How Can Kazakhstan Get Out of the Crisis?

Kazakhstan is a developing country. Its economy depends entirely on world prices for natural resources. Selling them provides a relatively comfortable living, but reliance on primary commodities will not take Kazakhstan to a leading position in the global economy. Kazakhstan cannot influence world prices for natural resources, and any fall in those prices leads to a crisis at home. One need only recall how the financial crisis of 2008 caused a sharp drop in energy prices, and how that affected us.

In 2015 there is no global crisis. There is a crisis of oil overproduction and a slowdown in growth in some of the world's major economies, such as the European Union and China.

But while low energy prices will lead to economic growth in the EU and China, since they are net importers, Kazakhstan and other commodity-exporting countries will face the negative consequences of falling oil prices.

The creation of the National Welfare Fund, the industrialization program and the diversification of production were strategically correct decisions. However, a whole group of unresolved problems prevents us from achieving these strategic goals and keeps us marking time, drifting from one crisis to the next. We can sidestep crises only with a diversified economy, where one sector gains when another suffers. Unfortunately, only one sector of ours functions relatively efficiently, while all the others are in an embryonic state and cannot influence the country's economy. Below are some of the factors that prevent us from properly diversifying the economy and breaking free of dependence on oil prices.

1. The state's large share in the economy. Today the Samruk-Kazyna National Welfare Fund accounts for almost half of Kazakhstan's GDP. True, the Fund attracts the best minds and foreign managers as independent directors, among other things, but however much it improves, the efficiency of such a megastructure will always be far lower than that of a private company. In many cases Samruk-Kazyna is used to carry out government tasks or implement social programs. Naturally, we cannot afford to abandon state participation in the economy entirely, but with such sweeping state intervention in economic processes, there is no point talking about greater overall efficiency. Until the state's share in the economy shrinks, raising efficiency in some sectors will simply be impossible. Moreover, private firms attract foreign partners faster than the state does, which also gives a boost to development.

2. The State Program for Accelerated Industrial and Innovative Development (SPAIID). The country's innovation development policy focuses on supporting only certain sectors of the economy. But the state cannot, by definition, choose correctly which sectors can deliver economic growth for the whole country; only the market can do that, through competition. Here, entrepreneurs' initiatives are forced into frameworks defined by the state, and nothing else. There is no guarantee that efficient projects capable of high growth rates will be supported by the state, since they may not fit the format set by officials. And changing any government program is simply impossible. As a result, many initiatives die at the approval stage. The second problem is bureaucracy, which exists at every level of public administration. To survive, it is better for officials to prohibit something than to permit it. And this is not their fault. The system is built so that, under the pretext of fighting corruption, any permit an official issues can become grounds for a criminal case.

In the social hierarchy, the entrepreneur ranks below the official and is forced to fawn and bargain. Until we change this paradigm, projects will move forward with great difficulty, grinding their way through the depths of ministries and agencies. To change the attitude toward initiatives from below, officials need to be given a target, as banks do: for example, to bring 100 projects a month to the stage of financing and implementation. If the target is not met, the official should be dismissed or denied a bonus.

The third problem is that the SPAIID is oriented toward large-scale production facilities, through which technology transfer is supposed to take place. But such a system has a number of shortcomings. First, there is no guarantee that the most advanced technologies will come to us. Second, localization of such production will be minimal. Third, equipment will be brought in at prices far above its real cost. It should be borne in mind that screwdriver assembly is generally located in countries with cheap labor. All this makes our production uncompetitive.

3. The financial system and the administrative methods used to control the financial sector. Overregulation and the underdevelopment of the financial market prevent Kazakhstan from establishing a functioning system of financing for the economy.

Kazakhstan's banking system has very serious problems. The cause lies not so much in current difficulties as in the decision-making mechanism. The huge volume of nonperforming loans is a consequence of weak risk management in the banking system. This means that bank management either could not or did not want to assess the potential risks correctly. To combat nonperforming loans, the National Bank has tightened the procedures for credit files and provisioning, but this does not solve the problem. The problem is as follows:

• There is no proper corporate financial reporting. In other words, many borrowers "draw up" their statements and come to the bank. The bank is unable to verify how closely the report corresponds to reality. Constant checks increase the banks' transaction costs, although this problem could be solved quite simply, by mandatory audits of large and medium-sized companies.

• There is no reliable marketing information. The underdevelopment of Kazakhstan's market makes any forecast of demand for products highly tentative. Kazakhstan has no quality information on which bankers can rely in making decisions. At best, bank managers can ask for a sales contract of some kind. Correctly determining demand and the real price of a product or service is very problematic.

Therefore the National Bank should not tighten its requirements but develop a program to improve corporate reporting and market analysis.

Another problem in the financial sector is the dead stock market, although in developed countries major projects and companies are financed mainly through securities. The consolidation of pension contributions finally killed the Kazakhstan Stock Exchange (KASE). The "people's IPOs" also failed to give the equity market any real lift. For our market to become attractive, we need more issuers and market participants. Their emergence is currently held back by several factors:

• Registering on the market is complicated. To become a market participant, a company must register as a joint-stock company, have audited financial statements, positive equity and so on. Creating a joint-stock company is quite expensive, and in addition it remains under the constant supervision of the financial regulator. We should either allow shares in limited liability companies to be traded on the exchange or simplify the registration procedure for joint-stock companies.

• There are no potential investors, because today it is more profitable to keep money in deposits than to invest it in securities. We need to make it easier for foreign companies to enter the Kazakhstani market, which will require a clearing center, arbitration and so on. There must be a comprehensive program for developing the stock market.

4. Reform of government institutions. Kazakhstan's judicial system is very weak and needs complete reform and independence. Although something is being done in this direction, our courts cannot be called impartial, which scares off investors considerably. Until we create a judicial system that meets international standards, investors will be cautious about investing in Kazakhstan.

The system of inspections should be handed over to independent experts. If a company holds a certificate issued by an independent expert, inspections by government agencies should be ruled out. At present, businesses often find themselves in absurd situations. For example, government agencies approve the commissioning of a facility, turning a blind eye to violations, and then come back and fine the company for those very violations. Meanwhile, no one fines the officials who signed the commissioning documents despite the violations. The question is not even about these agencies but about the system of approvals and oversight. On the one hand, our agencies sometimes demand compliance with standards that have long been considered anachronisms in world practice; on the other, they ignore truly significant violations. This area needs reform, possibly even with the involvement of foreign specialists. In an ideal system, every state institution is, in one way or another, under the oversight of the public and the population. That requires strengthening the role of parliament and ensuring the development of political parties and civil society organizations.

5. The subsoil use system. Extraction of mineral resources in Kazakhstan is relatively inexpensive compared with other countries, so even at low prices we can compete with other commodity exporters. However, the existing legislative framework hurts the development of this sector. Complicated approval procedures and the state's extensive rights to the subsoil prevent us from attracting foreign investors to Kazakhstan. Foreign investors come only after receiving guarantees from the government. This limits local entrepreneurs' opportunities to attract foreign partners. The commodity sector has become unattractive. As a result, oil production fell in 2014, and the forecasts for 2015 are discouraging. Until both the legislative framework and the government agencies themselves are reformed, the development of this sector will rely exclusively on the state.

6. Labor resources. Kazakhstan has a low population density and very expensive, low-productivity labor, so we suffer from a labor shortage. We need to change migration policy, both internal and external. We have a very large share of rural population (more than 40 percent), while agriculture produces about 10 percent of GDP. This is an extremely inefficient use of labor resources. We need to encourage relocation from villages to cities, and that requires a program to create large urban agglomerations.

These are only some of the problems that we will have to solve sooner or later. To address them, we propose the following:

1. Restructure Samruk-Kazyna through extensive privatization, reducing the state's stake to a blocking minority of 25 percent of shares. It is best to carry out privatization through the stock exchange, with IPOs on the local market and the involvement of foreign placement specialists. If shares are sold to a large number of investors, then even with a 25 percent stake the state will not be able to make decisions that reduce the companies' efficiency. This measure will, on the whole, help raise efficiency in many sectors and attract strategic investors.

2. The SPAIID must be completely overhauled. We need to formulate basic principles of state support for projects, covering two areas:

• Support for vital sectors, such as agriculture and food processing, which have low returns and are socially significant. They need a program of concessional lending, subsidies, infrastructure development, tax breaks and government procurement. This will protect these sectors from Russian competitors and strengthen the country's food security.

• Support for projects that meet requirements for profitability, own contribution and localization. We should finance projects that genuinely create value added in the country, rather than those that merely save on duties and transport costs. To this end, there must be clear criteria for localization of production and profitability, but never by sector of the economy. Then the state will encourage the development of domestic production. For example, it should matter more to the state to finance a plant producing cotton fabrics than a car plant. A car plant earns its money on duties, while a textile plant adds value to raw material produced in Kazakhstan. Accordingly, we need to focus on localization of production, and then we will be less exposed to changes in the exchange rate. The market itself will determine which sectors will interest entrepreneurs.

State programs should not be cumbersome. We need a simple program that entrepreneurs can understand, with a clearly described, simple mechanism for obtaining state support.

3. Review officials' functions so that any entrepreneur can resolve an issue in one place. The system of incentives for officials should be changed and tied to results, with bonuses several times larger than salaries. For example, if an akimat issues 100 permits a month, the official receives a bonus for each permit. But if procedures were not observed, the official is dismissed. Then the civil servant will have an interest in finding sound projects and simplifying procedures, and will turn from a brake into a "helper." This will also make it possible to initiate, from below, changes to duplicative and unnecessary procedures, since the officials themselves will have an interest in them.

4. Introduce mandatory audits and change corporate governance requirements. Mandatory audits should be introduced based on the size of enterprises, not their form of ownership. At the same time, requirements for audit and appraisal firms should be tightened. This will make reporting more transparent and reduce transaction costs. Requirements on second-tier banks regarding borrowers should be eased, especially in collateral policy. Under current conditions, banks can only engage in pawnshop-style lending.

5. Develop the stock market. We need to create conditions in which a critical mass of issuers and securities market participants would emerge. Examples include establishing a clearing organization and arbitration, privatizing state companies and easing requirements for issuers. We should also have the state take a more active part in supporting entrepreneurs through the stock market, for example by buying bonds and shares. Samruk-Kazyna itself could take large stakes in good projects without interfering in management.

6. Develop alternative sources of financing, for example by developing various funds. We have a law on investment funds but, unfortunately, it barely works. Under current legislation, investment funds are so restricted in their activities that they are unpopular with private investors. This law needs to be completely reconsidered, and the most important thing is to change the investment rules. This is a separate topic that also requires more detailed treatment.

7. The subsoil use system: procedures need to be simplified, first and foremost in the system of approvals and permits. We need to introduce approval procedures that are clear to everyone, with control over deadlines and a uniform approach to subsoil users. Today a subsoil user is wholly dependent on the state and has to wait months for this or that piece of paper before work can begin. The Ministry of Energy and the Ministry for Investment and Development are overloaded and pay attention only to large projects, while small and medium-sized subsoil users suffer from excessive bureaucracy. Simplifying the legislative framework, systematizing the work of subsoil use agencies and reducing bureaucracy will attract more foreign investors even at low prices, which will make it possible to draw on this groundwork when prices rise.

8. Create conditions for internal migration by building cheap and affordable housing in large cities. A growing urban population will create greater competition in the labor market and ease social tension in rural areas.

9. Change the migration legislation governing the recruitment of labor. Today entrepreneurs have to overcome great difficulties in hiring foreign workers. The availability of local specialists must be taken into account. In our view, the first things to consider are security screening and the migrant's education. This will increase competition in the labor market and lower labor costs. Moreover, good foreign professionals will inevitably pass on their experience to our own specialists.

In our view, these problems must be tackled first if we are to count on a structural transformation of the economy. And once the structure of the economy has changed, we will be able to overcome crises without major upheavals for the country.