanns8) and alternative energy. Sagadiyev explained that
current electricity tariffs, &a killer8 to alternative
energy, will be increased. &At 7-8 cents (per kw/hr),8 he
mused, &alternative energy will make sense.8 The U.S., he
added, is &quite advanced8 in this area.


10. (C) Batalov also emphasized that the plan presents an
invitation to foreign investors, describing the
identification of 30 domestic leaders as a &signal8 to
foreign companies of who their Kazakhstani partners should
be. He also mentioned the idea of creating consortia with
the participation of international financial institutions
(IFI,s) and the notion that private companies are better
vehicles for conducting tenders than the government. The

ASTANA 00001243 003 OF 006


thirty leaders will choose their partners among domestic and
foreign companies. Furthermore, Batalov stressed,
Kazakhstan,s Law on Investments provides the same legal
treatment to foreign and domestic investors. Still, Batalov
was clear about the strong domestic orientation of the GOK,s
current vision: &This is about proposing to domestic
companies projects that would, in the past, be offered to
foreign investors( The thirty will take the projects. This
is what protectionism is.8


11. (C) Batalov was both candid and vague on the precise
relationship the government will have with the corporate
leaders. He echoed Sagadiyev,s description of a quid pro
quo arrangement in which the government provides
&facilitation8 (e.g. engineering platforms, the legislative
base, WTO accession),and the &leaders8 will commit to
carrying out their projects. He mentioned another reason for
entrusting the &breakthrough projects8 exclusively to
domestic companies. &We cannot tell foreign investors, go
there and do this,,8 stated Batalov, &but we can say this
to domestic companies.8 He summed up the philosophy of the
vision as &ninety percent economics, ten percent national
pragmatism.8 Batalov acknowledged S/R Mermoud,s cautionary
note on the risk of creating monopolies. &We are familiar
with the experience of South Korean chaebols as well as the
British experience,8 Batalov said. Describing the South
Korean scenario as &too extreme,8 he remarked, &we will be
somewhere in the middle.8

Business Climate ) the View from Within
--------------


12. (C) The themes raised by GOK officials had little in
common with the concerns S/R Mermoud consistently heard from
representatives of the Kazakhstani private sector. Raimbek
Batalov, President of the Forum of Entrepreneurs ) an
Almaty-based NGO which positions itself as the genuine
national voice of small- and medium-sized business as well as
regional and industry business associations ) outlined four
government failures as the primary obstacles to economic and
business development in today,s Kazakhstan. The GOK,s key
failures, Batalov said, are in the areas of tax policy,
customs policy, rule of law, and trade policy. (Note:
Raimbek Batalov is not known to be related to Vice Minister
Batalov. His focus on trade policy appears to stem from his
role as the CEO of a major retail chain. End note.)


13. (C) These policy and enforcement failures, according to
Batalov, are driving an untold portion of the country,s
economic activity into the shadow economy. Much of the
trend, Batalov explained, starts at Kazakhstan,s borders. A
regulatory loophole for small- and medium-sized businesses,
combined with customs officials, notoriously corrupt ways,
leads to a situation where most goods entering Kazakhstan do
so &under the radar.8 Importers break up their wares into
smaller portions and &misdeclare8 them at the customs
control, relying on the customs officials, incompetence and
venality. Thus escaping the tariff system, such goods
directly proceed to enter Kazakhstan,s shadow economy via
bazaars, where they reach the consumer without ever being
subjected to taxation, standardization or other regulations.
(Note: In September 2006, Lubov Khudova, Chairwoman of
Kazakhstan,s Light Industry Association, described to
Econoff precisely the same phenomenon and partly blamed it
for the spectacular decline of Kazakhstan,s textile
manufacturing. Ref C. End note.) Batalov concluded that
the Business Forum,s research indicates that over 60% of all
business activity in Kazakhstan takes place in the shadow
economy, far above official estimates of 24%.


14. (C) Courtney Fowler, Partner of Price Waterhouse Coopers,
and Kenneth Mack, Partner at Chadbourne & Park and President
of AmCham Kazakhstan, firmly confirmed Batalov,s emphasis on
corruption as the key impediment to business development in
Kazakhstan. Fowler stressed that tax administration )
marred by corruption, incompetence, and a lack of proper
accounting practices ) places a tremendous burden on
business. On the corporate side, she told S/R Mermoud, the
situation is also troubling. It is common for companies to
keep two sets of (unmatching) books ) one for accounting
purposes, the other for taxes. Heads of auditing
departments, Fowler added, are frequently not accountants,
let alone auditors. Echoing Batalov,s message on the shadow
economy, she remarked that &no one bats an eye when you pay
for something with $200,000 cash.8 Fowler lamented the
GOK,s failure to address the &systemic8 issues and cited

ASTANA 00001243 004 OF 006


the rule of law deficit as a major problem: &if foreign
investors cannot trust their Kazakhstani partners,8 she
mused, &Kazakhstan will never achieve diversification.8


15. (C) Serik Akhanov, Chairman of the Association of
Financiers of Kazakhstan, presented to S/R Mermoud a rather
optimistic view of the country,s financial system and
macroeconomic situation. He named inflation as a principal
macroeconomic risk but stressed that the central bank remains
watchful in guarding against it. He stated that the
Kazakhstani private sector,s mushrooming external borrowings
are creating a vulnerability to external shocks, particularly
to rising interest rates, but explained that Kazakhstan,s
financial institutions are turning abroad due to a lack of
long-term capital at home. While lauding Kazakhstan,s
banking sector as highly developed and operating on par with
international standards, Akhanov said that the insurance and
pension industries continue to lag. He appeared largely
unperturbed by the rapid expansion of the real estate sector,
saying that only the &elite8 top 2% of the housing market
was showing significant signs of speculative activity.

Inside the State Holding Companies
--------------


16. (C) Arman Moldakhmetov, Vice President of the National
Innovation Fund (NIF),briefed S/R Mermoud on the Fund,s
approach to spurring diversification. The NIF is a component
of the Kazyna Fund for Sustainable Development, a state
holding company currently encompassing 14 development
institutions. The NIF,s model is based on equity
participation in high-tech, &knowledge-economy8 projects.
This participation ranges up to 49% ownership, since )
Moldakhmetov explained ) &we do not want to manage.8 The
NIF sees its key role as bringing together the government,
the academia, and the corporate sector. &Kazakhstan,8 he
remarked, &is full of money. The shortage is of good
projects.8 Moldakhmetov mentioned the NIF,s involvement in
three &technoparks8 established in Uralsk, Karaganda, and
Almaty to provide infrastructure for entrants into the
knowledge economy. These, he said, &are not doing well.
There is furniture, nothing else. No one is working.8


17. (C) Samruk State Holding Company CFO Ulf Wokurka briefed
S/R Mermoud on Samruk activities within the framework of the
holding companies, &three principal activities8:
improving corporate governance, helping to develop
Kazakhstan,s domestic capital market, and facilitating
&select investment opportunities.8 Expanding on the third
topic, Wokurka explained that in May, Samruk would establish
a fully-owned &investment subsidiary,8 which would
coordinate targeted infrastructure projects, addressing such
issues as project finance, until the point in which the
projects could be &handed over8 to interested private or
state entities. Wokurka mentioned the construction of a
combined heat and power plant near Balkash (Ref D) as an
example.


18. (C) Wokurka explained that in order to facilitate
development of a domestic capital market, the Prime Minister
had directed Samruk, along with the other state-holding
companies, to develop further candidate companies for IPOs,
in accordance with the rules establishing the Almaty Regional
Financial Center. To this end, Wokurka said, Samruk was
steering its companies toward financing by means of debt
instruments, in addition to the more-customary commercial
loans. Wokurka told S/R Mermoud that Samruk,s next IPO (of
the Mangistau oblast electrical grid operator) would occur in
late 2007. The GOK had planned to transfer to Samruk another
fifteen companies, Wokurka said, but Samruk had asked that
the transfer be delayed while the holding company better
assimilated its existing holdings. Wokurka also confirmed
that a new company, &Samruk Energy,8 would soon be
established to manage Samruk,s five power generating
companies.


19. (C) Alikhan Smailov, Chairman of the Managing Board of
the newly created state agricultural holding company
&KazAgro,8 briefed S/R Mermoud on his organization,s
plans. KazAgro, he explained, currently incorporates seven
of the GOK,s agricultural companies, whose missions range
from intervention in grain markets to providing microcredits
to rural communities to purchasing and reselling livestock
products. KazAgro,s overall mission, Smailov said, is to
manage the state,s agricultural assets in accordance with
corporate management standards as well as national goals.

ASTANA 00001243 005 OF 006


The plan, he explained, is to increase these assets, value
by &taking some corrective measures to establish proper risk
management, internal control, etc.8 The next step would be
to privatize some of the holdings. &This,8 Smailov summed,
&is our approach, and it has been approved by the Prime
Minister.8


20. (C) Smailov spoke extensively about KazAgro,s plans in
the ethanol market. The vision is to construct bioethanol
plants to produce ethanol for export and achieve production
levels of 3 billion liters per year. Large-scale beef and
dairy farms are also planned, and KazAgro is expanding grain
export infrastructure by building terminals on the Caspian.
He noted that KazAgro is seeking foreign investors, interest
in these projects, particularly in bioethanol. What is
needed from foreign partners, Smailov said, is &modern
equipment at reasonable prices8 and help with marketing
these products abroad.

Prospects for the Public-Private Partnership
--------------


21. (C) S/R Mermoud received wide-ranging input from his
interlocutors on the possible directions of the bilateral
Public-Private Partnership Initiative (PPPI). Masimov
expressed an interest in proceeding with the Initiative. He
named Sagadiyev as the primary Kazakhstani interlocutor on
the issue and suggested that Sagadiyev travel to Washington
in June to explore the avenues the PPPI may take. Minister
of Transport Serik Akhmetov told S/R Mermoud that his
ministry has a great interest in developing international
contacts and attracting foreign investment. The $30 billion
Transportation Strategy passed last year, Akhmetov said,
provides for some of the funding to come from &non-budget8
sources, such as foreign investment.


22. (C) Business sector representatives ) Fowler, Mack, and
the Forum,s Raimbek Batalov ) focused on the PPPI,s
potential in addressing the &systemic8 issues (e.g. tax and
customs administration, the rule of law) currently getting
short shrift from the GOK. Batalov and Mack, in particular,
expressed a strong interest in establishing collaboration
between the Entrepreneurs Forum and the AmCham. Both Batalov
and Mack held the view that organizing a discussion of ) and
proposing solutions to )&systemic8 issues in a PPPI forum
could spur the GOK to much-needed action. Fowler suggested
building links between U.S. and Kazakhstani business schools
as a way to rectify the shortage of management expertise.
The Financiers Association,s Akhanov likewise expressed
interest in fostering exchanges among corporate leaders at
varying levels. The Innovation Fund,s Moldakhmetov offered
to provide input on any future plans or ideas in the context
of the PPPI. Azat Peruashev, Chairman of the&Atameken8
Union of Entrepreneurs, which purports to be Kazakhstan,s
official national business association, expressed a strong
interest in building links with U.S. counterparts.

Comment
--------------


23. (C) The fact that the proposed bilateral PPPI coincides
with the GOK,s own public-partnership program presents
opportunities as well as potential challenges. The GOK,s
new approach is unapologetically focused on domestic
companies and highly results-oriented. Kazakhstani
officials, underlying question seems to be: how can the PPPI
fit into Kazakhstan,s own public-private program and what
concrete results (i.e. investment commitments) can it bring
in the foreseeable future? The GOK,s intensity may be
partly explained by practical considerations: Masimov
recently told Ambassador Ordway that his government will only
have two to three years to achieve its goals.


24. (C) The GOK,s &30 corporate leaders8 program, while an
outgrowth of the macroeconomically sound desire to diversify
the economy away from the extractive sector, is fraught with
risks. Without proper safeguards, the vision may well lead
to creation of more monopolies, a phenomenon already plaguing
a range of key economic sectors such as telecommunications
and civil aviation. In any case, the policy signals the
GOK,s continued adherence to a &top-down8 approach to
economic diversification and an apparent lack of urgency in
confronting the &systemic8 issues that are the main
concerns of the business sector. Notably, the business
representatives, hopes for the PPPI were that the Initiative
would specifically address the problems the GOK is continuing

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to ignore. End comment.


25. (SBU) Action request: Post requests Department guidance
regarding next steps on the Public-Private Partnership
Initiative, as well as clarification of which office will
have the lead.


26. (U) This cable has been cleared by S/R Mermoud.
MILAS