KAZAKHSTAN MANAGING REVERBERATIONS OF THE U.S. SUBPRIME

UNCLAS SECTION 01 OF 03 ASTANA 003025

SIPDIS

SENSITIVE
SIPDIS

DEPT FOR SCA/CEN (O'MARA)

E.O. 12958: N/A
TAGS: ECON PGOV EFIN EINV KTDB KZ

SUBJECT: KAZAKHSTAN MANAGING REVERBERATIONS OF THE U.S. SUBPRIME
CRISIS

Ref: (A) Astana 1512 (B) Astana 372 (C) Astana 2765 (D) Astana
2823 (E) Astana 2716

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1. (SBU) Summary. The global reverberations of the subprime
mortgage crisis in the U.S. have not passed Kazakhstan by. Though
most observers believe that the impact of the current turbulence
will be limited and not threaten the country's long-term economic
prospects, there are nevertheless shorter term challenges. In
particular, while the banking sector remains stable and the effects
on the broader economy have been largely muted, the real estate and
construction sectors have taken a hit. On a more positive note, the
global financial turbulence has staunched a liquidity glut in
Kazakhstan's banking system, forcing a financial readjustment that
may actually be beneficial. More problematic for the country,
perhaps, is a significant uptick in inflation, which is posing
dilemmas for policymakers and taking on decidedly political
overtones. The tenge remains stable, though the Central Bank
recently had to draw down reserves by several billion dollars to
support the currency in the face of significant downward pressure.
End summary.

The Financial Crisis: From Middle America to Kazakh Steppe
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2. (SBU) Kazakhstan's banking sector has taken a hit from the
U.S.-inspired global financial turbulence, but remains stable.
While Kazakhstan's major banks do have significant exposure to the
domestic real estate sector, the Chairman of the Financial
Supervision Agency (FSA),Arman Dunayev, recently told the
Ambassador that because Kazakhstan does not have a domestic subprime
mortgage market, the country's only link to the global financial
crisis is via its banking system's external borrowings. These
external borrowings by Kazakhstani banks mushroomed over the past
two years, attracting substantial notoriety (ref A) and resulting in
the country's financial system developing a dependence on a
continuing inflow of liquidity from abroad. According to most
informed observers, these borrowings had created an unhealthy
liquidity glut.

The Banking Sector: How Painful the Moment of Reckoning?
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3. (SBU) The global financial crisis has dried up global liquidity,
and interrupted Kazakhstani banks' external borrowing binge. This
has helped prevent further aggravation of liquidity-driven
imbalances in Kazakhstan. As Anvar Saidenov, Chairman of the
National Bank of Kazakhstan (NBK, the country's central bank),
stated to the Ambassador on August 15, "we actually wanted to slow
down the credit activity of the banks, even perhaps the economy
itself."


4. (U) With Kazakhstani banks suddenly finding themselves unable to
continue their binge of borrowing from abroad, some questions have
arisen about their ability to service their external debts. For
example, on October 9 Fitch Ratings downgraded the debt of
Kazakhstan's three leading commercial banks; Moody's followed suit
three weeks later with six downgrades. According to the NBK
statistics, net external borrowings of Kazakhstani banks were, as of
September, $23.6 billion. Debt service payments due by the end of
year were $3.8 billion. Nevertheless, key actors in the Kazakhstani
banking sector have sounded reassuring, indicating that the debt
service payments are not a substantial burden. Central Bank
chairman Saidenov has publicly stated that the banks are "capable of
handling the situation themselves."


5. (SBU) In addition, Magzhan Auezov, Managing Director of
KazKommertsBank, told the DCM on October 3 that most of the
Kazakhstani banks' external debts are in the form of syndicated
loans, not bonds. Thus, Auezov claimed, their terms can more easily
be renegotiated. According to Saidenov, the primary risks appear to
reside in the smaller banks, not the leaders. On the other hand,
FSA Chairman Dunayev told the Ambassador, smaller banks did not
participate in the external borrowing binge. In any case, the NBK
and the FSA are not taking any chances. In order to strengthen the
banking system's financial footing, the regulators have raised
reserve requirements. "Other countries' central banks are adding
liquidity; we are taking it out," Dunayev said. He stressed the
regulators' resolve to do what is needed to avert a deep banking
sector crisis: "If something happens," he said, "clearly the NBK
will have to use gold reserves to help our banks to repay their
debts."

Construction Sector Hit, Real Estate Market Cooling
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6. (SBU) With securities markets woefully underdeveloped, much of

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the banking system's excess liquidity had been pouring into the
domestic real estate market, through both mortgage lending and
construction financing provided by banks. In turn, the real estate
sector, particularly in Astana and Almaty, had been showing worrying
signs of overheating.


7. (SBU) While the impact of the global crisis on the overall
Kazakhstani economy has so far been muted, it has hit the real
estate and construction sectors. Some Kazakhstani banks have since
cut back sharply on their mortgage lending, particularly for housing
developments in the new parts of Astana. As a result, interest
rates on (tenge-denominated) mortgages have soared from 14-15%
before the crisis to 21-22% now. Reports abound of work on many
construction sites in Almaty and Astana having been suspended.
While there are no reports of mass defaults of mortgages, a cooling
in the real estate market is evident. Although housing prices in
Almaty and Astana are still up sharply year-on-year, they currently
appear to be receding in Almaty and stagnating in Astana.

When It Rains, It Pours... Inflation Breaks out
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8. (SBU) It is not the banking sector, however, but the inflation
that is currently capturing Kazakhstani headlines. With monthly
inflation soaring from 0.7% in August to 4.4% in October (and
year-on-year inflation rising in the same period from 9.4% to
15.3%),the outbreak is significant and attracting a lot of
attention. The political ramifications of the uptick are magnified
by a disproportionate rise in bread prices specifically (ref C) and
food prices in general. Despite obvious links to rising wheat
prices on the world market, the growth in bread prices - and food
prices overall - is taking on increasingly political overtones. At
an October 12 conference, President Nazarbayev stated that "somebody
is trying to destabilize the economic situation in the country."
This remark comes in the wake of the government's repeated
pronouncements blaming monopolies, working in tandem with corrupt
akims, for the spike in inflation.


9. (SBU) There may, however, be tangible economic roots of the
rising inflation. Possible contributors include the effects of the
mushrooming (pre-August) liquidity glut, fiscal loosening in the
run-up to the August Parliamentary election, and delayed
post-election hikes in government-regulated utility tariffs.
Furthermore, the relative lack of competition in Kazakhstan's
economy, especially at wholesale level (and particularly in the food
industry) may be acting as a significant magnifying mechanism for
external inflationary pressures, a phenomenon quite pronounced in
the current growth of food prices.

Save the Tenge
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10. (SBU) During the recent U.S.-inspired economic turbulence, the
tenge has remained quite stable against the dollar. (Note: After
trading in the 123-126 KZT/$ range in August, the tenge has not
since ventured outside the 120-122 range. End note.) This
stability, however, belies some substantial downward pressure on the
tenge, which prompted the NBK to undertake an apparently gargantuan
effort to support the domestic currency. Speaking to the DCM,
Auezov attributed recent pressure on the tenge to two causes. One
was a panic sell-off due to the very brief stoppage of the inflow of
foreign currency into Kazakhstan due to a customs shutdown. (Note:
The foreign currency portion of customs shutdown (ref D, E) led to a
brief panic-buying of dollars by the Kazakhstani public during late
August and early September, but was resolved within days. End
note.) The second reason, said Auezov, is the end, brought about by
the American financial crisis, of the dollar-to-tenge carry trade.
According to Auezov, Morgan Stanley had a tenge-denominated position
worth $1.2 billion, which it quickly unloaded when the troubles in
the U.S. began. The NBK, Auezov added, ended up supporting the
tenge on the open market, "selling $800 million on a single day."
(Note: official data supports this. During the August to September
period, the NBK's gold and foreign reserves fell from $22.0 billion
to $18.5 billion. End Note.) Dunayev told the Ambassador that if
the NBK had not stepped in to drain the liquidity, "inflation would
have been even higher."

Comment
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11. (SBU) With the National (Oil) Fund still flush with
petrodollars, and foreign reserves still strong, the National Bank
of Kazakhstan remains in a firm position to ward off any truly
serious banking system crisis. In fact, as noted above, the sudden
drying up of global liquidity may, in the long term, be good for
Kazakhstan's financial system, by helping to resolve imbalances

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driven by the liquidity glut. Concurrent rising inflation may, in
the end, prove to be the more turbulent factor. If it searches for
a quick fix to the inflation problem, the government could end up
introducing measures that have little to do with the economics of
the phenomenon. The National Bank's steady hand on the monetary
policy and resolve to control liquidity may itself be sufficient to
bring the inflation spike under control. End comment.

ORDWAY