03 Mar 2011 | World

Kazakhstan - A New Investment Frontier 

Andrew Stobart of Baillie Gifford's Emerging
Markets team looks at Kazakhstan and its economy.

To many people, Kazakhstan will be forever associated with the film Borat. Others may recall that seven times Tour de France winner Lance Armstrong came out of retirement to ride in the colours of the Kazakh team, Astana. And there will be those whose memories are indelibly marked by a 7000 mile return trip from London to Almaty to see England beat Kazakhstan in the FIFA World Cup qualifiers.

Beyond that, little is widely known about the land locked republic at the heart of Eurasia, which shares its borders with Russia, China, Turkmenistan, Uzbekistan and Kyrgyzstan. The ninth largest country in the world in terms of area – it is five times the size of France – yet with a population of just 16 million, Kazakhstan is governed by the autocratic Nursultan Nazarbayev, who has been president for over twenty years.

It holds around 3% of the world’s oil reserves, more than 15% of global uranium reserves and a rich seam of other commodities such as copper, coal, iron ore and rare earth metals. Kazakhstan has the dubious distinction of having been at the forefront of the Global Financial Crisis – it suffered a banking collapse when wholesale funding from European banks dried up in October 2007. The government subsequently injected $19 billion in return for equity stakes in four banks.

From an investment perspective, Kazakhstan represents around 3% of the MSCI Frontier Markets Index, with Kazmunaigas EP one of the top 10, Halyk Bank and KazKommertzBank the three constituents, while the mining companies Kazakhmys and ENRC are quoted on the London Stock Exchange and are in the FTSE 100 index. There are several locally listed banks, some smaller oil and resources companies, as well as others such as KazakhTelecom and Chagala Properties. The stock market is likely to broaden as privatisation gathers pace.

A state of growing maturity

Kazakhstan is a young country. It will celebrate its 20th birthday this year, having been the last of the former USSR republics to gain independence. The country is multi-ethnic, with Kazakhs making up almost two thirds of the population, Russians around 25% and a host of minorities accounting for the rest.

It is a unitary state with a presidential government and a prime minister who heads the executive. In 2007, the parliament passed constitutional changes which allow President Nazarbayev to stand again in presidential elections in 2012 and serve for a further five years. Nazarbayev has succeeded in preserving stability in a country with many different ethnic groups and enabling Kazakhstan to become a successful and independent economy.

Despite its progress over the past two decades, Kazakhstan remains shackled by the chains of its Soviet past. Government tends to be bureaucratic, cumbersome and slow to adapt to change, new legislation often comes with myriad unintended consequences, and the judicial system leaves a lot to be desired. Education suffered a lost decade in the 1990s although schools and universities are now improving, albeit slowly.

Like most Commonwealth of Independent States (CIS) countries, Kazakhstan’s economy collapsed in the 1990s in the wake of the break-up of the USSR, almost halving between 1989 and 1998. Inflation peaked at nearly 3,000% in 1994. Oil exports increased from the mid-1990s as new fields came into production, aided by investment from foreign firms, supplementing strong metals, agriculture and heavy industry sectors of an economy which is now worth around $120 billion. Economic growth was close to 10% during the 2000s until the financial crisis in late 2007 brought things to a juddering halt (although not officially a recession). Growth of high single digits seems a reasonable estimate for the next few years.

Bubbles, banks and barrels of oil

Fuelled by wholesale funding from European banks in the mid-2000s, Kazakh banks embarked on a lending boom which stoked an asset bubble that burst spectacularly. When the wholesale funds were called rather than rolled over in October 2007, the Kazakh banks, with loan-to-deposit ratios of 200%+, had nowhere to go for funding. They were forced to restructure their loan books and to stop lending. Kazakhstan’s National Wellbeing Fund Samruk-Kazyna had to rescue three invested over $4bn to bail out the banks, and acquiredring stakes in the two largest players in the sector, Kazkommertsbank and Halyk Bank.

Perceived corruption has also attracted attention in the west, partly because the London Stock Exchange has embraced what are now two FTSE 100 constituents in the mining companies Kazakhmys and ENRC. Transparency International’s recently published Corruption Perceptions Index for 2010 places Kazakhstan at 105=, ahead of Indonesia, Nigeria and Russia, and on a par with Argentina and Algeria. While hardly a paragon of transparent openness, it is far from a basket case.

Kazakhstan has 35 billion barrels of oil equivalent of proven oil reserves and Tengiz and Kashagan are two of the largest oil fields, with Kashagan being one of the largest oil discoveries of the past 30 years. The country welcomed foreign expertise and capital, and this paid rapid dividends when Tengiz was developed by a consortium headed by Chevron and including Exxon and state oil company NC KMG (National Company KazMunai Gas). National production in 2009 was 1.54 million barrels of oil per day, with the prospect of doubling production over the next decade. Kazakhstan also has two trillion cubic metres of gas reserves, with Karachaganak, owned by Eni and British Gas, being one of the world’s largest gas and condensate fields.

There are numerous other fields under development in the Kazakh section of the Caspian Sea. The old Russian trading town of Guryev, renamed Atyrau, sits close to the mouth of the Ural River, the boundary between Europe and Asia and has become the main hub for the hydrocarbon industry in the region. Original PSAs (production sharing agreements) signed with international oil companies in the 1990s at a time of low oil prices have been ripped up and re-written, although the Kazakh government is not the only one to have done this. The tax regime is complex and progressive.

Samruk-Kazyna owns stakes in companies which, in total, represent around 50% of Kazakh GDP. Kazakhstan has not suffered as many oligarchs as its neighbour to the north and this has made establishment of a sovereign wealth fund much easier. Sir Richard Evans, the ex-Chairman of British Aerospace (which owns 49% of national carrier Air Astana) was recruited by President Nazarbayev in 2006. His role is to try to bring greater transparency and corporate governance to Samruk-Kazyna. This is partly show and partly to endorse the ‘open for investment from the west’ policy, although the organisation is opaque, and big decisions are still made at a higher level. Samruk-Kazyna has also been instrumental in the ‘anti-crisis programme’, taking stakes in banks, stabilising the property market, supporting SMEs and managing the mortgage refinance programme.

Investment opportunities

Frustratingly, direct investment opportunities in Kazakhstan are currently limited in number (oil company KazMunaiGas EP, London-listed miners Kazakhmys and ENRC, Canadian-listed based Uranium One). However, the banks all have small amounts of investable shares, while there is a pipeline of possible privatisations expected that will improve access to the market. Among the IPOs of state-controlled businesses anticipated over the next few years, the most interesting are likely to include the state oil company, the banks (liquidity permitting), the power companies, the railway operator and the gas and oil transport companies. Clearly, Kazakhstan is not without its risks but these must, as ever, be balanced against the opportunities and we look forward to more Kazakh companies coming to the market.

Investing in emerging markets is only suitable for those investors prepared to accept a higher level of risk. This is because these markets could go down or up more than the main international markets.

Market values for securities which have become difficult to trade may not be readily available, and there can be no assurance that any value assigned to such securities will accurately reflect the price you might receive upon their sale.

This article may contain investment information which does not constitute independent investment research. Accordingly, it is not subject to the protections afforded to independent research. Baillie Gifford and its staff may have dealt in the investments concerned. Investment markets and conditions can change rapidly and as such the views expressed are those of the manager and are subject to change without notice.

Author: Andrew Stobart
Andrew graduated BA in Economics from Cambridge University in 1987. After three years working in London in investment banking, he joined Baillie Gifford in 1991. Andrew is an analyst in the Emerging Markets Investment Team.