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Perspective
01 October 2016

Central Asia: Transition-in-process

Senior Underwriter at Zurich
Twenty-five years ago the five nations of Central Asia (CA) – Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan – emerged from the shadows of Soviet central control to embark on a transitional process expected to result in the development of market-based economies.

Twenty-five years ago the five nations of Central Asia (CA) – Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan – emerged from the shadows of Soviet central control to embark on a transitional process expected to result in the development of market-based economies. That transition is still a work in progress, which this article describes, highlighting facts and observations that may be of interest to those considering business opportunities in these emerging markets.

The Berne Union in Central Asia

The Berne Union footprint in CA has grown steadily since 2005, with year-end exposures increasing by about 500% over the period 2005-2015, reaching just over $29 billion in 2015. In comparison, regional GDP (nominal) grew by 250% over the same period[1]. So Berne Union activity in the region has grown twice a fast as the region has grown over the last decade. While Kazakhstan accounted for about 62% of total year-end exposure in 2015, BU members have significant exposure in all five CA countries.

Observing Central Asian economic transition: Hindsight is 20/20

It is much easier today, with the benefit of 25 years of experience, along with knowledge of recent external economic shocks (the “new” oil crisis, recession in Russia and the slowdown in China), to understand the challenges of transition for CA countries and identify key success factors for the next 25 years of transition. Under USSR leadership, economies of the Soviet republics were specialised and interconnected within a broader, albeit isolated, economic community that while considered inefficient in some Western eyes, was highly integrated and did not require independent sovereign decision making. Following a few years of initial volatility, low hanging fruit such as previously underutilised natural resources and human capital, as well as a prolonged period of increasing commodity demand and prices, fueled relatively rapid GDP growth in CA, averaging 7.5%[2] over the first 20 years or so of full-on independence. Readily achievable growth in this initial period of transition made it easier to avoid proactively tackling longerrun challenges related to fundamental, structural economic transition through diversification.

Dependence on commodities

CA oil and gas exporters, Kazakhstan, Turkmenistan and Uzbekistan, have been heavily dependent on strong hydrocarbon prices to support their economies. In Kazakhstan, oil and gas directly accounts for 20% of GDP, 50% of fiscal revenues and 60% of exports. In past years the country has run capital account surpluses largely due to favourable oil and gas prices. But breaking even from a capital account and fiscal balance perspective, in 2017 for example, would require an oil price of about $85 per barrel[3]. Turkmenistan and Uzbekistan are less diversified than Kazakhstan so they are more dependent on oil prices. Assuming prices remain lower than in past years, all three of these countries will need to diversify economic activity to continue transitional growth.

Dependence on Russia

CA oil and gas importers, Kyrgyzstan and Tajikistan, depend indirectly on hydrocarbon prices through remittances from domestic human capital employed in Russia and

neighbouring countries that are directly affected by the decline in oil prices and, in the case of Russia, commodity price and sanctions driven recession. Remittances account for 45% of GDP in Tajikistan and 30% in Kyrgyzstan[7]. External shocks affecting Russia and neighbouring CA countries are immediately transmitted to Kyrgyzstan and Tajikistan through declining remittances, which has an offsetting effect on the benefit of cheaper energy supply. Kazakhstan, Turkmenistan and Uzbekistan also rely on remittances, as well as hydrocarbon export earnings from Russia. So when Russia sneezes, CA very quickly catches a cold, and since Russia’s economy is hydrocarbon dependent and affected by sanctions, so are the economies of CA oil and gas importers and exporters.

Renewed CA transition efforts will require diversification away from dependence on Russia as well as oil and gas. Like many countries that have enjoyed years of robust economic growth based upon reliance on high commodity prices, especially in oil and gas markets, without looking ahead to potentially leaner times and the need for developing a broader economic base, CA countries now face the challenge of simultaneously dealing with the immediate effects of external economic shocks, diversifying to reduce disproportionate dependence on commodities and other countries, as well as continued transition with the benefit of hindsight.

Kazakhstan: Shifting focus in response to the oil price shocks

Kazakhstan’s growth in GDP terms has been impressive averaging 8.1% over the period 2000-2012, but dropping to just over 1% in 2015, a trend that reflects the country’s dependence on oil and gas production[4]. One response to external economic shock resulting from declining oil prices appears to be tightening state control of the other subsoil resources and, in particular, uranium, an industry in which it has a strong market position, accounting for about 40% of world production in 2015[5]. Introduction of a long awaited, new mining code was expected in 2016, but has been postponed to 2017. Details are not yet readily available, but observers expect the new code will favour increased state control of sub-soil resources. It remains to be seen what impact this will have on existing and new foreign investment and, in turn, future prospects for foreign investors.

In March of this year, the government announced that, in its view, some foreign investors in the uranium sector have not lived up to their mine development commitments under joint venture agreements with Kazatomprom, and that it may need to respond by returning some assets to the state. This pronouncement was likely intended to prompt foreign investors in the uranium sector to respond with proposals that will lead to increased production value and redistribution of joint venture ownership benefits to the state. Cameco Corporation, one such investor, subsequently signed a publicly announced agreement with Kazatomprom[6], which is expected to increase Kazakh ownership in JV Inkai from 40% to 60%, extend the duration and quantity of existing mining rights, and lead to enhanced uranium processing opportunities within Kazakhstan. This is a good example of partnership, with a foreign investor demonstrating flexibility in view of economic transition challenges faced by host government investment partners, as well as transparency by both parties in communicating intentions to the public in an open and detailed manner.

These developments probably reflect government concern over the future value of oil and gas reserves, and realisation that economic transition by the country since independence has not sufficiently emphasised diversification.

Moving forward – what will the future look like?

Kazakhstan is in a relatively stronger position in adjusting to the new oil crisis than some of its CA neighbours, having built up foreign exchange reserves (currently more than 7 months of imports) and avoided heavy indebtedness (debt/GDP currently sits at about 22% compared to closer to 70% in Kyrgyzstan)[8]. It also has the advantage of having established sovereign wealth fund Samruk-Kazyna, which provides the country with some added financial flexibility. But like hydrocarbon dependent countries in the Middle East, it will need to diversify relatively quickly to avoid sliding backwards in future years of transition. Other hydrocarbon exporters, Turkmenistan and Uzbekistan, also enjoy temporary buffers, but are less diversified than Kazakhstan and are feeling the new oil crisis crunch sooner and more acutely. Other CA countries, Kyrgyzstan and Tajikistan, that are indirectly, but more quickly, affected by the new oil crisis, transmitted through disproportionate dependence on Russia and its economic woes, will feel the need to diversify more immediately and, arguably having weaker institutional and structural foundations to build upon, may need to rely more on donor assistance and lending. Unemployment related to returning expat workers may also result in increased, additional social burdens.

Going forward, foreign exporters, lenders and investors will hopefully find themselves pursuing infrastructure, value added natural resource production and manufacturing sector development opportunities in the CA region, as diversification proceeds.

Central Asia and China

Economic linkages between CA and China have been steadily growing[9], which is not surprising given China’s need for natural resources and the region’s need for growth in trade and investment. Trade between China and the region, including Caucasus neighbours Armenia, Azerbaijan and Georgia, grew from only $5 billion in 2005 to close to $50 billion in 2014, with China accounting for significant shares of total trade for Kyrgyzstan (50%), Tajikistan (42%), Turkmenistan (27%), Kazakhstan (22%) and Uzbekistan (21%). Over the same period, Chinese official lending to the region grew from $260 million to almost $4.5 billion. FDI from China reached $5.5 billion in 2012 and is expected to increase to $30-35 billion by 2020. So diversification away from Russia is fortunately already underway, although economic slowdown in China is another source of economic stress that the CA region would have preferred to avoid.

Geopolitical affiliations – location is everything

The New Silk Road?

To support resource access, it is said that the China sponsored One Belt One Road initiative is to construct a Silk Road Economic Belt that will stretch through Central Asia connecting China to Europe and providing opportunities for development through infrastructure gap filling and economic diversification[10]. All five CA countries are members of the $100 billion Asian Infrastructure Investment Bank, which will support this initiative alongside a separately allocated $40 billion Silk Road Development Fund. Details of the new Silk Road concept remain somewhat vague, but the concept does seem to mesh well with growth in China–Central Asia economic trade and investment to date. Chinese strategic intentions vis à vis investment in Central Asia may resemble resource access motivated investment approaches in Africa, except closer to home and on the way to EU markets.

European Economic Union (EEU): Soviet 2.0 or pivot to Asia?

Although originally proposed by Kazakhstan as an idea in the 1990s, more recent institutional development and the 2014 treaty of the Eurasian Economic Union (EEU) are thought to be the brainchild of leadership in Moscow. The EEU is an economic union of states that is said to be Eurasia’s answer to the EU common market. A treaty establishing the EEU was signed on 29 May 2014, with currently membership limited to Russia, Kazakhstan, Kyrgyzstan, Belarus and Armenia, prompting some Western observers to conclude that the objective is to resurrect a new version of Soviet-style regional integration. That could be the case, as other CA and former-Soviet republics consider membership. Another view is that it could also be part of Russia’s so called pivot to Asia, which was underscored by the $400 billion thirty-year gas delivery agreement signed between Gazprom and CNPC in 2014. There has been some speculation that the EEU will attract interest in formal cooperation, if not membership, by China, which would certainly boost the organisation’s economic diversity and significance. There is some precedent for this in a similar alliance, the Shanghai Cooperation Organisation (SCO). All five CA states, along with Russia and China, are members of the SCO.

Turkey has thus far not been involved with the EEU, perhaps preferring the prospect of EU membership, but with EU accession appearing further in the future, and with tensions rising between Turkey and some Western powers, and recent reconciliation in diplomatic relations between Russia and Turkey, it is possible that Turkey could consider a formal relationship with the EEU. Turkey and four of the CA states share Turkic heritage and cooperation on some levels has been evident since CA independence, as illustrated by mutual membership in the Cooperation Council of Turkic Speaking States (www.turkon.org). At the very least, Turkey likely views the region as being geopolitically important and can be expected to welcome opportunities to foster soft power through economic cooperation in the region.

In short, Central Asia is geographically located to be integral to the interests of a number of potential economic partners and geopolitical affiliations, which may provide a partial means to increased diversification and continued economic transition. Foreign investors ought to follow these developments closely in assessing what the future will look like in the region and what opportunities that future will bring.

Key take-aways for foreign business interests

  1. Although it has been 25 years since CA states gained independence from the former- USSR, economic transition remains a ‘work-in-progress’.
  2. Regional and individual GDP growth rates have been significant over the last 20 years, largely because of direct and indirect gains from unsustainably high hydrocarbon and other commodity prices.
  3. Dealing with economic shocks resulting from the new oil crisis, recession in Russia, and slowdown in China, are hard felt in all CA states and will preoccupy decision makers over the coming several years.
  4.  In particular, the coming years of transition should be characterized by economic diversification away from commodity reliance and dependence on Russia, leading to business opportunities for foreign exporters, investors and lenders in the infrastructure, value added natural resource production and manufacturing sectors.
  5. The geographic location of the CA region means that it will be increasingly important to neighbouring economic powers including China, Russia, Turkey and the EU. Geopolitical affiliations will be important to the region’s continued economic transition provided such partnerships are managed with a long-term strategic focus and in a mutually beneficially manner. Foreign investors will need to be prepared to take a similar approach to establishing and managing partnerships with host governments.

Norm Kimber

Zurich Credit and Political Risk


Notes

  1. “Regional Economic Outlook Update: Middle East and Central Asia”, International Monetary Fund, April 2016.
  2. The Caucasus and Central-Asia: Transitioning to Emerging Markets, International Monetary Fund, 2014.
  3. “Regional Economic Outlook Update: Middle East and Central Asia”, International Monetary Fund, April 2016.
  4. Ibid
  5. World Nuclear Association, May 2016.
  6. “Cameco and Kazatomprom Sign Agreement to Restructure JV Inkai”, Press Release May 27, 2016, available at www.cameco.com.º
  7. “The Spillover Effects of Russia’s Economic Slowdown on Neighboring Countries”, International Monetary Fund, 2015.
  8. Data reported by Standard & Poors Ratings Services, from various sources, March 2016.
  9. All data from “CCA: Reforms Needed to Weather Shocks from Commodity Prices and Russia”, International Monetary Fund, 2015.
  10. Ibid
  11. All data from “CCA: Reforms Needed to Weather Shocks from Commodity Prices and Russia”, International Monetary Fund, 2015.
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