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 KAZAKHSTAN International Business Magazine №5/6, 2008
 Financial Crisis. Risks and Opportunities
Financial Crisis. Risks and Opportunities
The second international conference “Risk Management in Developing Economies” was held in Almaty in late October. Forum participants – professional risk managers from Kazakhstan, Russia, CIS and other countries – tried to analyse external and internal risks posed to the domestic economy amid the global financial crisis and its organisational shortcomings, and discover possible ways of correcting them.
New old crisis
Experts believe that the world has faced the problem of the global undervaluation of risks in the financial sphere in recent years. As a result of a rapid growth in savings and the weakening of coordination of developed countries’ monetary policies, ratings agencies and regulators started adopting more liberal approaches, losing control over investment and financial companies. According to Citibank’s latest report, the assets of the world’s top 50 players have more than doubled to $50,000bn in the past six years. However, their capital adequacy has fallen from 4.09% to 3.36%. This means that the capitalisation of banks grew inadequately. Citibank analysts calculated that at least two or three years had to be spent on bringing this coefficient to the 2002 level and either their assets should be reduced to $10,000bn or capital should be increased to $420bn.
Had regulators uncovered this imbalance on time, they would have had a better understanding of the risks piled in the financial system. However, this did not happen. In the situation of having excess cheap money, banks started offering new, increasingly complicated financial instruments at the expense of their reliability. The results of this approach are well known to us now. The bubble that had grown in the US sub-prime mortgage market turned into a confidence crisis and the liquidity squeeze. It has finally led to the global financial crisis, accompanied by bankruptcies and the nationalisation of the backbones of the global financial system, the stock market crash, and economic recession.
The chair of the board of directors of Halyk Bank Kyrgyzstan, Zhanat Kurmanov, noted in his report that market economy developed cyclically, which is why there was nothing unusual in the regular outbreak of crises. Moreover, they help correct imbalances in the economy. Many countries experienced crises in the past and they made, as a rule, the very same mistakes and adopted the same measures to overcome them. This chain is quite simple: aiming to ensure economic development, central banks pursue cheap money policies, which bubble markets of certain assets if there is a lack of regulation. In response, central banks tighten monetary policy and the bubbles explode. In order to eliminate consequences, the cheap money policy is pursued again and this starts another bubble.
The price that has to be paid for this sort of regular “self-correction” can be really high. For example, government spending on overcoming crisis accounted for 47% of GDP in China in the 1990s, 18% in Mexico (1994-97), 30% in Turkey (2000-2003) and 175% in Spain (1977-85).
It is not hard to calculate that the public funds that Kazakhstan has allocated or promised for overcoming the ongoing crisis have already reached 20% of GDP.
In any event, crises have emerged and will emerge, while risk management has to reduce their frequency and scale. For this purpose, financial stability should be considered an important component of financial development and they should interact through a proper system of risk management, whose methods and approaches should concern not only the very system but also its regulation.
Anatomy of risks
The latest crisis events and their negative impact on Kazakhstan’s economy have shown that in order to ensure sustainable development, new approaches to solving strategic tasks are needed. The growing level of integration into the global financial system has forced our country to feel all the disadvantages of globalisation. Moreover, it has turned out that the smaller the economy the more sensitive it is to external effects.
Professional risk managers note that in order to understand the current situation, one should consider the existing types of financial crisis, the risks that characterise each of them, and to which of them Kazakhstan is more susceptible.
The crisis of the national currency. The main risk variables here are the actual exchange rate, the current account balance (positive/negative), the degree of the dollarisation of the economy, foreign factors, and the ratio of foreign debt to GDP. Specialists estimate that the risk of such a crisis emerging in Kazakhstan is generally small. Thanks to the National Bank’s policy, the tenge’s exchange rate is stable, the level of dollarisation has fallen from 80% in the 1990s to the current 50% and the balance of payments is positive. The only significant risk to our country in this category is foreign factors, since major foreign players can hypothetically destabilise the exchange rate quite easily, because of the small size of the country’s economy.
The banking crisis. It was the banks that first felt the negative impact of global financial problems in Kazakhstan. The small size of the domestic base of funding is the most significant risk that has already hit the domestic banking system. Up until mid-2007 when the global liquidity crisis broke out, our commercial banks had been aggressively obtaining foreign loans, but today, when access to these resources has been closed, the main problem of Kazakh banks is the repayment of their sizeable foreign loans. The managing director of Kazkommertsbank, Magzhan Auezov, says that the past year has shown that banks are managing to cope so far. At least, “no bank has so far gone bust” and our commercial banks have passed the first test. They have improved their strategies, realigning towards domestic sources of funds, sharply cutting their spending and building up additional reserves and provisions.
The relative strengths of our system are the quality of regulation and the level of competition, one of the highest levels of the capitalisation of commercial banks in the CIS, the well-developed market infrastructure (financiers’ association, a credit bureau and a deposit security fund), as well as the adoption of corporate management systems and international financial reporting standards.
However, the director of the Kazakh branch of the Professional Risk Managers’ International Association (PRMIA), Eldar Isatayev, believes that the financial sector has not yet solved all of its problems. According to his calculations, Kazakh banks will have to pay up to $2bn in foreign loans in the fourth quarter of 2008 alone. Since they can obtain new foreign loans nowhere this means that they will have to rely only on their own resources. It should be remembered that the share of the banking sector in Kazakhstan’s total foreign debt has fallen insignificantly and is still around 40-50%.
The primary risks are now the quality of loan portfolios and the transparency and availability of information. Mr Kurmanov says that if – as a result of distorting data on the quality of assets – at least one bank goes bust, this will undermine confidence in the whole banking system.
The crisis of sovereign debt. Experts believe there are no particular risks of this in Kazakhstan. Even though the country’s sovereign ratings in the national and foreign currency have been downgraded, they still remain relatively high. The country has not faced defaults since its independence and it has local institutional investors. We have a low budget deficit and the ratio of public debt to GDP is only 3.5%. However, this is a quite disputable indicator because not only the direct, but also the indirect, liabilities of a country should be taken into account while assessing risks, since, as the practice shows, the government will have to offer support to core banks and national companies if they start facing problems.
Incidentally, conference participants were most concerned about risks related to a possible crisis of corporate obligations and the population’s insolvency. A sharp decrease in loans issued by banks has not yet uncovered the weaknesses of the Kazakh economy. Risks of this category that have already been faced are the lack of alternative sources of funding for companies and, as a result, the scaling down of the activity of small and medium-sized businesses and high inflation. Although the necessity of boosting competition and diversification has been raised at high government levels for several years, our economy is still highly concentrated and export-oriented. Now when world prices of oil, grain and metals have fallen these risks may strongly hit both businesses and the population of Kazakhstan. Low incomes, savings, and investments of the Kazakh people and their low purchasing power, do not offer any optimism either.
Mr Kurmanov thinks that the risk of funding should be singled out from all the mentioned risks. The Kazakh economy is continuing to grow, major projects have been launched or are about to be commissioned, and these projects may demand between $200bn and $300bn. At the same time, the assets of domestic banks, pension schemes, insurers and investment funds do not reach even $120bn. This means that in order to keep going, the country’s domestic funds are not enough, so hopes are pinned on the stock market. However, it has also, unfortunately, developed poorly. Its capitalisation started to grow in Kazakhstan in 2005 when it reached 75% of GDP, whereas now this indicator has fallen below 60%. Generally, this is comparable to levels in countries, such as Thailand (68%), Brazil (67%), the Philippines (58%) and Poland (44%). The main problem is the low liquidity of the stock market. This indicator stands at 0.02% in our country, which is 20 times smaller than in Poland. This is because the Kazakh stock market is highly concentrated: the share of the top 10 issuers of the KASE is over 85% of total capitalisation. Three of them are raw material companies and the others are banks.
As experts believe, one of the main reasons for the poor development of the stock market in a pre-crisis period was the unrealistic interest rate. In the conditions when our banks attracted foreign loans at low interest rates set by foreign central banks, funds of national institutional investors devalued, whereas their yields were lower than inflation. Therefore, the government, namely the Ministry of Finance, now can and must set a benchmark for the corporate sector through issuing government securities. As a result, a realistic curve of yield will be drawn.
Another long-term problem is to increase the share of foreign funds on the stock market. For this purpose, Kazakhstan needs above all to adopt a law on protecting the rights of portfolio investors and create a fund for securing deals. At the same time, an opinion was floated at the conference that it was precisely the underdevelopment of the stock market and its weak role in the real sector of the economy in the crisis that benefited Kazakhstan. This is partly true, but if our country still intends to build an open economy and integrate into the global financial system, it is impossible to avoid the development of the stock market and the risks that accompany it.
For the first time since its independence, Kazakhstan faced a financial crisis, and judging by existing preconditions, this crisis has all chances to spill well beyond the banking sector. Understandably, amid the constant economic growth in recent years, risk management received the least possible attention. Thanks to requirements set by regulators, commercial banks created risk management systems a long time ago, while private businesses have only now realised that they should reconsider their corporate management standards. The crisis will demand that all the existing shortcomings be corrected both at an individual level and on the macroeconomic scale. The government has already adopted a set of measures to stabilise the situation and it has pledged to draft a large-scale anti-crisis programme. Time will show how efficient this programme will be.
Kazakhstan is now passing its first real test of creditworthiness. Depending on how we cope with this challenge, the international community will judge whether we are ready to rise to a higher level of economic cooperation.

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