How Kazakhstan Became a Mono-Economy: From the Oil Boom to Devaluation

For Kazakhstan, news from the commodity markets reads like dispatches from the front line. Oil has already fallen below $30 a barrel and is awaiting the IAEA report on Iran's compliance with its nuclear program commitments. If Iran's compliance is confirmed, the oil price will probably drop even lower.

Many people ask: how is it that we have no diversified production, and our economy depends on nothing but the oil price?

Why is it, they say, that Kazakhstan has so many natural resources and yet we don't live like the Arabs, who have only oil and nothing else?

It is true that Kazakhstan has a great many mineral resources, but variety does not mean abundance. This wealth still has to be extracted and sold, or better yet, processed and then sold.

As it happens, oil is what we extract most of, and our economy can fairly be called a mono-economy.

Even if the oil sector accounts for 20 percent of GDP, it must be said that in reality its weight is greater than 20 percent. Oil revenues generate demand in other sectors too, so when the leading sector falls, all the others fall with it.

The structural imbalances arose during the period of rising oil prices. With production growing every year and oil prices climbing fast, our country grew proud of its success. All of this was covered up by the growth of consumption-oriented sectors, notably construction and services.

It worked roughly like this. The oil sector's huge windfall revenues made it possible to pay high salaries to employees of oil and oil-related companies. Corruption, which certainly exists, was fed by this income and provided a good living for many people connected with the oil sector. Money that came not from higher labor productivity but purely from oil prices and the luck of holding the right position fueled consumption, which stimulated consumer industries and trade, above all construction. Construction created another category of consumers: builders began to live well, as did the savvy real estate speculators. Construction boomed, and that boom had nothing to do with diversifying the economy. Construction in turn gave rise to another fast-growing sector, banking. Banks rushed to lend to builders and to issue mortgages to consumers, which pushed real estate prices higher still. Against this background the manufacturing sector looked frankly weak, and naturally nobody invested in production.

The balance sheet looked beautiful while the economy was rotting from within, but everyone admired the picture and nobody stopped to think about what would happen if prices fell. The fast-growing National Fund gave even more optimism in case of any force majeure.

Then came 2008–2009, and with it the crisis. Oil prices fell sharply, and only then did people think about the need for diversification. They came up with the State Program for Forced Industrial-Innovative Development (SPFIID), tightened local content requirements, and made Samruk-Kazyna the locomotive of diversification.

But oil prices quickly bounced back.

Samruk and other quasi-state companies, with KazMunayGas as a screen, launched a grand program of production diversification. At that time the task was to put on a show of frenzied activity and stage pompous ceremonies to open this or that production facility. To some extent it worked, and then the projects were quickly wound down and/or closed. The petrochemical cluster was never created, the refineries were not modernized, they could not assemble helicopters, nor tablets and computers, nor build the Balkhash thermal power plant, nor produce silicon. The locomotive plant barely survives, and Samruk remains as dependent on the oil industry as it ever was.

Local content. To stimulate other industries, subsoil users were pressured to buy goods, works and services from Kazakhstani companies. But there are two problems here:

1. If the oil sector goes under, these companies go under with it, because they depend entirely on the oil sector. As a result, this has nothing to do with diversification and only increases risks when oil prices are low.

2. Non-market stimulation of individual industries breeds parasitism and removes the motivation to develop.

Which is, in fact, exactly what happened.

The SPFIID was also narrowly focused and looked more like a pompous, grandiose document without any working mechanisms or real support for the manufacturing sector.

Instead of developing the institutional environment for doing business and improving the business climate, the authorities began to support individual industries and give preferential loans to the chosen few, deciding for entrepreneurs what is profitable and what is not, where to build and what to build. Naturally, such a program did not work. When business is built not around what to produce but around what to build and where, entrepreneurs quickly catch on and start building not for the sake of production but for the sake of making money. As a result, the program failed, and there are no new breakthrough industries, just as there were none before.

Until 2014 everything was fine: the pomp and the high oil prices let everyone live well. But our officials managed to ruin the cash cow as well. Production growth stalled, the other potential screen, Kashagan, failed, and it became harder and harder to show growth without growth in other sectors.

Production growth stalled solely because of the extreme bureaucracy in subsoil use. Funnily enough, even state-owned companies had to bend over backwards to get anything approved by ministries and agencies.

To stimulate production somehow, they decided to use a tried and tested method, devaluation, and we got the devaluation of 2014, supposedly carried out in advance and in good time. Such foresight is truly enviable.

Then came a dark patch. Oil prices began to plummet, and the Russian ruble sank like a stone.

The first skeletons began to come out of the closet. The first was BTA. To cover it up, they swapped one problem for another and quickly got rid of BTA, paying more money to have it taken over along with its debts. The hole left by BTA was plugged with KMG shares, and a wonder unheard of anywhere in the world appeared: the National Bank became a shareholder in an oil company))))

No sooner had they dealt with one skeleton than another tumbled out: KMG, which turned out to have enormous debts. The stake in Kashagan was quickly sold internally to the parent company, and the problem was solved. Money was printed without much thought and handed to Samruk, putting additional pressure on the tenge exchange rate.

How many more of these skeletons are waiting is unclear. Meanwhile, problems with the national budget began: revenues are not being met, which is obvious in a crisis, and the only tool available is devaluation. They began devaluing the currency relentlessly, citing the international economic situation.

All of this might be tolerable, but everyone understands that devaluation helps only in the short term and something else has to be devised. For the medium term they decided to raise taxes, mainly on individuals and SMEs. Realizing that this would not be enough, they decided, under the banner of combating VAT laundering, to introduce a turnover tax to make up for lost revenue.

Unfortunately, none of this has anything to do with diversifying production or genuinely rescuing the economy. It looks more like a game of imitation.

And finally: yesterday I called a bank and asked about the terms for a working capital loan in tenge. The rate was 70 percent per annum.

A fine way for the National Bank to stimulate the economy, though it does match its objective: to devalue the tenge to fill the budget, with low inflation maintained by a shortage of tenge liquidity. Both objectives have been achieved. Inflation of 13 percent against a 100 percent devaluation in an import-dependent economy deserves a Nobel Prize.