KAZAKHSTAN: GOVERNMENT ADDRESSING CHALLENGES IN BANKING,

UNCLAS SECTION 01 OF 02 ASTANA 003185

SIPDIS

SENSITIVE
SIPDIS

DEPT FOR SCA/CEN (O'MARA)

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

SUBJECT: KAZAKHSTAN: GOVERNMENT ADDRESSING CHALLENGES IN BANKING,
CONSTRUCTION; SEES MODERATED GROWTH IN 2008

Ref: Astana 3025

ASTANA 00003185 001.2 OF 002



1. (SBU) Summary. Kazakhstan's central bank foresees 7 percent
economic growth in 2008. Even so, the bank's chairman acknowledged
to the Ambassador that challenges remain, particularly for the
banking and construction sectors. The government appears firm in
its commitment to support Kazakhstani banks, as necessary, and is
already propping up the construction sector with budgetary funds.
Still, the construction sector appears to be heading for difficult
times. Nevertheless, the tenge remains stable, the outflow of
foreign reserves has ebbed, and the National Oil Fund is growing
briskly. End summary.

A Soft Landing?
--------------


2. (SBU) Anvar Saidenov, Chairman of the National Bank of Kazakhstan
(NBK, the country's central bank),told the Ambassador on November 9
that the aftereffects of the current global financial turbulence on
the Kazakhstani economy (reftel) are well under control. According
to Saidenov, Kazakhstani commercial banks are servicing their debts
on schedule. As the banks are slowly unwinding their large external
debts,`Qc4Qs 10.7 percent in 2006 and 9.7
percent in the first nine months of 2007. End note.) Saidenov
added that the current inflationary pressures are mostly due not to
domestic liquidity ("which is high but not growing"),but to global
trends, such as rising food and commodity prices. Still, he stated
that with December-to-December inflation expected to reach 15
percent, the NBK will probably have to raise interest rates.


3. (SBU) After a prolonged period of building up foreign reserves in
an effort to slow down the tenge's appreciation, the NBK had to
sharply reverse course in August in order to keep the domestic
currency from falling (reftel). With Kazakhstani banks no longer
able to borrow abroad and instead servicing their accumulated
external debts, their growing demand for foreign currency is
pressuring the tenge. By intervening via open market operations to
keep the tenge at or around 121 to the dollar, the NBK has been
providing implicit support of sorts to Kazakhstani banks (which have
deposits in tenge but debts in foreign currency). As a result, the
NBK's foreign reserves fell from $22.0 billion in August to $17.4
billion at the end of October. In a possible sign that market
pressures on the tenge are receding somewhat, the NBK's reserves
recovered by November 15 to $18.2 billion. Saidenov told the
Ambassador that the NBK does not want to lose "too much in reserves"
in defending the tenge and, therefore, expects it to depreciate
somewhat.


4. (SBU) Saidenov noted that the National (Oil) Fund (NF) continues
to grow "very fast," already exceeding $20 billion in assets, and
"is not being touched for now." He elaborated that only a KZT 340
billion ($2.8 billion) "guaranteed transfer" from the NF to the
budget is currently planned for 2008. Increasing the guaranteed
transfer or sending more petrodollars into the budget (instead of
the NF) would, Saidenov noted, require an act of Parliament.

But Real Estate and Construction Catch a Cold
--------------


5. (SBU) Kazakhstani banks, Saidenov continued, remain vulnerable to
a collapse in the domestic real estate sector. However, he expects
a cooling, not a collapse. He stressed that the government will
support the real estate sector due to "social factors," referring to
the government's recently announced $4 billion support package. The
sum is to be disbursed over several years, and is earmarked
specifically for the banking and construction sectors, which are
seen as most affected by the current turbulence. Approximately $1
billion has already been disbursed under the plan. The money,
explained Saidenov, has been given to the Kazyna Sustainable
Development Fund, which will lend it, at reduced interest rates, to
commercial banks. Under the terms of the program, the banks will be
obligated to loan the funds to the construction sector at favorable
interest rates. Still, Saidenov acknowledged the challenges facing
the banking sector ("next year will be tough for banks") and the
construction sector ("some cleansing and consolidation will have to
happen").


6. (SBU) Very difficult times on the construction sector's horizon
was the picture painted on November 9 for the Ambassador by Dennis
Price, an Almaty-based American executive with Kuat, a leading
Kazakhstani residential construction firm. According to Price, the
Kazakhstani construction industry's two leaders, Kuat and Basis A,
are both in dire straits. According to Price, the two will not

ASTANA 00003185 002.2 OF 002


merge, but only one will survive. He said that Kuat's sales have
virtually come to a standstill over the past six months, and the
company has not been paying wages since mid-August. (Note: On
November 1, about 100 Kuat construction workers held a largely
unprecedented rally in Astana in front of President Nazarbayev's
palace, protesting unpaid wages. End note.) Price described Kuat
as a company plagued by a lack of transparency and bad management.
While Kuat's cost structure is very vague, Price estimated the
company's construction cost at $2,000 per square meter, a figure he
described as excessively high, partly due to managerial "skimming."
By contrast, Price said, the government is only willing to bail out
banks and construction companies at $1,000 per square meter. He
added that he expects the Almaty real estate prices to settle down
in the $1,500-1,800 per square meter range in the next four years.


7. (SBU) While government support may be key to helping the real
estate and construction sectors weather the current storm, its
actual effects may, at least in the short term, be more complex.
Galym Orazbakov was quoted by the media in October, stating that the
government would buy housing from "weak" builders and sell it to the
public at just $800 per square meter. According to one informed
observer, the well-intentioned announcement had a chilling effect on
the real estate market, as the already nervous public settled in to
wait for prices to fall to $800.

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


8. (SBU) The latest projection of 7 percent economic growth in 2008
provides a telling indicator of the Kazakhstani economy's oil-fueled
resilience. While the unwinding of Kazakhstani banks' commercial
debt may lead to medium-term tenge depreciation and some depletion
of foreign reserves in support of the currency, the long-term trend
for the tenge will be dictated by the country's growing oil exports
and thus remains toward appreciation. The government stands ready
to support the banks and, to some extent, the construction sector.
In the case of the banks, this is designed to provide liquidity and
credit to the non-extractive sectors that might otherwise be in
serious trouble if credit lines dried up. In the case of housing,
the government is motivated in part to "rescue" individual
purchasers who have made very substantial pre-payments when or
before construction started. It is unclear, however, how effective
government action will be in supporting the unraveling real estate
bubbles in Almaty and Astana. There is also some risk that
government action will go too far, rewarding reckless lending with a
bailout and creating a moral hazard. Prime Minister Masimov told
the Ambassador that the government is looking into purchasing
existing mortgages from lenders, thus creating a secondary market.
Such a step would inject liquidity into the economy, help compensate
for the weak deposit base of the domestic banks, and avoid having
the government or its institutions direct lending to specific
sectors.

ORDWAY