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Macroeconomy. September 2009

Sergey Kasyanenko, Edilberto L. Segura

The macroeconomic overview provided by SigmaBleyzer Company

Economic Growth

Weak domestic and foreign demand continueto weigh down on business activity in Kazakhstan. That said, there are signs that theduring the first half of this year, industry shrank by 2.7% year-over-year (yoy), comparedto a decline of 4.7% yoy in the first quarter of 2009. More than that, a reversal of thedowntrend appears to be emerging in manufacturing economic slowdown may be losing speed. Indeed, (see chart 1).

Growing output in the oil and gas extraction industry continues to shield Kazakhstan against double digit declines in industrial output experienced by the majority of the CIS economies. According to the CIS Statistical Committee, industrial production of the CIS member states shrank by 15% yoy during the first half of this year.

During the first quarter ofthis year, output in manufacturing declined by almost 12% yoy, while it fell by only 9.5% yoy in the first half of 2009. This means thatin the second quarter of 2009, manufacturing grew by about 9% compared to the quarter before. As a result, in April-June, industrygained 3.1% against the first three months of this year.

Essentially, stronger performance of metallurgy during the second quarter of 2009helped to boost manufacturing output (see chart 2).

In particular, during the second quarterof this year, output in the ferrous and non-ferrous metal industries grew by 10% yoy and 1.7% yoy against the same quarter oflast year, respectively (or by 28.3% and 14.6%, compared to the first quarter of 2009). In April-June, production of ferro-alloys, refined copper and flat rolled steel jumped by33.1%, 28.5% and 23.8% against the first quarter of 2009. It appears that foreign demand may be returning, helped by the stronger growth in Asia. After all, China's insatiableappetite for industrial metals as well as its resilient economic performance fueled Kazakhstan's exports to China in the secondquarter of 2009. Indeed, during April-June2009, Kazakhstan's exports to China grew by about 18% compared to the quarter before, asexports of ferro-alloys, refined copper andiron and steel gained 28.5%, 69% and 6.5%, respectively. As a result, during the first half of 2009, Kazakh exports of iron and steel,metal oars and non-ferrous metals to China surged by 57% yoy. Iron and steel, ores, copper, zinc, lead and aluminum and articles made of non-ferrous metals accounted for over 60% of all Kazakh exports to China in January-June 2009.

Although a resurgence in foreign demandfrom China adds strength to the Kazakh manufacturing sector, world commodity prices remain(see chart 3). In particular, prices of fertilizers (one of the key export commodities of the Kazakh chemical industry) continue tofall. According to the International Fertilizer Industry Association (IFA), world fertilizer consumption is estimated to drop by 5.1% in2008-09. This means that Kazakhstan's producers of fertilizers and related chemicals will continue to face difficulties in the near term. low on the back of weaker global demand

In April-June 2009, production of constructionmaterials recovered by about 33% against the first quarter. Still, readings on theduring the second quarter of 2009, the average monthly growth rate of the volume of construction works and investments into residentialhousing accelerated to 28% and 15%, respectively. At the same time, construction activity remains weaker than the year before. InJanuary-June 2009, the volume of construction works and investments into residentialhousing fell by 11% yoy and 49% yoy, respectively. Furthermore, despite a 7.3% yoygrowth of fixed capital investments in the first half of 2009, capital outlays on construction and building maintenance fell by 22.3% yoy.Lastly, downward price pressures on the housingmarket persist (see chart 4), which reflects a lack of demand due to tight access to bankcredit and slower growth of household incomes. construction sector are mixed. In particular,

Weaker construction activities in the secondquarter virtually canceled out a revival in manufacturing.As a result, in January-June,Kazakhstan's GDP fell by 2.3% yoy as construction declined by nearly 10% yoy (versusa decline of 6.6% yoy in the first quarter of this year, see chart 5). Lower volume of construction works, in turn, has been exerting a toll on the transportation sector. Indeed, during the second quarter of 2009, automobilefreight traffic (which accounts for nearly 80% of all freight traffic in Kazakhstan) dropped by 15.5% yoy versusof 2.6% yoy in the first quarter of 2009). Falling retail sales have contributed to the sector's woes as well. During the second quarter of 2009, retail sales decreased by over 13%yoy compared to a drop of only 3.5% yoy inthe first quarter of this year. the same quarter of 2008 (compared to a decline

Sales of new cars represent about 6% of all retail sales in Kazakhstan, while another 14% come from the retail sales of fossil fuels. During the first five months of 2009, imports of passenger cars into Kazakhstan plunged by 37% yoy, while retail prices of gasoline and diesel fuel fell by about a third. Obviously, these trends tend to intensify the observed decline in retail sales.

All told, in January-June 2009, the transportation sector posted a decline of 11.7% yoy, dragging theservices sector of the economy into negative territory (although output in the services sector edged down by only 0.3% yoy). On a positive note, in April-June, both retail sales andfreight traffic grew on a quarter-over-quarter comparison (up by 2.2% and 7.3%, respectively).

Lastly, the labor market in Kazakhstan appearsto be showing signs of improvement, while there is still little evidence of rising wage pressures. Indeed, during the first halfof this year, the growth of monthly nominal wages slowed to about 12% yoy on average from 16% yoy and 28% yoy in 2008 and2007, respectively. On a positive note, real wages have been growing since January thanks to a significant deceleration of inflation (in 2008, real wages remained mostly flat as consumer prices spiked following the global commodity bubble).More importantly, non-farm employment increased in the first and second quarters of 2009, pushing the unemployment ratedown to 6.7% (see chart 6).

Agriculture employs about 30% of all workers in Kazakhstan versus about 4.5% average for 23 OECD countries. This means that civilian employment in Kazakhstan tends to fluctuate substantially following crop production cycles.

Construction and industry (which provide 10% and 17% of all non-farm jobs, respectively) lost about 1% and 3.6% of jobs over the last three quarters.On the upside, both sectors reported job gains in the second quarter of 2009. Meanwhile, the trade sector, which employs one fifth of allnon-farm workers, remains a soft spot in the Kazakh labor market as weak consumer spending forces companies to lay off employees. Indeed,in the second quarter of 2009, the number of jobs in this sector fell by 1.4% compared to the quarter before.

Fiscal Policy

In January-July, the state budget reported adeficit of about 0.6% of projected full year GDP (see chart 7). However, the non-oil component1of this deficit rose to about 4.3% of GDP compared to 1.7% the year before.

1. The non-oil budget deficit is measured as the gap between budget spending (excluding debt service, balances on budget loans and operations with financial assets) and budget revenues net of the transfers from the National Oil Fund.

This wider budget gap mostly reflects a sharp deterioration of fiscal revenues as a response to a structural shift, brought about by last year'stax reform, and an abrupt recession-driven cyclical decline in tax collection. Indeed, during the first seven months of 2009, fiscal revenues dropped by 20% yoy to only 58% of all statebudget revenues (last year, fiscal revenues yielded 74% of all state budget revenues). Proceeds from the corporate income tax and VAT2 plunged by 32% yoy and 17% yoy, respectively.

2. These two taxes generate over half of all fiscal revenues. Proceeds from the personal income tax (PIT) fell by only 5.6%yoy. PIT accounts for about 12% of all state budget tax revenues and is collected by the local budgets. At the same time, the two largest cities - Astana and Almaty, contribute about 44% to the collection of this tax. Slower wage growth and a deeper contraction of the local economies (due to a higher exposure to the construction and retail trade sectors) led to the 24% yoy and 12% yoy declines of PIT collection in Almaty and Astana, respectively.

After all, profits of Kazakh companiessuffered a heavy blow due to stagnating domestic and foreign demand, a deep decline of the prices of key export commodities andlarge losses in the banking system.

According to the ASRK, during the first half of 2009, pre-tax profits of large and medium size Kazakh companies shrank by over 65% yoy. Meanwhile, in January-July 2009, commercial banks paid 78% yoy less in income taxes as heavy losses on loan portfolios eroded banks' profits.

On top of that, VAT revenues, 3/4th of which are collected on imports, and proceeds from custom duties fell under the pressure of lower volumes and values of the cross-boarder tradeflows. That said, the government had to tap the National Oil Fund to close the revenueprogram. In particular, during the first seven months of 2009, transfers from the National Oil Fund to the state budget grew by 72% compared to the year before, amounting to over $5 billion. On a positive note, by the end of August, the assets of the Nation Oil Fund stood at $22.3 billion, which means that in the near-term the government can comfortablycontinue balancing decreasing fiscal revenues with non-debt financing. shortfall and fund its economic stabilization

Meanwhile, state budget expenditures (excluding budget loans and purchases of financial assets)grew by 8% yoy as spending on education, healthcare, social protection and housing (spending on these four items accounted for over 60% of all budget expenditures versus only 53% a year ago) advanced by over 20% yoy.In particular, current expenditures, which includewages in the public sector, pensions and welfare transfers as well as spending on goods and services, increased by 19% yoy. However,this higher budget spending was partially offset with a 7% yoy decline of capital spending (about 1/4th of all budget spending) as the government cut or froze spending onsome large public projects. All told, the government appears to be striking a reasonable balance between its spending commitments tosocial protection and investments into public infrastructure. In particular, socially sensitive items remain shielded from spending cuts, while capital spending is delayed, whichhelps keep a tighter lid on deficit growth.

Monetary Policy

In August, the consumer price index (CPI)grew by only 6.2% yoy compared to 20.1% yoy in August 2008 (see chart 8).

Consumer prices increased much slower this year on the back of last year's record high world commodity prices, which peaked in July-August 2008. In particular, during the first eight months of 2009, prices of bread and cereals, key consumer staples in Kazakhstan (about 42% of consumer spending in the republic is allocated to foods), inched up by only 0.3% ytd, compared to 16.2% ytd in thefirst eight months of 2008. Meanwhile, prices of gasoline and diesel fuel declined by 1.6% ytd and 17% ytd, respectively, compared togrowth of 17% ytd and 43% ytd in August 2008. This may imply that disinflation dynamics will slow as the high base impact of lastyear's prices gradually fades away. On a positive note, core inflation, which ignores price volatility of fuels and foods, has been falling since the beginning of 2009 as well. Thismeans that inflationary pressures are still a remote threat to macroeconomic stability. Indeed, sluggish growth of nominal wages andweak bank lending helped to cool consumer demand. On top of that, currency depreciation restrains consumer demand through thehigher prices of mostly imported non-food durable and non-durable products, including medicine, clothing, household chemicals andappliances. All told, lower inflation prompted the National Bank of Kazakhstan (NBK) to reduce its refinancing rate in September by 50basis points for the fifth time in as many months. This rate was set at 7% – the lowest level in over 4 years (see chart 9).

This means that the health of the banking system is of major concern to the NBK. Indeed,Kazakh banks continue to face significantfunding constraints due to a combination of the closure of international credit markets, deteriorating quality of loans and mountingcredit losses. In particular, the share of non-performing loans grew to 32% by the end of August from only 8% at the beginning of2009. True, nearly 70% of all non-performing loans sit on the books of just two banks – BTA Bank and Alliance Bank,3 while the share ofnon-performing loans of other large banks does not exceed 20% (see chart 10).

3. Both banks defaulted on their foreign debts in April and received large capital injections from the government. The third Kazakh lender in default, Astana Finance, is negotiating with its creditors.

Creditors of Alliance Bank have already agreed to restructure $4.2 billion in debt. At the beginning of September, BTA Bank released adebt-restructuring plan, offering $1 billion to buy back its $10.3 billion debt at an 82.25% discount. Additional options includeseven and fifteen-year debt rollovers with a grace period as well as a possibility for a debt for equity swap with an 80% haircut.All told, notwithstanding large injections of public money into the financial system, it is likely to take longer for bank lending to returnto normal levels as two of the major lenders are going through a lengthy reorganization process.

International Trade and Capital

During the first half of 2009, the foreign trade surplus stood at $4 billion or down by78% yoy from $18 billion the year before.On the upside, a recovery of world crude oil prices and resilient demand for commodities from emerging Asia add strength to exports(see chart 11). In particular, during the second quarter of 2009, Kazakh exports to China grew by over 10% compared to the first quarterof this year. More than that, this year China trails only Italy as the second largest export market for Kazakhstan, absorbing over13% of all Kazakh exports.

In 2008, China was the third largest export market for Kazakhstan (10.8% of all exports), following Italy and Switzerland. However, exports of Kazakh mineral fuels and crude oil products accounted for about 92% of all exports to Italy and Switzerland (mineral products represented only 57% of all Kazakh exports to China). This means that stronger demand from China is likely to have favorable implications for thebroader Kazakh economy due to a more diversified mix of exports.

However, as crude oil prices remain significantly less than last year's level, Kazakhstancurrent account dives deeper into the red. Preliminary estimates place the current account deficit at $1.8 billion in the second quarter of 2009, compared to a surplus of about $1 billion in the same quarter a year ago (see chart 12). As a result, during the first half of this year, the current account deficit widened to $2.8 billion or to about 6% of Kazakh GDP in January-June 2009. On a positivenote, lower oil prices put a curb on the value of profits repatriated by the foreigners, including international oil companies, down by 60% yoy (net repatriation of profit earned on foreign direct investments (mostly in the oil sector) fell even deeper – by 63% yoy).Furthermore, continuing consumer retrenchment from purchases of importeddurable goods helped curb imports (down by 24% yoy in January-June 2009). Finally, the current account gap remains fullycovered with net inflows of foreign direct investments, which amounted to $4.7 billion or down by only 9.4% yoy.

Other Developments Affecting theInvestment Climate

According to the latest Global CompetitivenessReport 2009-2010, Kazakhstan holds 67th place out of 133 countries rated by the World Economic Forum (see chart 13). In essence, Kazakhstan's competitive disadvantagesare rooted in the excessive reliance of the economy on resource-based sectors and a fragile banking system. On the upside,Kazakhstan managed to maintain its competitiveness relative to the two other largest CIS economies4 Russia and Ukraine, which saw substantial downgrades of their competitiveness ratings. Equally important, Kazakhstanhas suffered little damage to its fiscal position due to the global financial crisis, while political stability supports the country's commitment to market reforms and economic diversification.

4. Kazakhstan is the third largest economy in the CIS region. In 2008, the country's nominal GDP stood at $132 billion compared to $1,607 billion and $180 billion in Russia and Ukraine, respectively.

This lays the groundwork for the sustainableimprovement of Kazakhstan's competitiveness in the future.

SigmaBleyzer is a private equity firm focused on investing in regions that are making the transition to free market economies – specifically countries of the Former Soviet Union and Eastern Europe. With a strong presence on the ground in the selected countries of operation, SigmaBleyzer takes an active, hands-on role in the management of the funds’ investments.In addition to working actively with portfolio companies, SigmaBleyzer engages the governments of the countries in which it invests to help them carry out the reforms necessary for economic growth and development. SigmaBleyzer leverages a strong infrastructure of local and Western talent to manage and improve our holdings, while working through our think-tank The Bleyzer Foundation, to help the countries in their transition to a market economy.


Table of contents
Caspian Gas: One for All?   Sergei Smirnov 
Insurance Market: Sight from Outside  The special report of Standard & Poor’s 
Macroeconomy. September 2009  Sergey Kasyanenko, Edilberto L. Segura 
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· 2011 №1  №2  №3  №4  №5  №6
· 2010 №1  №2  №3  №4  №5/6
· 2009 №1  №2  №3  №4  №5  №6
· 2008 №1  №2  №3  №4  №5/6
· 2007 №1  №2  №3  №4
· 2006 №1  №2  №3  №4
· 2005 №1  №2  №3  №4
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· 2003 №1  №2  №3  №4
· 2002 №1  №2  №3  №4
· 2001 №1/2  №3/4  №5/6
· 2000 №1  №2  №3

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