Kazakhstan

Highlights and Key Issues

* The slowdown this year will be sharper than previously expected, with GDP growth falling below the government's revised 5.3% projection as it tackles inflation, which is causing social strains. Growth will quicken again in 2009, driven by commodity exports.

* Major banks' profits will fall and bad debts will rise as a result of slower growth and a property price downturn. This may force some to sell more equity to boost capital and meet large foreign debt obligations. The government wants to avoid having to use its large reserves to support over-extended banks, but it will allow monetary loosening to boost their liquidity despite this working against its anti-inflation policies.

* The inflation rate went above 19% in Q2, and has forced interventions, including direct price controls and temporary bans on grain and oil product exports. Compensating state wage and pension increases may add to inflation pressures, meaning that rising public expenditure will not address supply-side deficiencies until a big communications investment programme starts in 2009.

* Inward investment remains strong, with oil staying attractive despite new export taxes and electricity projects addressing capacity shortage. State-owned firms' rising debt will force continued foreign partnership, as a swing to current account surplus helps ease debt problems without arresting growth.

Overview

Inflation battle worsens slowdown...

The official growth forecast for 2008 has been cut to 5.3%, due to slower investment and non-oil export growth that dropped Q1 expansion to 6%. The government will combat this by letting its central deficit widen, to 2.1% of GDP. Resultant domestic debt issuance will help to soak up excess liquidity from booming mineral exports. These had lifted official reserves to US$21.5bn by end-May, with another US$24bn in the National Fund for resource revenues, whose current strength means the general government finances remain in surplus.

* However, the wider central deficit risks worsening the already serious inflation overshoot. At 1% on the month and an annual 19.5% in May, consumer price inflation is already causing social tension as rising prices erode real wages and pensions. A planned US$1.3bn public spending increase will mainly finance pay rises, which could fuel inflation, with an IMF-approved communication investment drive only starting next year. While official growth projections of 6.9% growth in 2009 and 5.6% in 2010 are attainable, being based on conservative oil price assumptions, risks are on the downside as inflation forces a monetary squeeze that could worsen the investment slowdown.

...as banks forced to seek new funds

* Fears of inflation and reputation damage have also stopped the government promising assistance for the main commercial banks, despite their acknowledged difficulties in meeting foreign debt obligations of up to US$14bn this year. Capacity to finance these has been hit by domestic slowdown and international interbank market constraints, which led S&P to post a negative credit rating outlook in April. The central bank has been forced to promise lower reserve requirements for foreign debt, weakening its anti-inflation stance. Halyk Bank, the third largest bank, has reported Q1 net income down 9% to KZT9.8bn (US$80m) in June, citing more non-performing debt and higher costs of attracting deposits; but other banks may be more heavily exposed to rising foreign debt costs. Although there are ample funds available to offset banks' liquidity difficulties, any that need extra capital are being pushed to obtain it privately by inviting more foreign participation, with Middle East banking groups the most likely new entrants.

New oil taxes to widen public surplus

* The new oil export tax took effect in May and has added to the growth of mineral revenues. Although holders of production-sharing agreements (PSAs) are exempt, a new sub-soil tax applicable to all producers is due to take effect from January 2009 under the revised tax code. Foreign PSA holders have warned the new tax could deter investment and undermine ambitious targets for oil expansion: despite strong prices, official output projections have been cut to 1.35m b/d this year due to transport constraints, and oil-product exports were suspended in May to help curb inflation. But multinationals' globally strong profits, and limited alternative new fields, make it unlikely they will win any moderation of the tax plans. Renegotiation of terms on the Kashagan oilfield, to reflect higher costs, is due to be finished this month. The incentive to get better terms for the state-owned company in this and other large projects has been raised by the need to restructure the debts of state holding company Samruk, whose planned domestic share flotation will not take place before Q3.

New projects tackle power shortage

* While announcing a US$400m loan to grid company KEGOC to upgrade the electricity network, the EBRD has warned of power shortages ahead unless the government boosts supply and promotes energy efficiency to restrain demand growth. As a condition for assisting expansion, multilateral lenders will also push for an end to the current electricity price caps, which help to curb inflation in the short term but are a disincentive for businesses and households to save on fuel. Utilities remain a key target for foreign direct investment, with South Korean firms close to agreeing a US$4.5bn power station plan, which (at over 1.3MW) would be their biggest-ever foreign electricity project.