In the past 10 years, the former Soviet satellite of Kazakhstan has received billions of dollars of investment. As Christopher Pala reports, the government has much to pride itself on... and much more work to do to maintain such high levels of investment.

Kazakhstan’s financial reforms have left comparable countries such as Russia or Turkey far behind, and foreign investment is pouring in at the rate of $2bn-$3bn a year.

After taking a dive, caused by its close links to the Russian economy in 1998-1999, Kazakhstan’s economy has rebounded so far that last year, bucking the worldwide recession, this nation of 14 million people in a country around the size of Western Europe achieved a growth of 13.4%. In 2002, said Grigori Marchenko, governor of the National Bank of Kazakhstan, predicts that the economy will grow by another 7% or 8%.

Much of the foreign investment is pouring into the jewel in Kazakhstan’s crown: the three giant oil fields: Kashagan (the fifth largest in the world), Tengiz (sixth largest) and Karachaganak, a large gas and condensate field. The mining sector, despite mineral wealth comparable to Australia or Canada, remains mostly in the hands of Kazakhstanis.

Inspired by Norway, the Kazakhstan government used windfall profits from its oil exports of about half a million barrels a day to create an oil fund (which has grown to $1.3bn) to cushion the country against any future drops in the prices of oil, copper, steel and wheat – the country’s main exports.

Reforms bear fruit

The government has been trying to rein in a still-powerful bureaucracy. The tax police’s ability to freeze bank accounts arbitrarily has been curtailed by the central bank, so that now the tax police must submit evidence of criminal activity (other than tax dodging) to freeze a bank account.

The government has voluntarily opened its data-gathering methods and its fiscal process to IMF officials for inspection and advice. The salaries of judges have been doubled, and the number of taxes cut from 52 to eight.

From the top

President Nursultan Nazarbayev, a one-time reformist and close ally of former Soviet president Mikhail Gorbachev, in his perestroika days – has been speaking with increasing forcefulness about further streamlining the bureaucracy. Its venality and obstructionism are still denounced by local and foreign companies alike, and it is often blamed for the lack of growth of small and medium-size enterprises. Yet some remain to be convinced. “He is talking the talk, but will he walk the walk?” wonders one senior foreign envoy who declines to be named.

The banking sector is Kazakhstan’s biggest success and one it can call its own. With no help or pressure from the West but steady support from Mr Nazarbayev, a former steel engineer with no economic training, the last three governors of the Central Bank (Daulet Sembayev, Oraz Jandosov and the current one, Grigori Marchenko) have pared down the number of banks from more than 200 to 39.

Mr Sembayev went on to join the country’s largest bank, Kazkommerts-bank, as chairman of the supervisory board. KKB, as the bank is known, has seen its rating upgraded in April by the big three rating agencies.

Fitch, after leaving KKB with a B+ long-term rating for six turbulent years, upgraded it to BB-, placing it several notches ahead of any bank in Russia, of which Kazakhstan was a colony only a decade ago. In its annual report on Kazakhstan in late-April, Moody's upgraded Kazakhstan to Ba2/Ba3 country ceiling ratings and positive outlook due, it said, to “improved external liquidity, lower medium-term debt repayments, tight budgets and favourable economic conditions”.

Author of the report and Moody's vice-president and senior credit officer, Jonathan Schiffer, says: “Four years after the Russian economic crisis, Kazakhstan is well placed for a period of reasonable economic growth.”

The picture is less rosy in the utilities sector, however, where International Power, a British company, has sold its one-half share to its Israeli partner. International conglomerate Vivendi – which has been negotiating for three years to take over the Almaty water system which is plagued by Soviet-era inefficiencies – will be cutting its staff of five expatriates as prospects for a contract dim.

Government stalls

Both companies moved in, believing the government would allow them the rate hikes required to turn a profit. However, the government has been unwilling to do so for fear of a popular backlash, and it also has been unable to devise a rate structure that would protect the retired, whose pensions usually do not exceed $25 a month. More than one-third of the country lives on less than 15 cents a day, the official poverty level. Still, the average salary is about $105 a month, higher than in Russia.

Despite concerns about the government’s double-talk on the sanctity of contracts and a controversial foreign investment law proposed a year ago, the huge oil deposits of the Caspian Sea – long neglected by the Soviets because they lacked the technology to exploit them – are proving an irresistible magnet. “Demand for a piece of the action is bigger than supply,” says one oilman.

The big exception in non-oil investment is the Ispat Karmet steelworks, the country’s largest private employer (see below). Foreign companies operating in Kazakhstan say foreign investment will slow if a controversial foreign investment law, proposed a year ago and stalled in parliament, is passed. It would eliminate the stability clause that guarantees foreign investors protection against changes in tax and other laws. It also removes the right to international arbitration.

Contract controversy

There has been controversy in the country about how much contracts are honoured by the government following a showdown with a member of a new political party The Democratic Choice of Kazakhstan when a written agreement was not kept to.

Galimzhan Zhakyanov, a former governor of the Pavlodar region, was arrested after spending six days at the French Embassy, which shares a building with the British and German Embassy. He left the building after the three ambassadors obtained a written commitment that he would remain under house arrest in Almaty. But six days later, he was transferred to Pavlodar, his home town.

In late-April, a senior European Union official, Cornelis Wittebrood, flew from Brussels to head a delegation that met with senior Kazakhstani officials in Astana, the capital. The strength of his protest over the violation of the agreement with the ambassadors surprised Kazakhstani officials, says another EU official who was present, and they promised to have Mr Zhakyanov back in Almaty under house arrest within a week.

Mr Wittebrood said this “cavalier attitude” with a written commitment reflected a general deterioration of the investment climate, with first and foremost a challenge on the sanctity of contracts. “The way the rules are being applied or enforced is having a negative effect on the willingness of investors to come to Kazakhstan,” he said in an interview. “Now it is the individual treatment of an individual company that, in the end, will decide whether an investment is profitable or not.”

The government has argued, however, that certain contracts had been negotiated when the country was inexperienced in international commercial law and at a disadvantage before huge multinational corporations.

Balancing act

Representatives of these companies argued that the contracts reflected the risk they were taking in dealing with what was a highly unstable region in the early-1990s and that they are more than a decade away from turning a profit on their investment.

Kazakhstani officials counter that because the number of taxes has dropped from 52 to eight, companies are receiving improved conditions.

“We will respect the contract but we will insist that it be changed on the basis of good will, where both sides agree that the contracts have become unbalanced,” says Doulat Kuanishev, a vice-foreign minister familiar with foreign investment issues.

Laurent Ruseckas, an analyst at the industry-funded Cambridge Energy Research Associates, says that for the past 18 months or so: “The Kazakh government has behaved in ways that are giving companies pause for thought about the long-term investment climate.”

Kazakhstan’s oil reserves are too attractive to be ignored. But the rate of exploitation and the amount of foreign money invested will depend on the country’s investment climate.

Steel magnate’s shining reputation

When in 1995 the Indian steel magnate Lakshmi Mittal pledged $350m to take over a giant steel plant in Termirtau, a company town near the city of Karaganda in the middle of the vast Kazakhstani steppe, it was considered a risky gamble.

The plant had been designed in the 1960s, had failed to be revived by an Israeli company and was producing little steel, none of it of quality. Its workers had not been paid for months and the company had even issued its own currency. Pessimists said Kazakhstan’s tiny domestic demand – its population is less than 15 million – and great distance to foreign markets would make success difficult. But the mill was located on the world’s most extensive railway grid next to iron mines and some of the globe’s finest coke-producing coal deposits.

It also happened to be where president Nursultan Nazarbayev began his career as an engineer.

“Before we took over,” Mr Mittal recalled in an interview in Almaty, Kazakhstan’s economic capital, “he sat down with me and we discussed the steel business for several hours. He wanted to know what our plans were, my experience and so on, and we understood each other very well.”

Now, Mr Mittal says, “we are producing four million tonnes a year.” Of the 12 steel mills in the London-based Ispat International empire, Ispat Karmet is the third largest producer. “We sell mostly to China, Russia and Iran,” he said.

Ispat (which means steel in Sanskrit) Karmet (the acronym for the Karaganda Metallurgical plant) was even selling 4% of its output to the US until it was hit with an anti-dumping ban last year.

Ispat Karmet acquired 15 coal mines, an iron mine and two power plants in the area. “We have invested $700m so far, and we are spending another $400m in the next five years,” Mr Mittal said.

For Kazakhstan, Ispat Karmet has been an important investment. After oil and unprocessed metals, steel is the country’s third largest export, and helped it buck the worldwide recession with 13% growth last year. “We used to be 10% of the Kazakhstani economy; now we are 5% because the Kazakhstani economy has grown,” Mr Mittal said. “Karaganda and Temirtau depend on us for about 60% of their income. They have 400,000 people put together, so you feel some social responsibility.”

Two loans totalling $450m from the EBRD, the International Finance Corporation and several private banks brought not only finance but also an examination of how the plant was acquired and a close monitoring of its toxic emissions. The former was judged fair and legal and the emissions have been cut from 4.5 times the European level to 2 times.

President Nazarbayev considered Mittal such a model foreign investor that he named him Kazakhstan’s honorary consul in London so he would promote the country’s interests in City circles to which the normal diplomatic representation has little access.

Doulat Kuanishev, a deputy foreign minister, said Kazakhstan has about 20 honorary consuls around the world. “We look for people of prominence, authority and high achievement who have spotless records and have exhibited commitment to Kazakhstan’s development,” he said. “Mr Mittal fits the profile.”

But after Mr Mittal was accused of having donated Ł125,000 pounds to the UK’s Labour Party in exchange for getting prime minister Tony Blair writing a letter of recommendation to the president of Romania during Ispat’s purchase of a steel mill there, Mr Mittal decided to forego the honorary consulship.