KAZAKHSTAN: GLOBAL FINANCIAL CRISIS HITS HARD, BUT

UNCLAS SECTION 01 OF 04 ASTANA 000068 SIPDIS SENSITIVE STATE FOR SCA/CEN, EEB STATE PLEASE PASS USTDA FOR DAN STEIN E.O. 12958: N/A TAGS: PGOV ECON EFIN EINV KZ SUBJECT: KAZAKHSTAN: GLOBAL FINANCIAL CRISIS HITS HARD, BUT GOVERNMENT TAKES AGGRESSIVE MEASURES TO SUPPORT ECONOMY REF: (A) 08 STATE 134459 (B) 08 ASTANA 2291 (C) 08 ASTANA 2320 (D) 08 ASTANA 2338 (E) 08 ASTANA 2351 ASTANA 00000068 001.2 OF 004 ¶1. (U) Sensitive but unclassified. Not for public Internet. ¶2. (SBU) SUMMARY: The financial crisis continues to hit Kazakhstan hard, but the government has responded in a vigorous, aggressive manner that should maintain social stability and support modest economic growth in 2009, particularly if oil production increases as expected. That said, there are continuing concerns about the transparency of the government's anti-crisis measures, the vulnerability of Kazakhstan's banking sector, and the ability of the National Bank to support the currency. END SUMMARY. GROWTH RATE DOWN ¶3. (U) At a January 6 meeting in Almaty, the government and National Bank delivered a joint report to President Nursultan Nazarbayev on Kazakhstan's economic achievements in 2008 and prospects for 2009. Prime Minister Karim Masimov informed Nazarbayev that according to preliminary estimates, GDP growth for 2008 "topped 3%." This figure is below downward-revised earlier estimates of 5% growth for the year and is a marked decline from the average annual 9.6% growth achieved during 2005-07. Sergei Shatalov, World Bank Country Manager for Kazakhstan, told us on January 13 that the World Bank expects Kazakhstan's GDP to grow by 5% in 2009, provided the government's expectations of a 13-15% increase in oil production are met. Shatalov noted, however, that the IMF projects just 1% growth for Kazakhstan in 2009, primarily due to stagnation in non-tradable commodities. ¶4. (SBU) The sluggish growth is largely attributable to the direct and indirect effects of the global financial crisis. Bank lending has been significantly constrained, with Kazakhstani banks unable to replenish their external borrowing and holding portfolios in which, according to government estimates, 6-7% of loans are non-performing, and perhaps up to 20% are "under stress" (see reftel C). The global economic slowdown caused by the financial crisis has significantly reduced prices for key Kazakhstani commodity exports, including crude oil and metals. BLUE CHIPS TAKE A TUMBLE ¶5. (U) During a January 13 Cabinet meeting, Minister of Labor and Social Protection Berdibek Saparbayev said that due to the global economic crisis, 25 enterprises in Kazakhstan have gone out of business, costing 7,000 employees their jobs, while 234 enterprises were forced to reduce operations, resulting in an additional 28,000 layoffs. Even Kazakhstan's strongest, most well-established enterprises have not been immune from the crisis. For example, from June 2, 2008 to January 2, 2009, the value of shares in a number of leading Kazakhstani companies dropped dramatically: - Global Deposit Receipts (GDRs) for KazKommertsBank were down 55%, from $16.30 to $7.45 per share; - GDRs for KMG Exploration and Production, a subsidiary of national oil and gas company KazMunaiGas, declined by 58%, from $31.40 to $13.20 per share; - GDRs in Alliance Bank dropped by 84%, from $5.55 to $0.89 per share; - shares in Eurasian Natural Resource Corporation were down 75% on the London Stock Exchange, from 1,444.00 pounds to 362.50 pounds per share; and - shares in copper giant KazakhMys fell by 85% in London, from 1,686.71 pounds to 255.00 pounds per share. CRISIS RESPONSE PLAN ASTANA 00000068 002.2 OF 004 ¶6. (U) At the January 13 cabinet meeting, Minister of Economy and Budget Planning Bakhyt Sultanov presented a detailed action plan to Prime Minister Masimov in response to the financial crisis. As previously announced, approximately $10 billion for anti-crisis measures will be allocated from the National (Oil) Fund, which currently holds assets of $27.6 billion. In total, the government has announced plans to inject up to $18 billion (approximately 20% of GDP) into the economy. The government's crisis response plan includes a $4 billion investment in the financial sector, including the intended purchase of 25% equity stakes in Kazakhstan's four largest banks; $3 billion to complete housing construction projects and strengthen the mortgage lending system; $1 billion to bolster small- and medium-sized businesses; $1 billion for the agricultural sector; and $1 billion for infrastructure and industrial projects. "BILLION-DOLLAR BLACK BOXES" ¶7. (SBU) Ulf Hindstrom, senior banker for the European Bank for Reconstruction and Development (EBRD),told us on January 13 that the government's anti-crisis plan contains "a lot of billion-dollar black boxes," and lacks a compelling, overarching strategy to stabilize the economy. Furthermore, he added, "the government hasn't spent any of the money yet. They're only talking about spending the money." World Bank Country Manager for Kazakhstan Sergei Shatalov conceded this point, but added that the government's repeated public pronouncements may have positive psychological effects on the population, if they can be convinced that the government is taking decisive action to address the crisis. GOVERNMENT EXPECTED TO MAINTAIN SOCIAL STABILITY ¶8. (SBU) Both the EBRD's Hindstrom and the World Bank's Shatalov believe that despite the crisis, the government will continue to honor the social contract and deliver basic social services such as education, health care, and housing. Hindstrom is optimistic about the medium- to long-term outlook in Kazakhstan and expects stable growth in the country's production of oil, uranium, coal, and grain. In the short-term, however, he worries that the government has succumbed to a "temptation to enact populist measures" that may adversely affect economic growth. He noted in particular the government's proposal to impose price controls for electrical power that will likely deter private investment in the modernization or expansion of infrastructure. INVESTMENT IN INFRASTRUCTURE A WISE CHOICE ¶9. (SBU) Hindstrom defended investments in infrastructure as a sound crisis response measure and noted that the government is willing to undertake enormous infrastructure projects (e.g., roads, railroads, etc.) in order to demonstrate visible results, make large capital investments, and create jobs. (NOTE: Under the aegis of the Central Asia Regional Economic Cooperation, the EBRD, Asian Development Bank (ADB),and the World Bank are co-funding one of the largest infrastructure investments in Kazakhstan, the multi-billion dollar Transport Corridor to China project. END NOTE.) However, "The problem with the government's infrastructure investments," according to Hindstrom, "is the penchant for funding white elephant projects," such as the six-lane highway from Astana to the resort of Borovoe, which, he argued, "has no legitimate economic justification." STRAIGHT A'S ¶10. (SBU) Almaty, Astana, Atryau, and Aktau will receive the majority of money, support, attention, and protection during the financial crisis, contended Shatalov, possibly at the expense of other cities and regions. Prime Minister Masimov's actions seem to be consistent with Shatalov's prediction. On January 13, Masimov ordered Kairat Kelimbetov, chairman of the Samruk-Kazyna National Welfare Fund, to prepare a special anti-crisis plan for Astana and Almaty within the next two weeks because of the "special importance" ASTANA 00000068 003.2 OF 004 of those two cities to the economy. Masimov noted that Astana and Almaty are the real estate and financial centers of Kazakhstan and said "the lion's share of the government's anti-crisis measures will be taken in those two cities." BANKING SECTOR "VULNERABLE" ¶11. (SBU) The banking sector is extremely vulnerable and heavily leveraged, according to Shatalov and Hindstrom. Minister of Economy Sultanov seemed to acknowledge this when he told the Cabinet on January 13 that the government, "must urgently rehabilitate second-tier banks by using the Distressed Assets Fund to purchase problem assets as soon as possible." The problem, according to the World Bank and EBRD, is that the Financial Supervision Agency (FSA) does not know the true value of toxic assets and has no reliable way to determine their value. Hindstrom said, "We simply don't know how bad things really are," partly because a bank's loan portfolio is a fast-moving target. A borrower's status and fiscal health can change rapidly, he said, particularly if a company cannot secure the capital needed to fund expansion or even payroll obligations. Shatalov said the aggregate value of Kazakhstan's "doubtful debts" is could be as high as $30 billion. Both Shatalov and Hindstrom agreed that closer banking supervision and regulation are absolutely essential and they said the government is taking steps in the right direction, including its investment of $4 billion in the banking sector. RESTRUCTURING DEBT TO AVOID DEFAULT ¶12. (U) On December 9, Samruk-Kazyna Chairman Kelimbetov said publicly that the state is "prepared to negotiate with foreign investors on the restructuring of the debt of Kazakhstani commercial banks." Although major banks politely declined the offer, the threat of forced debt restructuring remains in play. Kazakhstani banks owe more than $40 billion to foreign creditors, including $10.6 billion due in 2009 and $7 billion due in 2010. In his December 9 remarks, Kelimbetov said that the government would like to discuss discount terms and repayment extensions with creditors. Kelimbetov's comment quickly set off alarm bells in the financial sector and was immediately "clarified" by National Bank Chairman Anvar Saidenov. The National Bank and FSA continue to downplay Kelimbetov's statements. On January 13, for example, FSA Chairwoman Elena Bakhmutova categorically denied banks will default on their payments. "We only raised the question of restructuring the banks' external debts. Nobody is talking about default." She added that the FSA has been talking "on a voluntary basis" with major creditors, but the banks have not embraced the idea of debt restructuring. EXCHANGE RATE IS A CANARY IN A COAL MINE ¶13. (SBU) According to the World Bank's Shatalov, "there is massive nervousness" about the exchange rate. Kazakhstan unofficially pegged the tenge to the dollar in late 2007 and kept the exchange rate between 120 and 121 tenge throughout 2008. On January 13, the rate broke out of the corridor, with the tenge falling to 121.12. Shatalov said the World Bank will monitor changes to the exchange rate as an early warning indicator of structural stress in the economy. National Bank Chairman Saidenov is well aware of the importance of exchange rate stability and said on January 13 that Kazakhstan will keep the exchange rate of the tenge under tight control to protect Kazakhstan's heavily dollar-denominated economy. ¶14. (U) Imports have continued to increase even as overall economic growth has stalled. In particular, Russian and Ukrainian imports are driving Kazakhstani goods from local markets, which led Minister of Industry and Trade Vladimir Shkolnik to call for higher duties on imported food products. At the January 13 Cabinet meeting, Shkolnik said, "The term for low tariffs on some of the most significant foodstuffs imported into Kazakhstan expired on January 1, 2009. Unless we raise the tariffs, cheap, imported products will flood our ASTANA 00000068 004.2 OF 004 markets and drive out local manufacturers," he warned. DOUBTS ABOUT SAMRUK-KAZYNA ¶15. (SBU) Analysts continue to debate the purpose of Samruk-Kazyna, the behemoth, state-owned National Welfare Fund created by the merger of mega-holding company Samruk and national development fund Kazyna (see reftel D). The EBRD's Hindstrom said, "It is still not clear what the intent was behind the creation of this organization, or what its current strategy is." He also said the merger might lead to a conflict of interest, if, for example, Kazyna was to provide funding for projects in which Samruk's companies are invested. Prior to the merger, Samruk alone owned more than 90% of Kazakhstan's asset base, including 19 companies and more than 300 legal entities in the oil and gas, mining, telecommunications, transportation, and training sectors. Samruk reported more than $24.5 billion in revenue in 2007. ¶16. (SBU) COMMENT: The government has taken aggressive steps to respond to the financial crisis and has done well to keep unemployment, inflation, and currency volatility in check. One immediate priority appears to be maintaining social stability, which the government hopes to achieve by completing housing construction, regulating electricity and food prices, and encouraging foreign investors to maintain current levels of employment. In the medium term, there is serious concern about the ability of banks to meet their outstanding obligations, with debt restructuring and industry consolidation both a distinct possibility. Over the long term, there is a danger that the government's increased involvement in and ownership of the economy, especially the banking sector, will restrict competition and prevent the emergence of new private sector players. It is not clear at this point whether the government has any intention of selling or divesting the assets it is acquiring and aggregating. END COMMENT. HOAGLAND