Identifier
Created
Classification
Origin
07ASTANA1512
2007-06-03 11:04:00
CONFIDENTIAL
Embassy Astana
Cable title:  

KAZAKHSTAN,S FINANCIAL SECTOR: A DANGER TO ITSELF

Tags:  ECON EFIN PGOV KZ 
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VZCZCXRO3722
PP RUEHDBU
DE RUEHTA #1512/01 1541104
ZNY CCCCC ZZH
P 031104Z JUN 07
FM AMEMBASSY ASTANA
TO RUEHC/SECSTATE WASHDC PRIORITY 9651
INFO RUCNCIS/CIS COLLECTIVE 0191
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEAIIA/CIA WASHDC
RUEBAAA/DEPT OF ENERGY WASHDC
C O N F I D E N T I A L SECTION 01 OF 04 ASTANA 001512 

SIPDIS

SIPDIS

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

E.O. 12958: DECL: 06/04/2017
TAGS: ECON EFIN PGOV KZ
SUBJECT: KAZAKHSTAN,S FINANCIAL SECTOR: A DANGER TO ITSELF
(AND OTHERS)?

REF: A. ASTANA 1243

B. ASTANA 1240

C. ASTANA 1122

D. ASTANA 1234

Classified By: Pol-Econ Chief Deborah Mennuti; reasons 1.4 (b) and (d).

C O N F I D E N T I A L SECTION 01 OF 04 ASTANA 001512

SIPDIS

SIPDIS

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

E.O. 12958: DECL: 06/04/2017
TAGS: ECON EFIN PGOV KZ
SUBJECT: KAZAKHSTAN,S FINANCIAL SECTOR: A DANGER TO ITSELF
(AND OTHERS)?

REF: A. ASTANA 1243

B. ASTANA 1240

C. ASTANA 1122

D. ASTANA 1234

Classified By: Pol-Econ Chief Deborah Mennuti; reasons 1.4 (b) and (d).


1. (SBU) Summary: In spite of the failure of a regional bank
and the International Monetary Fund's recent characterization
of Kazakhstani private sector external borrowing as an
emerging "global market risk," the mood among Kazakhstani
financiers remains upbeat. With no end to petrodollars in
sight, they see major opportunities for growth in financial
services, particularly insurance and asset management.
Still, the IMF's focus on the size of Kazakhstani banks'
external borrowings has helped highlight the Kazakhstani
economy's vulnerability to higher global interest rates as
another risk to the country's financial system. Most
well-informed observers are already concerned by the apparent
real estate bubbles in Astana and Almaty. Even more, when
speaking frankly, acknowledge that the twin deficits of
proper corporate governance and the rule of law remain major
obstacles to the development of Kazakhstani business in
general and the financial sector in particular. End summary.

Driven by Oil and Intent to Keep Going
--------------


2. (SBU) However they may assess the principal economic
risks, decision-makers in the Kazakhstani financial sector
agree that oil will, for the foreseeable future, continue to
fuel the Kazakhstani economy and, concomitantly, the
financial services industry. Roman Solodchenko, CEO of Bank
Turan Alem (BTA),told a visiting Treasury official and
econoff on April 16 that the outlook for the Kazakhstani
economy remains rosy, as oil prices are not expected to
plunge. Even if oil does fall, Solodchenko noted, it will
still support economic growth, because oil contracts are
structured in such a way that the actors are interested in
increasing production "no matter what the oil price does."
Furthermore, Solodchenko implied, the Kazakhstani
Government's (GOK's) ongoing sterilization of its oil
revenues through the National Fund has limited the government

budget's dependence on the oil sector, thus cushioning the
economy against any dramatic falls in the price of oil.


3. (C) Notably, Kazakhstan's National Bank (NBK) Deputy
Chairman Gulbanu Aimanbetova does not see oil's classic side
effect, "Dutch disease," as a significant problem for the
Kazakhstani economy. She explained during an April 17
meeting that Kazakhstani firms rely heavily on imports for
their inputs, citing the example of Rakhat Candy, which
imports 70-80% of its inputs. Tenge appreciation, therefore,
does not necessarily have an adverse effect on the global
competitiveness of Kazakhstani producers, since it helps
lower their costs, according to Aimanbetova. (Note:
Aimanbetova may have merely been restating the GOK's official
position, which another NBK official described as "Kazakhstan
does not have Dutch disease, just the symptoms." Whatever
the GOK's principal decision-makers think of the threat of
Dutch disease, however, they are currently embarking on a new
major effort to diversify the economy away from the
extractive sector. Ref A, B, and C. End note.)

Kazakhstan: Attracting Capital (and Notoriety)
-------------- -


4. (SBU) While oil-funded economic optimism is the spirit of
the day, views appear to be significantly more diverse in
regard to the Kazakhstani private sector's current borrowing
binge abroad. The already much-discussed phenomenon was
featured in the IMF's April 2007 Global Financial Stability
Report. The IMF report specifically highlighted the combined
external borrowing by Russia's and Kazakhstan's private
sectors as "an emerging market risk." The report makes
particular note of the external borrowing by Kazakhstani
banks. In 2006, according to IMF figures, Kazakhstan's
financial institutions borrowed $8.4 billion abroad; in just
the first 44 days of 2007 (Jan. 1 through Feb. 13),they
borrowed $6.3 billion. The report sees this as a factor in
the context of "global risks," due to Kazakhstan's
"relatively low capital adequacy" and "relatively high
nonperforming loans ratio," particularly when the country's
rapid credit growth is taken into account.


5. (C) One prominent actor in Kazakhstan's financial sector

ASTANA 00001512 002 OF 004


privately called the IMF's decision to place Kazakhstan
alongside the U.S. and Russia "flattering." Some
well-informed observers expressed to us the view that the
causes of the Kazakhstani private sector's borrowing binge
were rational and benign, rather than speculative and
dangerous. Kazakhstan's banks, they explained, are turning
abroad to access long-term capital that they cannot obtain at
home. Magzhan Auezov, Managing Director of KazKommertsBank
(KKB),remarked, "it's just that borrowing abroad is
cheaper," echoing the often-stated view that Kazakhstan's
banking system, although widely described as the
most-developed in the CIS, is not an adequate source of
long-term capital. Some bankers explained that while the
public-at-large continues the gradual post-Soviet process of
warming up to banking, deposits remain relatively small and
"flighty." As a result, the argument goes, the domestic
market only provides banks with limited, short-term capital,
forcing seekers of long-term capital to go abroad.


6. (C) NBK's Aimanbetova, however, stated unequivocally her
concern with the extent of the banks' external borrowing.
Kazakhstan's external debt - now at $73 billion - has, she
said, greatly expanded in the past two years due to private
sector borrowing. Banks are currently responsible for 45% of
the country's external debt, she added. Aimanbetova also
said that banks are becoming overly aggressive as they drive
up interest rates in competition for deposits. Erlan
Balgarin, CEO of Centras Securities, an Almaty-based
investment company, was more blunt in an April 16
conversation. Credit expansion, he said, represents a
serious risk to the Kazakhstani economy. Banks enjoy a high
ability to borrow but very limited investment opportunities,
which leads them to provide loans to questionable projects.
As a result, Balgarin concluded, the quality of the credit
portfolio tends to be very low.


7. (SBU) The Financial Supervision Agency (FSA) recently
tried to limit banks' external borrowing by instituting
stricter reserve requirements. As these requirements take
effect, some of the largest banks are turning to issuing
equity abroad or seeking foreign investors as alternate ways
of attracting foreign capital. For now, however, the IMF
figures appear to indicate that the external borrowing binge
is continuing.

Real Estate: How Big a Risk to the Economy?
--------------


8. (C) There is consensus among observers that a lot of the
capital borrowed abroad by Kazakhstani banks ends up flowing
into domestic real estate. There appears to be agreement
among top Kazakhstani bankers that the real estate markets in
Almaty and Astana pose risks. However, the bankers differ in
the levels of their concern and their approaches to mortgage
lending. The National Bank's Aimanbekova said that the real
estate market is being driven by "speculative, not real,
demand," and that "problems" are expected in 2008. She
blamed the excess demand on Kazakhstan's shadow economy,
which produces large sums of money in need of laundering.
(Note: for discussion of Kazakhstan's shadow economy, see Ref

A. End note.) Balgarin of Centras seconded this view:
compared to securities investments, he said, real estate
investments enjoy a high level of non-transparency, making
them an ideal vehicle for "parking" illicit capital. Greater
transparency of the oil sector, Balgarin added, would lessen
pressure on the real estate market and "spread money around."


9. (C) Grigoriy Marchenko, the CEO of Halyk Bank and former
NBK Chairman, echoed Aimanbekova's comments, telling us on
April 17 that real estate prices are "the biggest industry
risk for the banking system" and that a correction could come
in 2008. Marchenko emphasized his bank's "contrarian"
orientation in treading carefully in the real estate sector.
Yet even he qualified his pessimism: while the real estate
market, he said, is overpriced in Astana and Almaty, it
remains "very segmented" and still has room to grow "in the
provinces."


10. (C) BTU's Solodchenko -- who described his bank as "not
the most aggressive one" in the context of real estate (that
title, he said, belongs to KKB) -- provided a mixed view. He
said that Kazakhstan -- with a living space per capita figure
of 17 square meters -- still has some catching up to do with
Eastern Europe's 34 square meters per capita. Solodchenko
added, however, that his bank has now pulled out of Astana's
real estate market, which is approaching "saturation" at

ASTANA 00001512 003 OF 004


22-23 square meters per capita. Still, he stated, the real
increase in housing in Almaty is not as great as it may
appear. The first floors of many residential buildings,
Solodchenko explained, have been converted to retail stores.
The need to replace this "lost" residential space, combined
with the continuing post-Soviet "decompression" of extended
families crammed into single apartments, is often viewed as
at least partly responsible for driving the demand.


11. (C) Auezov of KKB, Kazakhstan's largest bank, readily
acknowledged his bank's substantial involvement in the real
estate sector. However, he said, KKB's risk is "particularly
structured." Auezov explained that KKB focuses on financing
construction, including construction of industrial and
governmental buildings. This preference for "construction
risk," he implied, helps insulate KKB from the risks of the
real estate market's fluctuations. Mukhtar Bubeyev,
Department Head at the Financial Supervision Agency (FSA),
expressed a similar perspective, stating that Kazakhstan's
banking sector is "quite diversified." The real exposure to
the real estate market, he said, is shouldered by mortgage
companies, which also fall under FSA's purview.

After Valut Transit Debacle: How Good is the Oversight?
-------------- --------------


12. (C) Most observers do not see the recent collapse of the
Karaganda-based Valut Transit Bank (VTB) as an indication of
systemic problems in Kazakhstan's banking system. (Note: Ref
D reports the legal proceedings surrounding VTB. End note.)
The consensus appears to be that the VTB's downfall was
precipitated by unmistakably "criminal" factors. Balgarin of
Centras framed the saga in terms of corporate governance; the
bank, he said, issued a lot of credit to finance its own
stockholders' projects. Other observers echoed this view but
differed somewhat in their assessment of the regulator's
(i.e. the FSA's) fault in the bank's downfall. Bakhyt
Mazhenova, General Director of the Deposit Insurance Fund,
shared her personal opinion with us that "politicization"
and "weakness" of the FSA prevented it from spotting and
bringing to light the VTB's troubles in a timely fashion.
Other observers also thought that the FSA may have been
excessively timid and slow to the scene, particularly in
pulling the sinking bank's license.


13. (C) Halyk's Marchenko, however, painted a picture of a
largely blameless FSA, which was simply prevented from doing
its job by a lack of power and a faulty legal system. It was
essentially impossible, Marchenko said, for the regulator to
unravel the multi-layered loan scheme at the center of the
VTB's demise. Any action the FSA takes, he explained, can be
challenged in court. Marchenko added that in the VTB case
the FSA likely assumed that it would lose such a challenge,
"even if (the bank) had not bribed the judge - a big if."
FSA's Bubeyev, while sounding rather defensive about the VTB
scandal, appeared to support Marchenko's thesis. In the wake
of the VTB's bankruptcy, Bubeyev said, legislative amendments
have been enacted, expanding the FSA's powers. The
legislation, in part, dictates that the FSA's instructions
must be followed even if they are being challenged in court.


14. (C) Marchenko suggested that knowledgeable domestic
investors, particularly large financial institutions
(including Halyk),had pulled their investments out of VTB in
time to avoid falling victim to the bank's collapse. On the
other hand, foreign institutions and domestic depositors,
Marchenko added, could not see the trouble coming.


15. (C) The ripple effects for Kazakhstan's financial sector
of the collapse of the VTB are, according to a discernible
consensus, rather limited. Mazhenova of the Deposit
Insurance Fund (DIF),"Kazakhstan's FDIC," however, stated
that the impact on the banking system would have been "big,"
had the DIF not made payments to the VTB's depositors. The
DIF's actions, she said, prevented a major outflow of capital
from the banking system following the VTB's collapse.
Mazhenova said that the failed bank served 100,000 depositors
and held 250,000 accounts. Mazhenova described the VTB as a
"large regional bank" and a key player in the economy of the
industry-heavy Karaganda Oblast. The DIF, she said, insures
bank deposits up to the amount of KZT 700,000 (approx.
$5,833); 52% of VTB's deposits were under that threshold.
Mazhenova stated unequivocally that the VTB meltdown is
taking a major financial toll on the DIF, resulting in
obligations of approximately KZT 15 billion (approx. $125
million). She added that a decision has been made to grant

ASTANA 00001512 004 OF 004


to the DIF an inflow of capital, possibly to the tune of 5
billion KZT (approx. $41.7 million),from the National Bank.

New Horizons and Where the Buck Stops...
--------------


16. (SBU) In spite of the clouds of the VTB debacle and
excessive external borrowing by banks, Balgarin of Centras
presented an optimistic vision of the Kazakhstani financial
sector's foreseeable future. The asset management and
insurance industries, he said, lag behind the "very
well-developed" banking sector but have great potential.
Balgarin added that insurance companies may receive a major
impetus if existing pension funds come under their
management. While the lack of "financial literacy" among the
Kazakhstani public remains an obstacle, he said, "the public
mind is evolving." As evidence, he cited $20-22 billion now
in deposits and $400 million under asset management, although
only 15-20% of the latter is "active on the market."


17. (C) Balgarin was decidedly gloomier when discussing
issues of corporate governance. He said that the lack of
transparency is a problem, and that it is very difficult for
a shareholder to influence a company. "The problem,"
Balgarin stated, "is not legislation but the legal system and
the culture. When it comes to enforcing rights, the buck
stops at the courthouse steps." Balgarin's remark was a
clear allusion to the notion that the fate of the Kazakhstani
financial services industry is strongly tied to that of the
domestic corporate sector, which remains plagued by poor
corporate governance and the legal system's failures in
enforcing contractual and property rights.

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


18. (SBU) Whatever the extent of the risks that Kazakhstan's
overindulgence in foreign debt brings to the global financial
system, the phenomenon certainly exposes Kazakhstan's banking
system to external risks, particularly higher interest rates.
Should global interest rates rise, Kazakhstani banks may
find it difficult to refinance their maturing -- and
mushrooming -- debt. A possible switch in focus from debt to
equity may alleviate this concern. Concern will remain,
however, over the quality of the banks' investments and
loans, particularly in real estate.


19. (SBU) The optimists' assessment that Kazakhstan's banking
sector is relatively impervious to a possible bursting of the
real estate bubble understates the wider socio-economic
effects of a truly hard landing. Astana and Almaty's
construction boom relies on the cheap labor of untold numbers
of Central Asian migrants, who will abruptly and collectively
become unemployed if the real estate music stops.
Furthermore, many middle-class Kazakhstanis in Astana and
Almaty - many with mortgages - have invested large portions
of their net worth in newly built apartments. A wave of
foreclosures would be a phenomenon both unprecedented and
deeply worrying for an important layer of Kazakhstani
society. While well-informed observers increasingly mention
2008 as the year when the real estate market is likely to
peak, the behavior of market bubbles is notoriously difficult
to predict. End comment.
GILMER