Kazakhstan's Bursting Bubble

After almost a decade of high growth, Kazakhstan’s economy has faltered. First the real estate bubble burst. Then the price of oil began to plummet. After that came the bank failures. And then came the currency devaluation.

All in all, the situation looks bleak, but it is not much different than in many other countries at this time, and better than in some areas. What is surprising is not that the country has entered an economic crisis, but that it was not foreseen since the areas of the economy affected are all well studied areas and there was plenty of warning and a multitude of case studies pointing to the coming crisis.

The boom years

From 2000 to 2008, Kazakhstan’s GDP had shown a remarkable growth. According to figures from the US State Department, Kazakhstan’s GDP rose by 9.5 percent in 2002 over the previous year; 9.2 percent in 2003; 9.6 percent in 2004; 9.7 percent in 2005; 10.7 percent in 2006; and 8.5 percent in 2007. By any standard the rate was impressive.

At the same time, the country was able to reduce its debt to GDP ratio. It repaid its loans to the International Monetary Fund (IMF) in 2000 - a full seven years ahead of schedule - and reduced its debt ratio from 21.7 percent of its GDP in 2000 to just 8.9 percent in 2005. In real terms, however, its gross external debt went up from US$18.2 billion in 2002 to US$96.37 billion, but its increased GDP made that debt more bearable. Simultaneously, its National Oil Fund grew from US$3.6 billion in 2003 to US$27.6 billion in October 2008. Official unemployment fell from 8.7 percent in 2003 to 7.1 percent in 2007. Inflation did rise, going from 6.6 percent in 2002 to over 10 percent by 2007, but wages were rising as well.

It all looked so good. And then came the bad days.

The real estate bubble

With the growth of GDP, the construction business embarked on major development projects, building everything from office space to luxury housing and resorts. Between 2005 and 2008, the building market increased by over 20 percent per year. The fastest growing section of the construction industry was in high end buildings that included the importation of top quality fixtures and materials. Astana twinkled in the sun with its many mirrored new skyscrapers, while all around Almaty luxury apartment complexes with one-bedroom flats going for over US$200,000 sprang up like mushrooms.

The housing market was given further impetus with the introduction of mortgages. Mortgages were first introduced in Astana in 2002 as a way of attracting people to the then fairly empty new capitol. Although slow to take off, in the summer of 2005 they became accessible to the general public with relatively easy terms for obtaining a mortgage. Before then, people had to pay for their housing in cash by borrowing from family and friends, limiting how much property owners could charge for their real estate.

With the introduction of mortgages the price of apartments doubled in the space of a few months, as buyers could now pay for the properties over 20 years. The following year they doubled again. At the peak of the housing bubble in 2007 one square meter of residential space in central Almaty was going for US$3,000, and the high end construction projects were going for well beyond that.

At the same time, wages could not justify mortgages of US$100,000 or more. In October 2008, Kazakhstan Today reported that average wage stood at 61,622 tenge per month, roughly US$505. The highest wages were in the financial sphere at 124,400 tenge or US$1,020, and the lowest in the agricultural sphere at 34,320 tenge or US$286. Even those earning the high end wages could not afford the mortgages necessary to buy the shiny new apartments.

When the housing bubble burst, it did so quickly. By the summer of 2008, housing dropped 40 percent from its peak and it is now only half of what it had been in 2007. As a result, the construction developers found themselves with unsold and unsellable apartments in their complexes. Construction was driven to a halt in many of the new complexes and those who paid for new apartments are now finding their flats unfinished, while the developers do not have the funds to complete their projects. A lose-lose situation.

In addition, those with mortgages from 2007 found their properties worth half of what they owe to banks and are unable to sell the real estate for enough to escape their onerous debt. In the meantime, the default rate on mortgages has been growing.

The price of oil

Much of Kazakhstan’s economic growth had been powered by the rise in oil prices between 2003 and 2008. In 2003, oil was generally trading at under US$25 per barrel. The price rose to US$60 per barrel in 2005 and Kazakhstan’s oil exports amounted to US$17.4 billion that year and accounted for 70 percent of all of its exports. In July 2008, oil topped US$147 per barrel. Then came the plunge.

By December 2008, oil was trading at under US$40 and remained in the US$30s to US$40 range through the early part of 2009. Needless to say, that ravaged the projected oil earnings to which Kazakhstan had grown accustomed and had relied on to fund various welfare and development projects.

Not just that, but Kazakhstan had been poising itself to become a major global exporter. Between 2005 and 2008, its production had reached some 1.4 million barrels per day and it was exporting over 1.2 million barrels daily placing it amongst the world’s 10 top exporters. The country hoped to increase production to over 3 million barrels and export oil in similar quantities to Norway at some 3 million barrels a day.

One of the main projects meant to contribute towards that increased production rate was the Kashagan field. Yet the offshore Kashagan field in the northern Caspian Sea is considered one of the most difficult projects, technologically, to complete, as well as being one of the most expensive. It has repeatedly seen delays in the projected date of its production from 2005 to 2008, then 2011, and now even later.  In addition, while the project was hot when oil was racing past the US$100 per barrel mark, at US$40 per barrel it is uncertain whether it is commercially viable.

Maria Dissenova from the Institute of Economic Strategies in Almaty told ISN Security Watch it was unlikely that the Kashagan project could proceed if oil was trading at US$40. The project could only be viable if it was in the US$70s to US$80s range, she said.

As the Kazakh government had been accruing more revenues by imposing all sorts of excess profit taxes on oil producers since 2005, oil companies were finding their profit margins tightly squeezed despite the high oil prices between 2005 and 2008. As of February 2009, there was a realization that the heavy taxes were preventing the oil companies from continuing to work in the country and Minister of Energy and Minerals Sauat Mynbayev announced that a tax reduction on the companies would have to be considered. Thus, the grand plan of becoming one of the world’s top five exporters and financing all sorts of projects through its oil has suffered a serious setback.

Bank failures

The reduction in oil revenues and the real estate bust have had repercussions for Kazakhstan’s banking system, which was financing much of that activity.

Kazakhstan’s banks had received favorable ratings as high as “investor grade” by Moody’s investor service, which grades the credit-worthiness of banks and companies. By 2009, Kazakh banks had been downgraded to "B," or the high credit risk category due to poor credit quality. Essentially that put them in the category of junk bonds.

The downgrade was not surprising when looking at the easy credit terms Kazakh banks had been offering to both businesses that were investing in grandiose projects as well as individuals who were straining themselves on mortgages and on personal credit for cars, expensive electronic gadgets and the remodeling of their pricy new homes. Rather than lending at a one-to-one ratio of one dollar in loans per dollar of deposits, Kazakh banks reportedly loaned US$2.14 per dollar of deposits and so were heavily exposed to any downturn in the economy.

In order to shore up the ailing banks the government took US$10 billion out of its National Oil Fund in October - more than one-third of the account - to save the banks.

One heavily indebted bank - Bank Turan Alem (BTA) - was effectively nationalized in 2009, prompting speculation about the story behind its nationalization. Banks such as TimurBank, run by President Nursultan Nazarbayev’s 24-year-old grandson, all received bailouts from the money taken from the National Oil Fund, but BTA had been run by a former political opponent of the president's, Muhtar Abylyazov, and rumors are widespread that there may have been factors beyond the bank’s mismanagement that led to its nationalization.

Other banks that saw the government acquire a quarter of their shares included KazkommertzBank and Halyk Bank, while the Alliance Bank was also effectively nationalized.

Currency devaluation

As if the bust in housing and oil prices was not enough, rumors started spreading by late January 2009 that the currency would be devaluated. Initial reports said the devaluation would take place gradually between February and June, during which time the tenge would drop from 120 per US dollar to around 150. Instead of the gradual devaluation the tenge was devaluated in the first week of February.

The justification for its devaluation was that Russia, Ukraine and other countries of the Commonwealth of Independent States (CIS) had devalued their currencies so that Kazakhstan’s exports were no longer competitive in those markets without a corresponding devaluation of the tenge.

The effects were immediate. Economists predicted prices on imported goods would go up by 25 percent - and that happened almost immediately. Prices in shops were being marked up on a daily basis, while people worried about their jobs and the unpaid credit bills they faced from the good old days.

There are concerns that the tenge will devalue further, making all of the expensive imports more expensive.

The problem for Kazakhstan is that apart from its extractive industries, it produces little else. The other major industries were banking and construction, both of which are feeling the sting of the global economic crisis.

Who is to blame?

So far, the culprit behind the crisis has been the global economic situation, and in the case of the banks that have been nationalized, their management has been blamed. But otherwise, the blame has been contained. Yet the reality is that the crisis should have been foreseen.

There have been many documented cases of real estate booms that ended up going bust after housing prices got so high they were out of reach of most buyers. Britain in 1990 saw that happen, as have Europe and the US in the past two years.

As far as oil prices go, there have been several occasions in history when the oil price tripled in a short period of time, ending in global recession that sent the price of oil plummeting. The 1973 Arab oil embargo was one, as was the fall of the Shah of Iran in 1979 and the ensuing Iran-Iraq War in 1980. The only surprising thing about the current slump in the price of oil is that the world had been able to sustain prices in the US$100 range for as long as it did.

As for the proliferate lending and easy credit that was being handed out by Kazakh banks, cases of such policies have well been documented, and repackaging a poor risk loan under a different name does not make it a more secure transaction. The designer mortgages that asked for no money down and lower payments in the early years with higher payments coming later are well known to be bad ideas.

Dissenova told ISN Security Watch that one problem with the Kazakh banks was that they lacked experience in commercial lending and people had no credit history so that banks had difficulty discerning good risks from bad.

While true, there is ample data on banks and unsound lending practices that is not meant to be emulated, but should serve as a lesson on what not to do. All in all, for all of the good credit ratings and kudos that Kazakh banks received from economists it would seem the Kazakh business managers were not such good businessmen after all.