Mechanical Engineering: Cooling Down
After mechanical engineering was named a priority sector in Kazakhstan’s industrial development, it really boomed during 2008–2013. However, in 2014 the industry for the first time declined by 0.5%. The results of the first six months of 2015 confirmed that this negative trend is becoming increasingly stronger.
As one of the key industries of any nation, mechanical engineering has a direct impact on its industrial development, national security, economic growth and competitiveness. All in all, this sector includes more than 20 segments. In Kazakhstan, it mostly consists of the manufacture of computer hardware, electronic and optical products (KZT 3,819 million or 0.2% of total industrial output); electrical equipment (KZT 6,891 million or 0.3%); motor vehicles, trailers and semitrailers (KZT 22,660 million, or 1%); other vehicles; machinery and equipment not included in other categories (KZT 3,505 million or 0.2%); repair and installation of machinery and equipment (KZT 40,307 million or 1.8%).
Adopted as part of first five-year plan, 2010–2014 Mechanical Engineering Development Programme gave the industry a significant boost. For example, according to the Statistics Committee of the Republic of Kazakhstan, last year industrial output increased by 2.9 times in nominal terms compared to 2008 (from KZT 301.4 billion to KZT 869.9 billion), which is a 177.3% growth in real terms.
During the years of implementing the Accelerated Industrial Innovation Development programs, mechanical engineering achieved all its major goal and targets. Already in 2013, gross value added in mechanical engineering in real terms increased from KZT 158.1 billion to KZT 389.2 billion, or by 74% compared to 2008 (with the target being 70%). Labour productivity per person increased from $11,100 to $19,600 (201%). The share of domestic businesses in the total consumption of engineering products increased from 8.1% to 18.1%, which is 5.9% above the target. The nation has created new full-fledged industries: automotive, railway, agricultural and petroleum mechanical engineering, manufacture of electrical equipment. According to the Kazakhstan Institute of Industry Development (KIID), the industry has been showing positive trends mainly due to increased production of railway and motor vehicles: by 21.2 and 5.2 times respectively.
Walk the Talk
The Ministry expected that by 2015 the industry’s output should exceed 1 trillion tenge. In the past five years, this figure was indeed growing and achieved KZT 905,090 million last year. Meanwhile, in January–June of the current year, the mechanical engineering sector produced only KZT 281,643 million worth of products, according to the Statistics Committee. Compared with the corresponding period last year, the index of industrial production (IIP) in the industry fell by 30.7%. That is, the positive trend of the past few years has now turned negative.
It should be noted that this development was quite predictable. For instance, at the end of last year, Prime Minister Karim Massimov warned domestic machinery manufacturers about a possible decline in demand for their products: “Now the world is entering a cycle of low prices for energy and basic commodities. It means that Kazakhstan and other countries, whose budgets depend heavily on energy prices and other basic commodities, will have less opportunities.” Mr. Massimov also emphasised that mechanical engineering has always depended on demand and should to be prepared for a situation when demand for some domestic goods will drop, so the sector needs to develop strategies, find reserves within companies in order to increase productivity and reduce overheads.
Predicted by the government, the negative scenario began to unfold already in the last year, when the output of engineering products in Kazakhstan declined by 0.5%. The production of automobiles fell by 0.8%, rolling stock – by 5.2%, passenger cars – by 55%, and diesel locomotives – by 44%.
Unfortunately, the industry cannot follow the Prime Minister’s advice because of a number of systemic challenges, such as lack of investment, low level of innovation, lack of qualified personnel and aged fixed assets. Today, Kazakhstan has more than 1,500 enterprises in the mechanical engineering sector, but not all of them are working businesses. Most of them are idle or operate on a one-time order basis. The country’s demand for engineering products is mostly covered by imports.
Specifically, automotive industry is one of the most dynamically developing segments of mechanical engineering, accounting for 18% of the sector’s output. However, more than 80% of the domestic market’s needs in cars are fulfilled by imports from other countries.
This situation is common for almost all industries. Lat year, Kazakhstan imported engineering products for a total of 17.5 billion, or 21.9% more than in 2008. The most popular are vehicles with internal-combustion engines (9%), telephones for cellular and other wireless networks (3%), fittings for pipes, boilers, reservoirs, cisterns and tanks (3%). Russia, China and Germany accounts for more than 50% of Kazakhstan’s imports. While 25% of imported mechanical engineering products come from Russia.
According to KIID, Kazakhstan’s mechanical engineering sector today has only two promising products, batteries and bearings, which already occupy more than half of the domestic market. As of the end of 2014, Kainar-VKB and Zhersu-Power filled 72% of Kazakhstan’s needs in batteries, while the Stepnogorsk Bearing Plant had a 52-percent share on the ball and roller bearings market.
Domestic manufacturers of electricity meters have been doing quite well. Saiman Corporation is a major player in this sector and the only such company in Central Asia. Today, the company fulfils more than 40% of the market’s needs in such products.
However, these stories are the exception rather than the rule. Locally made products are in low demand on the domestic market. Specifically, the landscape in the transport, oil & gas and a number of other sectors is shaped by large companies. Low demand for new equipment in agriculture is due to lack of funding on the producers’ and processors’ end. Kazakhstan’s automobile industry, although growing, cannot yet compete effectively with foreign-made products.
Balls to the Wall
To effectively overcome challenges and become more competitive, domestic mechanical engineering companies develop their growth strategies based on cooperation with global industry leaders. Joint projects, including with the EEU member-states, is an effective tool to deal with systemic problems, allowing Kazakhstan to create new high-tech ventures on its territory. The are already a number of joint ventures operating in Kazakhstan and producing cars, trucks, agricultural equipment, buses, etc.
With the emergence of the Eurasian Economic Union, Kazakhstan’s producers have new opportunities but also are facing new risks. On the one hand, the member-states have high potential for growth in the mechanical engineering sector thanks to high capacity of the common market, availability of the necessary factors to stimulate sectoral growth and opportunities to improve efficiency and increase exports. For example, automotive industry can only achieve profitability by mass production which must substantially exceed the needs of Kazakhstan’s domestic market. The EEU market could provide the required demand for Kazakhstan’s exports, ensuring growth in the automotive industry.
Yet, in a period of recession, demand for engineering products from the EEU countries falls significantly, which is exactly what are witnessing today. The competitiveness of Kazakhstani manufacturers is further hurt by currency imbalances with major trading partners. With the declining output of domestic manufacturers in 2014, car imports from Russia grew by 3%, from Uzbekistan – by 56%, and from Belarus – by 400%. Rolling stock imports have increased 2.3%, with Russian manufacturers accounting for 60% of Kazakhstan’s market. Aircraft imports from Russia increased by 2.3 times in the past year.
Given the current situation on the market, the mechanical engineering sector will definitely need support from the government. Although investments grew significantly (in 2014, investments in fixed assets in the mechanical engineering sector reacher KZT 52.6 billion, which is 3.7 times more vs. the same period in 2008), the industry’s funding needs are still considerable.
In addition to financial support, the government implements spot incentive programmes for certain sub-industries. Support of the automotive industry is a case in point. This included higher import duties for foreign cars and subsidised loans for purchasing domestically made cars.
A number of local companies signed industrial assembly agreements with the Government of Kazakhstan and were granted some privileges. In return, the companies promise to make some concrete progress over a particular time period, achieving deeper technological processing and launching the production of components.
Being one of the priority sectors of the economy, mechanical engineering is supported within the framework of the Efficiency-2020 programme. The first stage included subsidised lease financing for businesses through BRK-Leasing. During 2015–2020, the programme will be aimed at supporting new business initiatives and modernisation of existing enterprises.
The second five-year industrialisation programme started this year is expected to provide a new boost to the mechanical engineering sector. As part of the government’s 2015–2019 Industrial Innovation Development Programme, six sub-industries of the mechanical engineering sector will be supported by a number of incentives.
Mitigating the impact of the negative factors on the economy is a particularly relevant issue, as well as more efficient use of the existing capacity, increasing productivity and overcoming the technological gap. According to Ardak Tashenov, Head of Strategic Analysis and Monitoring of the Analytics Department at Eurasian Development Bank, this can’t be done without financial support, including through development banks which, unlike commercial banks, can and should invest more, when the economy is going through hard times.
Obviously, the government has to respond quickly to emerging challenges by choosing the lesser of many evils. One such step was devaluation of the national currency in August. Some exporters and members of the Atameken National Chamber of Entrepreneurs believe that this should help Kazakhstani business become competitive again.
Yet, this is by no means an opinion that everyone agrees with. Olzhas Khudaybergenov, Kazakh economist and Director of the Centre for Macroeconomic Research, thinks this is not going to happen, as the country heavily depends on imports, so prices on the domestic market will definitely rise. Products made in Kazakhstan are no exception, because the majority of components used by Kazakh manufacturers are imported. So any increase in competitiveness will be effectively negated. In its current form, free floating tenge will only benefit commodity exporters, merely helping them to operate at a low profit margin and stop losing money. Unfortunately, the effect will last only 6-8 months or even less, if oil prices will continue to fall. “All this proves that without structural reforms aimed at reducing production costs of the domestic manufacturers by at least 2 times, the devaluation will only lead to higher prices and the need for an even weaker tenge,” the expert said.
And yet, moving away from commodity dependence, creating an innovation-driven economy and massive industrialisation still remain relevant issues, despite growing uncertainty, pessimism and expected budget cuts. Any progress in achieving these goals will be impossible without a growing mechanical engineering sector, as one of the flagship of this process. This, in turn, requires a more balanced, systematic approach from the government, including a set of complementary measures. Only then quantitative changes will transform into qualitative.