Chapter 1. Overview: Overcoming constraints to fulfilling Kazakhstan’s development vision

Kazakhstan has adopted an ambitious vision for the year 2050, aiming to become one of the top 30 global economies. For that to happen, the country’s impressive economic growth of the first decade of the 21^st century will need to find new drivers that allow development to be more robust and resilient. This in turn requires a commitment to structural reforms that have the potential deeply to transform the Kazakhstani economy and society. This report is the second output of the Multi-dimensional Country Review (MDCR) of Kazakhstan. The goal of the MDCR of Kazakhstan is to support the country in achieving its development objectives by identifying the key constraints, providing practicable policy recommendations, and supporting the implementation of these recommendations. This second report analyses in depth four key issues for Kazakhstan’s mid-term development success: diversification, financial sector development, the role of the state in the economy, and the effectiveness of environmental regulation. This chapter examines the increasingly challenging external environment, revisits key conclusions of the first volume in its light, and presents the key findings and recommendations of this report.

Kazakhstan’s development objectives and performance since 2000

Kazakhstan is undergoing reform to realise its aspiration of becoming one of the top 30 global economies by 2050. It aims to have a competitive and diversified market economy that can respond and adapt to the changing global environment, and to provide a high standard of living for its citizens. Its goal is to be an open and integrated global player in the international community, as well as a prominent regional actor, seizing opportunities for export and trade with its neighbours. To benefit from strong sources of domestic growth driven by private enterprise, Kazakhstan will display an efficient financial sector, a favourable business environment, well-developed institutions, and an effective civil service that delivers high-quality public services. Kazakhstan as a major global economy will aim to deliver for citizens, and enable high levels of well-being with good quality jobs, an active social policy, and a vibrant and inclusive Kazakhstani culture.

The country has achieved remarkable progress since 2000 towards realising its long-term development ambitions. Gross domestic product (GDP) increased 2.8-fold between 2000 and 2014. Average monthly salaries rose from the equivalent of USD 101 to USD 565 in 2015, pensions quadrupled, while the proportion of the population living on incomes below the subsistence minimum fell from 31.8% to 2.5%. However, this rapid economic growth has only partly translated into improvements in other aspects of citizens’ well-being. To sustain economic progress, overcome recent difficulties, and drive improvements in well-being to realise its 2050 aspirations, Kazakhstan will need to address a number of challenges to ensure its economy becomes more productive and diverse, and is sufficiently flexible and resilient in the face of an ever-shifting external environment.

The next stage of economic transformation will be more challenging, with weaker external conditions and gains in productivity needing to contribute more to growth. External conditions in the second half of the 2010s are likely to be less supportive than they were between 2001 and 2014. Most relevant to Kazakhstan, commodity prices, and especially energy prices, are expected to remain at significantly lower levels than those achieved during that period, in view of the availability and falling marginal cost of new supply and slower growth in demand. External financing will also remain scarcer for markets such as Kazakhstan than was the case during the mid-2000s given ever stricter prudential requirements and the weakening in the country’s debt sustainability. Kazakhstan has been more affected than most countries by the decline in foreign direct investment (FDI) inflows. While debt levels have stabilised, and the country has taken some action to address its debt servicing needs, these remain at a relatively high level.

To raise productivity growth and improve resilience in the face of global shocks, Kazakhstan will need to transform the structure of its economy and diversify it away from resource extraction. The country will need to reduce the intervention of state in economic activity. It can achieve this through privatisation, improving the business environment by enhancing the contestability and transparency of markets, carefully implementing reforms to the labour market, and improving the attractiveness of Kazakhstan as a destination for foreign investment. Reforming the financial sector to improve access to finance for all private enterprises will be important to allow the private sector to realise new opportunities and to grow, and for it to invest to raise its efficiency and international competitiveness. The state can change its role from driving structural transformation through its investment programme to creating a supportive, transparent and stable operating environment for private actors to make these investments.

Continuing economic diversification and structural change require a changed approach to state support and regulation. Many programmes of state support are framed around target structures of economic activity or approaches to particular issues, rather than in terms of the underlying outcome that is desired. The prescriptive approach can restrict the flexibility in how economic agents behave, or can allocate resources to areas that do not offer the greatest returns or long-term opportunities. Better and more effective outcomes could be achieved by framing regulations and support towards generating an environment that allows independent actors to work towards achieving desired outcomes along the path of their choosing. An approach that better supports structural transformation and productivity growth is one that provides economic agents with an environment that is transparent and stable and with incentives to behave in ways that generate the outcomes that are desired. This approach also allows regulations and intervention programmes to be simplified. The benefits of this approach are evident across the topics addressed in this volume. Framing various targeted investment programmes and subsidy schemes more neutrally across the economy may support the emergence of unexpected areas of activity and competitiveness for the Kazakhstani economy. It would allow agents to find efficient mechanisms to manage their environmental impacts while limiting the regulatory burden for firms. And it would ensure that the state maintains a presence in the economy sufficient to meet its economic and social objectives.

Perceived weaknesses in the transparency of the business and investment climate can be addressed through an approach to state support and regulation that is less prescriptive and more focused on outcomes. Kazakhstan has recently undertaken many steps to improve the quality of the investment climate through, among other measures, administrative simplification, changes to the regulatory process, and efforts to reduce corruption. These efforts have earned Kazakhstan a substantial improvement in their World Bank Doing Business ranking with a rise of 16 places, up to 35^th position. The business and investment climate continues, however, to be considered to lack transparency. The benefits of reforms to formal rules and processes over recent years are undermined by a widening disconnection between policy and practice, and actions by the state which some actors may perceive as being unexpected. Enduring growth and diversification require improvements in the business environment that allow operators to emerge and flourish in ways that targeted support programmes rarely achieve. Some of the state’s investment and financing programmes have led to further concentration of economic activity in natural resource extraction. In some cases these interventions have been necessary to ensure that investment projects go ahead and generate revenues for Kazakhstan entities. However, these interventions have also diverted scarce finance and other resources from entrepreneurs with business ideas that might generate significant returns but are in non-targeted sectors, notably domestic consumption services.

Accelerating structural reforms will help reinvigorate economic development

To achieve Kazakhstan’s development aspirations and the country’s continued development and economic transformation, the country needs to improve the investment and operating environment, the efficiency of public spending, and the provision of public goods and services. The government has laid out an ambitious programme to modernise how the Kazakhstan state operates and works with the private sector in the president’s “100 Concrete Steps” agenda. This agenda, and its associated programmes, can help the country generate its next stage of growth in the face of weaker economic conditions. Much of the programme can be implemented in spite of the reduced outlook for fiscal space, as it targets how the state operates, rather than the scale or scope of what it does. Further, the agenda includes actions that expand the operating space of the private sector, from efforts to ensure markets are contestable, that reduce the burden of obtaining permits or passing goods through customs, or that provide a greater role for private providers in areas such as health care. The programme includes efforts to strengthen the rule of law, which brings well-documented benefits for long-term growth while having limited fiscal cost.

Civil service reform is central to changing how the state works with the economy at large, to improving the quality of public spending and as part of a wider modernisation process. Reforms to professionalise and raise the integrity of the civil service have been ongoing since independence and are a major component of the “100 Concrete Steps” programme. Reforms to the management of public servants include the creation of a specialised civil service management agency housed in a relevant ministry. The reforms shift civil service recruitment and promotion to a career-based system, rather than allowing open recruitment even at senior levels from those outside the civil service. This is seen as leading to appointments for reasons related to factors other than the candidate’s merit. Those entering the civil service are subject to a more exhaustive selection process. Throughout, the reforms seek to strengthen professional ethics, through a new ethics code and “ethics commissioner”.

Well-executed civil service reforms can contribute to a higher quality of governance and a strengthening of the rule of law, addressing important obstacles to economic diversification. The civil service reform programme is intended to address well-recognised weaknesses involving corruption, and to strengthen integrity and the perception that the civil service is based on merit. Greater civil service integrity can improve the value for money in public procurement. (These issues are discussed in Volume 1, Chapter 5 [OECD 2016b]). Progressive reform efforts to improve the civil service’s regulatory framework, training and recruitment and its management structures are important. However, their effectiveness is dependent on organisational stability. Reform efforts are weakened if there is a perception that the reforms will be reversed or substituted a short time later. This appears to be a concern in Kazakhstan given the rapid efforts to modernise the nation since the 1990s. Effective civil service reform also requires substantive changes in behaviour and work cultures that go beyond formal regulations and organisational structures. This is a long-term process.

Making markets more readily contested by outside actors will be fundamental to diversifying the economy, increasing competitiveness and attracting investment. Although there have been large advances recently in the contestability of local markets and the effectiveness of anti-monopoly policies, Kazakhstan markets remain highly concentrated and the competition framework is in need of fundamental reform (OECD, 2016a). Current enforcement practice focuses on observed cases of parallel pricing rather than on practices with proven harm to competition. Kazakhstan has committed itself to eliminating price controls in 2017, as well as the State Register for Dominant Undertakings which has acted as a de facto system of price and profit controls for all undertakings defined as dominant. Further reforms should ensure that the remit of the competition authority, the Committee on Regulation of Natural Monopolies and Protection of Competition (KREMZK), is clearly defined and that it has effective detection and enforcement instruments which also provide for predictability and transparency for the business community. By completing these reforms Kazakhstan should strengthen the judicial system and the rule of law. Effective competition policy needs technically competent judges who have some specialisation in the topic area.

Productivity and competitiveness can be increased by allowing private actors to compete in sectors currently reserved for state actors. Kazakhstan’s World Trade Organization (WTO) membership and the changes in the state’s involvement in the economy through privatisation of state owned enterprises (SOEs) have the potential to improve the competitiveness of many sectors where the state is active, by ensuring competitive neutrality across bidders. This can support private-sector providers and improve value for money for the state.

Labour law reforms have reduced regulation, shifting power towards employers from employees and are likely to reduce labour costs, not without controversy. The revised labour code became effective on 1 January 2016, with probation periods extended, overtime allowances reduced, and dismissal of workers made easier. The reforms also make collective bargaining more difficult. These reforms have not been uncontroversial. External observers have raised concerns about the laws’ practical effects on the freedoms of association and assembly, while some domestic actors have sought greater consultation. The arguments for these reforms centre on their stimulation of employment by reducing the cost of labour and increasing flexibility for employers. In practice, during a period of economic slowdown, the reforms are likely to reduce employment costs and real incomes in those sectors where skills are relatively available, with less of an impact for employees with the scarcest skills. In the longer term, as workers face greater uncertainty over their incomes without having the safety net of a solid social security system, they are likely to cut spending and build a buffer of precautionary savings in case they lose their income.

The contribution of the MDCR to the realisation of Kazakhstan’s 2050 development aspirations

The MDCR is a timely contribution to planning the policies and actions for the next stage of Kazakhstan’s progress toward its 2050 development aspirations. This second phase of the three-phase MDCR provides detailed analysis of key constraints on Kazakhstan’s ongoing economic transformation, and recommends how they can be addressed. The analysis presented in this volume has been prepared as Kazakhstan navigates a turning point in the global commodity price cycle, and incorporates these changed conditions into its analysis and recommendations. The analysis is also timed to inform the government’s preparations of its 2025 strategy. It highlights the areas where policy interventions are likely to do most to unlock Kazakhstan’s development potential. It provides deeper analysis and makes recommendations to improve economic diversification, accessibility of finance, environmental regulation, and the role of the state in economic activity. It also seeks to identify factors that are common to these limitations and that need to be addressed to achieve sustained progress in development.

This report tackles four of the seven most significant obstacles to multidimensional development identified during the first phase of the MDCR and detailed in the first report (OECD, 2016b). Beyond the four issues addressed in this report, the first phase of the review also identified three further key issues: widespread corruption that hinders the business environment and undermines meritocracy; limited implementation capacity to fulfil certain government functions, leading to mediocre service delivery in certain sectors, including public service delivery; and the inadequacy of the skills system vis-à-vis the needs of the labour market. A number of parallel OECD reviews address these issues in depth. Their preliminary results are taken into account when available and pertinent.

The analysis and recommendations of the MDCR are based on OECD experience and standards. They draw extensively on analyses based both on trends that are global and on those that make specific reference to the group of benchmark countries that were presented in detail in Phase 1 of the MDCR. It applies various specialised tools developed by the OECD and other bodies to diagnose the impediments to development progress and to identify the most effective policy responses. For example, the Product Market Regulation tool presents an objective assessment of the scale and implications of the state’s control of the economy.

The recommendations presented in this report will be further refined and contextualised during the third and final phase of the MDCR. This process will draw on further consultation with local stakeholders, to support the specifics of the action plan and to ensure that it fully accounts for the context, in particular the features of the institutional landscape and priorities and resources of the various actors involved in reforms.

Recent external economic developments have created new challenges

External economic conditions have deteriorated significantly and are likely to remain weaker

Kazakhstan’s external economic environment shifted from a driver of economic transformation to a drag on growth, as prices of Kazakhstan’s exports and demand for them became unexpectedly weaker. The global economic environment turned sharply negative for Kazakhstan as the “100 Concrete Steps” were being prepared in early 2015. Growth of Kazakhstan’s major export destinations weakened and underperformed forecasts. Economic growth in China diminished and became less reliant on heavy investment and more on consumption of domestic services, while advanced economies’ recovery from the 2008-09 global financial crisis continued to be less strong than expected. Reflecting these developments, global growth underperformed projections, which major forecasters repeatedly revised downwards (Figure 1.2). As demand underperformed, overall production of many of Kazakhstan’s major commodity exports continued to grow, leading prices to fall sharply. For example, in the two years to March 2016, world prices of crude oil fell by two-thirds, copper by one-quarter and wheat by 35%.

External developments sharply slowed the Kazakhstan economy. Weakening external conditions reduced inflows of receipts from exports and tax payments, and also of investments in future production (Figure 1.4). Kazakhstan’s trade surplus and inwards FDI contracted. The eventual depreciation of the tenge (KZT) (discussed below) compressed domestic consumption by raising the local price of imported items. A large fiscal stimulus package, financed by drawing down offshore funds, provided some offsetting support. Overall real GDP growth slowed from 6.4% between 2010 and 2013 to 0.6% projected over 2015 and 2016. That growth remained positive at all is remarkable given the scale of the negative external shocks: for example, the Russian economy is expected to contract by 5.5% between 2014 and 2016. The fall in oil prices halved the value of 2015 crude oil exports compared with 2014, falling from USD 53.6 billion to USD 26.8 billion: the exported volume fell from 68.2 million metric tonnes to 63.6 million metric tonnes. Overall, mining output volumes fell by 2.4%. A 1.7% decline in household production illustrated the effects of price inflation and the devaluation of the tenge on household incomes. Support to the economy came from the public infrastructure and housing investments within the Nurly Zhol economic stimulus programme, which were evident in the 4.4% increase in construction activity despite weaker investment in mining. Meanwhile agricultural activity also grew solidly, by 4.6%, despite the weakening of wheat export values.

Monetary and exchange rate policy have been adjusted for the weaker structural conditions

Deteriorating external conditions made Kazakhstan’s pegged exchange rate increasingly unsustainable. After the 2008-10 crisis Kazakhstan’s formal monetary policy tool to achieve economic and price stability was a stable exchange rate. This policy was sustainable while external conditions were supportive – rising export prices and solid growth of trading partners and strong investment inflows – and while reconsolidation of the domestic financial sector eased credit growth and domestic demand. These developments allowed external accounts to be in surplus and for these surpluses to be accumulated in foreign reserves, while domestic inflationary pressures were moderated by the strong real exchange rate and slow credit growth. As conditions first stabilised and then started to deteriorate, efforts to maintain the exchange rate peg would ultimately prove to be unsustainable and costly. Pressures became acute when countries with similar export baskets as Kazakhstan allowed their exchange rate to depreciate to absorb weaker prices and activity, meaning that the Kazakhstan tenge effectively appreciated, further undermining the economy’s competitiveness and domestic production and receipts. Among these depreciations, the most significant was the halving in value of the Russian rouble against the dollar between mid-2014 and early 2016, as its external position weakened with oil prices and the ramifications of its various foreign policies. This represented a particular loss of competitiveness for Kazakhstan, given the two countries’ membership of the Eurasian customs union and similarities in their domestic production sectors.

Maintaining the tenge’s peg undermined the government’s wider economic stabilisation and diversification goals. Foreseeing that the central bank would eventually allow the exchange rate to depreciate, economic actors switched from tenge to foreign currency for deposits and transactions. This reduced the pool of tenge in the domestic banking system, shrinking the money supply, while increasing the demand for foreign currency. It created short-term liquidity pressures for banks, as the pool of tenge deposits decreased while borrowers continued to prefer credit in tenge, leading to sharp spikes in interest rates on short-term tenge funds (see Chapter 3). The National Bank of Kazakhstan (NBK) attempted to maintain the tenge’s stability against the dollar through both rhetoric and its regular auctioning of foreign exchange, as well as providing banks with instruments such as long-term currency and interest rate swaps. It also sharply increased borrowing interest rates, from around 10% to 19%, depending on the term and borrower. These measures assured liquidity and reduced instability in the tenge market, but also offered banks greater profitability than their usual financial intermediation role of taking deposits and lending to businesses, and added to domestic firms’ difficulty in accessing credit for investment and working capital.

Monetary authorities responded to weaker conditions by shifting to an inflation-targeting regime, better adapted to Kazakhstan’s macroeconomic challenges. Shifting monetary policy to inflation targeting allows the exchange rate to cushion the domestic economy and will deepen the domestic financial system. In August 2015 NBK specified the monetary policy goal of achieving annual inflation of 3% to 4% by 2020, and the shift in its instrument to a policy interest rate, allowing the exchange rate to float. NBK reserved its right to participate in foreign exchange markets to offset volatility unrelated to fundamental factors and which may threaten financial stability, and started publishing monthly data on interventions as part of an effort to increase transparency around the conduct of monetary policy. The stabilisation of external and domestic monetary conditions will enable real interest rates to return towards levels consistent with international markets. This will encourage more funds to remain in tenge, and so deepen the domestic monetary system. The shift in the policy instrument allows the NBK to set the short-term price of money by acting in the domestic money markets to adjust the base interest rate. This activity has the aim of influencing savings and lending behaviour of commercial banks with the real economy. It allows movements in the exchange rate to help absorb fluctuations in Kazakhstan’s export prices, reducing the volatility in interest rates and in the availability of credit. This will enable more stable and predictable domestic inflation and GDP growth.

The full benefits of these policies are likely to take some years to emerge. Initially, controlling inflation during a period of substantial negative supply shocks and a depreciating exchange rate requires higher short-term interest rates, with the aim of slowing capital outflows and the exchange rate’s depreciation, while reducing inflationary pressures. After the tool of monetary policy shifted from the exchange rate to the new policy interest rates in August 2015, NBK raised its benchmark policy rate from its initial level of 12% to 16% in October 2015 and 17% in February 2016. As the economic environment stabilised, the new policy approach gained credibility, and the rise in inflation proved to be temporary and expectations of the exchange rate stabilised, the base rate was reduced to 13% by July 2016 and 12.0% by November, and NBK was able to reduce its activity in the foreign exchange markets.

The likely persistence of weaker conditions has put public finances on an unsustainable path

The plunge in oil receipts and the fiscal stimulus significantly weakened Kazakhstan’s public finances, an effect partly offset by the depreciation of the exchange rate. Weaker oil prices and overall economic conditions in 2015 cut government revenues, although not as sharply as the 2009 global financial crisis and associated policy measures. Revenues reached a low point in September 2015 at 8.6% below their peak (in 12-month rolling terms),1 largely because of a 28% decline in oil-related revenues, but also a 9% decline in non-oil revenues related to domestic activity (IMF, 2014, 2015). These trends reduced public revenues to their lowest levels relative to GDP since the early 2000s. The government sought to offset weaker private demand by maintaining public spending. Nominal spending grew very strongly in 2013 and somewhat more moderately in 2014, before broadly stabilising as economic conditions and revenues deteriorated in 2015.2 Current spending on wages and purchases of goods and services led the surge while other capital and other current spending were stable and transfers grew at their trend rates. These developments raised spending to 21.6% of GDP, its highest level since the 2009-10 global economic downturn. Indeed, this effort to support the economy contrasts with the global financial crisis, when nominal expenditure fell by 7% in 2009, before rapidly recovering. After accounting for financing transactions, these revenue and spending trends shifted the budget from a surplus of 5% of GDP in 2013 to an estimated deficit of 5.3% of GDP in 2015 and projected deficit of 4% in 2016. This represents a fiscal impulse of 4.5% of GDP or KZT 3.8 trillion (USD 21 billion at annual average exchange rates) over two years.

The government’s various economic support programmes quickly drew down the state’s financial assets. Total public offshore financial assets fell by USD 14.9 billion from their peak in 2014 before stabilising in early 2016, while the government also raised USD 6.3 billion through foreign debt sales, and also expanded domestic debt. By early 2016 the assets in the National Oil Fund had fallen by USD 13.7 billion from their historical peak in mid-2014 of USD 77.3 billion, while the government’s holdings of convertible foreign currency (CFC) fell by USD 2.7 billion over the same period. These drawdowns complemented the government’s return to international sources to finance its deficit. The government restarted issuing dollar-denominated bonds and tapping multilateral lenders from 2014.

The government’s stimulus efforts extended to programmes implemented through public entities. Economic support programmes were also implemented by state-owned entities outside of the budget. The 2015 and projected 2016 budget deficits required USD 14 billion in financing, while over USD 22 billion were raised through various sources. Examples of these programmes include the subsidised credit and entrepreneurship schemes or directed investment programmes implemented by companies within the Baiterek and Samruk-Kazyna groups, such as Damu or the Development Bank of Kazakhstan (discussed elsewhere in this report). These schemes contributed to domestic spending, expanded productive capacity, and supported demand for tenge in foreign exchange markets.

Kazakhstan’s sovereign debt rating has felt the impact of the drawdown in sovereign foreign assets and increased debt issuance and their implications for the sustainability of the national oil fund and its role as a source of macroeconomic stability. Within the international context of weaker growth among resource-exporting countries, the use of the National Fund assets to support countercyclical fiscal policy, weaker flows into the fund with lower oil prices, and the issuance of offshore public debt, have prompted agencies to cut their sovereign credit rating for Kazakhstan. This reduces the demand for offshore debt for the government as well as for private bodies, and increases the cost of issuing it. In early 2016 Kazakhstan’s overall gross external debt was equivalent to 92% of GDP, slightly lower than the 2009 peak of 98%, although approximately half of this is inter-company debt and has been stable in per capita nominal terms for a decade. Meanwhile the debt maturity profile appears to have been lengthened, with reserve assets now over four times the value of short-term external debt, reducing repayment risks. Rating agencies have cited the rapid drawdown of the reserves held in the National Oil Fund during 2014-16, given that these reserves represent an important buffer against weaker revenues and economic volatility. Relaxing the drawdown rules of the national fund so that it is more easily exhausted may undermine the quality of the stabilisation, savings and inter-generational equity objectives of such funds. Indeed, consistency in the application of inflow and drawdown principles is essential if sovereign wealth funds are to play their role as sources of stability and robustness for economies exposed to the natural resource cycle. This role of providing stability is central to funds’ contribution to national economies, acknowledged in the “Santiago” Generally Accepted Principals and Practices for Sovereign Wealth Funds, and in the OECD Guidance.3

Weaker external economic conditions have also challenged monetary policy, and the adoption of a simple, clear and stable goal is likely to benefit development and economic diversification into the longer term. Monetary authorities are seeking to reduce inflation while other factors are not supportive. The decline in the international prices of Kazakhstan’s leading exports effectively constitutes a negative supply shock, reducing the value of the country’s production and national income. Allowing the exchange rate to depreciate can absorb part of this, and effectively reduces real incomes by raising prices of imported items relative to domestic goods and services. But this is only effective to the extent that domestic production can substitute for imports. Further, these developments challenge the longer-term goal of making finance more readily available to support economic diversification. When it shifted its inflation management policy tool from the exchange rate to the new policy base rate, the central bank increased the costs of funds. Higher lending rates combined with weaker external conditions and lower expected returns on domestic investments to slow lending, reinforcing the weaker trends in economic activity. By reducing the expected returns to investments, these developments also make external finance less available for Kazakhstan entities. Since the early 2000s, there has been a positive relationship between the growth of lending to the economy and economic activity, although the relationship changed before and after the 2008-10 financial crisis, and does not show statistical causality. The relationship between lending and activity varies considerably between economic sectors, which suggests significant segmentation of the credit markets (IMF, 2015).

Weaker conditions are likely to persist, reducing space for development spending

Weaker external conditions are likely to persist into the longer term. Many forecasters have lowered their assessment of long-term sustainable growth rates for both advanced and emerging economies. In the longer term this is associated with a slowdown in productivity growth, which is explained by various developments. One analysis attributes it to a smaller contribution from new information and communications technologies compared with the innovations of the late 19th and 20th centuries. Productivity growth also appears to have slowed in emerging economies and the convergence of emerging economies with high-income countries is not occurring at the rates that were earlier expected. Finally, and of particular significance for Kazakhstan and its commodity exports, China’s economic model is adjusting to more moderate growth and a stronger role for consumer demand rather than heavy industrial investment.

The international climate change agreement reached in Paris in December 2015 represents an opportunity for Kazakhstan to improve the economy’s energy efficiency. To achieve the long-term temperature goal set out, the parties to the United Nations Framework Convention on Climate Change (UNFCCC) aim to reach global peaking of greenhouse gas emissions as soon as possible and then undertake rapid reductions of them, with the aim of limiting the rise in global temperatures. This presents challenges for Kazakhstan, by weakening expected global demand for the country’s fossil fuels, while requiring it to adapt its relatively emissions-intensive economy. Long-term cuts in global demand for fossil fuels will rely on major technological advances, including large improvements in reducing emissions or in capturing and storing carbon, while rapid gains in energy efficiency are likely to diminish demand for fossil fuels. This adaptation represents an opportunity to raise the efficiency and competitiveness of Kazakhstan’s industrial structure. Large investments and industrial adaptation will be required to raise the efficiency and competitiveness of Kazakhstan’s economy.

The government’s economic support measures are prudent responses to a temporary downturn, but cannot be sustained while weak conditions persist. The extent and likely duration of the weakening in economic conditions was not expected. Between 2013 and 2015, projections of total government revenues for 2016-18 fell by 28%, or KZT 10 trillion, or 3.5% of revised GDP4 (IMF forecasts of nominal GDP). The likely protracted weakness in outlook makes drawing down reserves and borrowing to offset weaker revenue unsustainable, even if resources remain robust. The weaker revenue outlook suggests that spending must be reduced and revenues strengthened to return public finances to a sustainable path (Behar and Fouejieu, 2016). This adjustment should also apply to spending by off-budget publicly owned entities that are able to draw on offshore funds, where these drawdowns have financed the economic support and directed investment programmes implemented by various state-owned entities. Achieving this requires mobilising revenues from the domestic non-resource economy more efficiently while stabilising overall spending. Overall spending can be adjusted with limited impact on the delivery of public goods and services by spending more efficiently, for example by adjusting the directed investment and subsidised credit programmes.

As conditions stabilise, the benefits of a floating exchange rate and of an inflation-targeting regime will start to be realised. By mid-2016 commodity prices and Kazakhstan’s terms of trade, as well as the exchange rate and foreign reserves had stabilised, albeit at significantly lower levels than the preceding decade. As the real exchange rate reaches its new equilibrium, market participants will no longer expect further exchange rate depreciation or intervention by the NBK, thus reducing the incentive to shift funds out of tenge. The central bank can build its credibility by remaining committed to reducing inflation while ensuring its interventions in foreign exchange markets are directed at maintaining market liquidity rather than delaying the exchange rate’s movement away from medium-term equilibrium. Given that perceptions about exchange rate movements can be self-fulfilling in the short term, changed perceptions and stronger clarity and credibility on the part of the central bank around its goals can help entrench stability in the exchange rate and the conditions affected by it, allowing the NBK to rebuild its buffers of foreign reserves. This stability also reduces inflationary expectations and the cost to the economy of reducing inflation. By mid-2016 the central bank was able to lower its benchmark interest rate. Fiscal policy can support this process by credibly moving back to a sustainable path, by improving the efficiency of spending and by reducing financing needs. This will stabilise Kazakhstan’s country risk outlook, improving access to external finance for the private sector. All of these developments would help rebuild domestic tenge liquidity, supporting lending by banks, and the long-term goals of developing and diversifying the domestic economy.

Assessment and recommendations

Diversification and resilience in Kazakhstan

The period of growth acceleration in Kazakhstan (2000-10) was characterised by an increasing reliance on natural resources, in particular oil. The oil and gas sector, including extraction and associated activities, generated at its peak 26% of GDP in 2012. Despite its relatively small weight in terms of employment, oil dominates exports (64%) and generates about a third of public revenues. As observed in Volume I of the MDCR (OECD, 2016b), oil exports are also concentrated in terms of their destinations. The pattern of concentration was largely, but not solely, led by the increase in oil prices.

Kazakhstan’s natural wealth has largely contributed to its economic take-off but has not been exploited to its full potential. Not only does Kazakhstan hold 1.8% of global oil reserves, it is also a major gas producer – although most of the gas production is used in oil extraction –, and is the world’s leading uranium producer. Reserves and production in metals – copper, iron, chromium, magnesium, zinc, gold and silver – are also significant. Mineral and metal production, however, remains largely dependent on outdated and inefficient equipment and as a result is not very competitive internationally, a state of affairs that has resulted in volatile iron and steel exports and a loss in the sophistication of exports among mineral products – with unrefined ores gaining share at the expense of refined products.

Production also became increasingly concentrated between 2000 and 2010. The economy’s reliance on individual sectors fell dramatically in the 1990s, as the economy recovered from the disruption of the transition phase and agriculture’s weight in GDP fell from 34% to 11.4% by 1997. However, concentration increased gradually from the late 1990s to the early 2010s. In particular manufacturing in Kazakhstan is much more concentrated than in many emerging economies, although it is comparable to other Central Asian countries. Concentration in production shows that export concentration was not merely a reflection of changes in terms of trade, but that those changes affected the allocation of capital.

Diversification is an imperative for Kazakhstan’s future development, to reduce its exposure to external risk as well as to further job and value creation domestically. Commodity-dependency exposes Kazakhstan to external shocks and can hinder long-term development prospects. There are multiple channels through which natural resource wealth can negatively affect long-term development prospects, offsetting the undeniable opportunities that it offers. One major channel through which natural resource wealth affects growth across countries is the volatility that it imposes in the economy. Oil is one of the commodities with the most volatile prices: oil prices not only have high-frequency volatility, but are also subject to large cyclical fluctuations. Price shocks affect Kazakhstan through multiple channels, most notably through shocks to the real foreign exchange rate and through shocks to public revenues.

The National Fund plays an important role in reducing the impact of oil price volatility and has also managed to limit “Dutch disease” effects. A fixed nominal exchange rate made it possible to limit some of the high-frequency volatility effects – especially given the level of price rigidity. Although the National Fund can help smooth public expenditure, its implementation has not altered the budget’s reliance on oil revenues. During the 2008-10 crisis, the National Fund played a major role in sustaining countercyclical stimulus. However, in the medium term, over-reliance on oil revenues to finance public expenditure is likely to limit the degree to which Kazakhstan can have countercyclical fiscal policy.

Diversification has been a major policy objective since the mid-1990s but its implementation only came into earnest in 2010 with the implementation of the first State Programme on Accelerated Industrial-Innovative Development (SPAIID). SPAIID suffered from a number of limitations, including the dispersion of effort, which gave rise to a large number of instruments and institutions and significant co-ordination problems. Essential lessons have been learned and incorporated into the design of the next phase of industrial policy, as described in the Concept of Industrialisation and the second SPAIID programme. The SPAIID 2015-2019 programme focuses actions more through the selection of a smaller number of sectors and clusters, incorporates private sector and regional representatives into the decision-making process, and consolidates actions across sectors that were previously scattered.

Since 2010, the process of relative deindustrialisation has stopped, and new major non-natural-resource export products have been “discovered”. Measures of concentration in production also exhibit a slight decline. Investment in fixed assets in manufacturing increased in real terms by 8% per annum between 2010 and 2014, after stalling for the five preceding years and grew from 8.9% to 11.1% of total investment in fixed assets. Unfortunately, evaluations of industrial policy are based on very aggregate indicators and do not follow a rigorous impact evaluation method, and therefore these successes cannot be unambiguously attributed to SPAIID. One of the key instruments of industrial policy, the Map of Industrialisation, is a tool for monitoring large industrial projects which are eligible for individualised state support. While criteria for inclusion in the Map of Industrialisation also make the projects eligible for significant state support, their inclusion also serves to co-ordinate logistic and financial support and to provide a picture of key industrial projects in the country. Its direct effects (in terms of job creation and investment) are significant. Indeed, a large share of investment in fixed assets during the first SPAIID programme went to the oil and gas sector, above and beyond the sector’s weight in the economy.

Despite recent improvements, industrial policy in Kazakhstan is largely reliant on direct financial support and depends on the selection of key sectors and projects by implementing agencies. Implementing agencies remain scattered, despite ongoing consolidation and rationalisation efforts. Particularly in what concerns monitoring and transparency, there is a wide diversity in the availability of information regarding the activities of the various actors concerned, and no uniformity in how this information is provided. Within financial support alone, sources typically report investment project sizes or credit or support, which makes comparing different programmes and their relative efficiency a very arduous task.

The number of priority sectors was narrowed down in 2016. The government decided in mid-2016 to trim the list of priority sectors from the wide set of 14 sectors originally considered in SPAIID 2015-2019 to eight branches in five sectors. They are ferrous and nonferrous metallurgy, oil refining, petrochemicals and agrochemicals, food processing, automotive and electrical engineering. These sectors were selected on the basis of their export potential. It is expected that companies in other sectors that engage in exports or in improving productivity will also receive support, but current normative texts and practice do not specify what instruments will be available to firms in non-priority sectors. Companies in the eight priority branches are expected to receive support in the form of infrastructure, and long-term and concessional finance, among others.

The reliance on the choice of predefined sectors can be a risky strategy in a rapidly evolving environment. With these sectors being predetermined for a relatively long period of time (five years), the ability of agencies implementing industrial policy to adapt to changing circumstances can be called into question. The recent announcement of a narrowing down of the list of priority list from 14 sectors to eight branches is one symptom of this lack of flexibility, as it happened a year after the significant structural shift that were the change to a floating exchange rate and subsequent fiscal tightening measures. The sector selection criteria are not fully transparent, which is not to say they are misguided. The sectors selected appear reasonable in the light of Kazakhstan’s position in the product space, its prospects to move up the value chain in sectors related to its natural resource extraction activities, and the ambition to develop a number of sectors where it already has a presence (chemistry, petrochemistry and vehicle manufacturing).

Main recommendations for the implementation of industrial policy:

Consistent objectives and clear principles of implementation should be set for industrial policy. The key guidance document, the Concept on Industrialisation, sets a number of core principles, but is silent on how balance will be achieved between sector-specific and horizontal support, or on what the basis is for selecting sectors for specific support.
Align monitoring and evaluation with the objectives and with best practices. Current publicly available information on industrial policy is scattered and not comparable. There should be a role for independent actors in evaluation, given the very significant sums involved. Evaluation functions should overall be strengthened both in terms of the evaluation framework and the evaluating agency.
A number of measures in industrial policy and especially complementary measures determining the framework conditions should be moved from a programmatic to a policy setting. There is merit in certain forms of support being time-bound, but those measures that constitute the conditions of operation in a sector should be predictable over longer periods to attract foreign and domestic investment, especially when SOEs play an important role in those sectors.
Seek sources of greater flexibility in implementation to allow industrial policy to adapt to changes in circumstances. Sources of flexibility can be found in the institutional and programmatic framework itself, by setting principles that allow objectives and key implementation issues to evolve over time. Flexibility can also be found by implementing more indirect instruments, which give a greater role to private sector actors – both entrepreneurs implementing projects and financial institutions providing finance – in identifying profitable opportunities.
Re-examine the key functions of industrial policy and the responsible bodies. Functions should be expanded beyond traditional finance and co-ordination to include also strengthening the anticipation, adaptation, embeddedness, interconnectedness and learning capacities in the economy. Public-private bodies can play an important role in providing these.
Put greater emphasis on non-financial instruments and increase the direct participation of the private sector based on responsible business conduct principles and standards. Non-financial functions of existing instruments, such as the co-ordination role of the Map of Industrialisation, are also important. They should be recognised in their own right, ensuring they remain, even if and when the financing role of the state diminishes. Private sector participation in decision-making and consultation bodies is an important advance over the command and control basis. Direct private-sector intervention through more indirect instruments can open up new avenues and projects.
Include other sectors in the industrial policy framework, in particular those industries in agriculture and services that have potential in Kazakhstan. The country has many features that would make it a good candidate for regional service provision in business, information technology (IT), and financial and environmental services. However, their development suffers from lack of appropriate specific infrastructure and a certain disconnect between public and private actors.

Continuous improvement in complementary inputs, especially high-quality infrastructure, and reforms, needs to accompany industrial policy if it is to have an effect. Continuing and recent reforms in the areas of regulatory quality, competition and public service can improve conditions for entrepreneurs and investors across the country but much remains to be done, especially in the areas of human capital formation, finance, and in levelling the playing field between economic actors. Significant efforts in the upgrading of physical infrastructure will need to be pursued, and should be complemented by efforts to develop logistics capacity to facilitate access to markets and the integration of value chains.

Education, training and innovation policies should be further developed in line with structural transformation objectives. This requires mechanisms to anticipate future skills needs and design appropriate training curricula and methods, possibly with the participation of the private sector. Innovation efforts will need to be upgraded if Kazakhstan is to become an innovation-driven economy; this will involve not only an upgrade in research and development (R&D) spending but also efforts to bring the innovation and research system closer to business.

Mobilising finance to transform Kazakhstan’s economy

Kazakhstan’s financial sector, especially its banking system, is unusually shallow. Whether measured by credit to the private sector or broader measures that include deposits and financial markets, Kazakhstan’s financial system is small relative to its GDP. Banks’ limited deposit bases and lending are particularly notable. The only countries that have achieved higher income levels with as thin a financial sector as Kazakhstan are even more reliant on narrow resource extraction sectors. Equity and bond markets lack the liquidity needed to provide effective funding, while the structure of the pension system limits its capacity to fund long-term investments.

The shallow banking sector hampers firms’ investments and operations and impedes the economy’s diversification and the emergence of new sectors. Smaller firms, especially those in domestic services sectors or newer firms, report that access to finance is a major obstacle to doing business. These firms are particularly reliant on banks for financing. International evidence and NBK research suggest that this weakness imperils investment and economic diversification more broadly, and that a robust banking sector is essential for sustained growth. Larger firms, and those with connections to the state, are able to work around these limitations by tapping international sources of finance or through the government’s systems of financing its SOEs. Shallow equity and other financial markets are less of a hindrance for economic development and diversification. Cross-country evidence suggests that these markets become important drivers of development for significantly larger economies with higher levels of productivity and diversity.

Both structural and cyclical factors explain the shallowness of finance in Kazakhstan. Banks have limited access to wholesale funding, reflecting the ongoing effects of earlier unsustainable use of international credit flows, as well as the structure of the pension system, and limited domestic savings. Domestic savers are discouraged from holding their savings onshore. The period of an unsustainably high exchange rate encouraged savers to shift their funds out of tenge and into foreign currency. Longer-term uncertainty over property rights and the continuing uncertain status of past transactions has also encouraged wealthy individuals to shift their funds offshore. The NBK’s efforts to stabilise the exchange rate also encouraged banks to engage in financial trading rather than business lending. All actors face uncertainty and a lack of transparency around the judicial system, including the protection of investors’ rights. Lenders even cite the uncertain integrity of financial statements and auditors’ reports as an obstruction to their ability to lend, especially to new firms.

The government’s various schemes to support firms’ access to finance were effective during the financial crisis, but have limited long-term benefits. The government has introduced a large number of schemes intended to improve access to finance for targeted categories of firms. These avoid some weaknesses of similar schemes by working through second-tier banks. The commercial banks are responsible for identifying borrowers and managing the loans. The schemes subsidise the interest rate or guarantee the loan, and can accompany this support with various efforts to improve the businesses’ operations through training and capacity development. The schemes have been funded by drawing on savings in the national oil fund and from Kazakhstan’s development partners. They made an important contribution to ensuring that firms could continue to access credit during the depths of the 2008-10 financial crisis. But econometric analysis could not find evidence that they have generated lasting gains in credit growth or investment.

Main recommendations to strengthen the role of finance for economic diversification:

Strengthening banks’ ability to access wholesale funding will improve their ability to provide credit. Banks’ lending is constrained by the availability of funding. The pool of domestic savings will remain limited into the medium term, even after the shift of monetary policy regime and the exchange rate stabilisation slowed the outflow of funds. In the short and medium term, international wholesale financing can address the immediate hindrance of shortage of financing. However, accessing these funds is likely to remain challenging for Kazakhstan’s financial institutions. The legacy of the stress of the 2008-10 period continues to limit banks’ ability to access international wholesale markets, and the recent downgrading of the state’s international sovereign credit rating adds to their difficulties. Government actions need to ensure that its sovereign rating is not further downgraded, including through sustainable budget deficits, and transparent and stable management strategies for the offshore reserves, including the National Oil Fund. To circumvent these issues, joint ventures or equity sales to international banks should be supported where they can improve banks’ access to international financing and internal management.
Other efforts need to continue to develop domestic savings. Management of the consolidated pension fund should focus on ensuring the funds are efficiently invested for secure but optimised long-term. Such behaviour usually requires competition between fund managers. The government is developing this policy, including transfer of management to private companies and removing the single accumulative pension fund from the NBK. The shift to a floating exchange rate, inflation-targeting monetary policy should stabilise the outflow of funds, if the policy is seen as credible and enduring. Efforts to improve the rule of law and protection of property rights will also support Kazakhstan investors’ willingness to hold funds onshore.
Strengthen with transparency and continuity the financial sector’s institutional environment. Kazakhstan has made significant gains in the quality of its supervisory system since the 2000s, and banks have strengthened their internal management. Converting these gains into improved access to finance will require ensuring that investors can be confident in the protection of their investments, ability to enforce agreements, and reliability of financial information and audits. Especially relevant for smaller enterprises, the capacity of accountants needs to be developed, while misleading audits need to be prevented, for example through credible sanctions. The Astana International Financial Centre may support this process, by providing a model legal and accounting jurisdiction alongside Kazakhstan’s institutions.
The programmes supporting access to finance for targeted categories of firms would be more effective with greater focus. The programmes are effective in responding to short-term crisis situations, when banks cut their lending. They can be effective at helping firms develop their internal management capacity. However, indefinite implementation of the programmes does not appear to accelerate the development of firms or of credit growth, and can lead to the misallocation of lending to investments that do not offer the highest returns. Further, they may mask the symptoms of deeper institutional weaknesses, at considerable cost for public finances.

Privatisation and the role of the state in the economy

The economy of Kazakhstan is dominated by state-owned enterprises (SOEs) and large private industrial and financial conglomerates. There are close to 7 000 registered state-owned enterprises, of which over 1 000 are considered large as they employ over 250 people. According to data supplied by the Ministry of National Economy, the gross value added by the SOE sector was 8.1% of GDP in 2014. In addition there are about 20 000 state agencies which engage in public administration and do not conduct commercial activity.

SOEs are the dominant form of state control in the economy. An analysis of the degree and mechanisms of state control using the OECD Product Market Regulation Indicators shows that state involvement in Kazakhstan stands out among benchmark and OECD countries. This assessment reflects the heavy involvement of government in network sectors, with full ownership and control of the largest firms in the gas sector, in several transport sectors, the post, mobile services, electricity distribution, supply and generation and the ownership of majority stakes in firms in other sectors. This scope of presence is larger than in OECD economies.

The extent of state involvement in the economy is such that even large-scale privatisation is unlikely to lower state involvement much unless the state relinquishes significant control over key firms. Beyond SOEs, price control is much more prevalent in Kazakhstan than in OECD member countries or major emerging economies. Price controls are applied across a wide range of sectors; plans to abolish price regulation from January 2017 have been announced and offer an opportunity to bring Kazakhstan into line with conventional OECD approaches that rely on prices for the provision of market signals. Regulation in Kazakhstan stands out for taking a coercive rather than an incentivising approach. Current efforts to reduce the amount of regulation through Regulatory Impact Assessment should be accompanied by efforts to change the nature of regulations in some sectors.

Kazakhstan has set a target to reduce the share of the state in the economy to 15% by the year 2020 from the present level, which represents its most ambitious privatisation programme since independence. There is significant support for the notion that privatisation can bring about significant increases in the profitability, output and efficiency of companies. The use of that particular target, based on book value to GDP, as the key measure of privatisation efforts is debatable. The ongoing privatisation programme is very ambitious, with close to 800 entities up for privatisation including the “Top 65”, a set of large enterprises whose privatisation has been given priority.

The legal framework for privatisation has been reformed in advance of the launch of the comprehensive privatisation plan. Public firms which operate in markets where private enterprises exist should be privatised or exit the market. The Law on State Property was amended in view of the new privatisation programme, setting out the possibility of carrying out privatisations by auction, tender or direct sales. The January 2016 reform has also simplified procedures to make them more agile: following the reform, only the price is decisive in auctions and tenders with or without the existence of conditions. Direct sale of state assets to “strategic investors” are now allowed, following the recent amendments to the law. To limit the risk of corruption, requirements have been included for independent pricing for assets worth over KZT 5 billion and for the participation of independent external advisors in all directed sales.

Following the examples of KazTransOil and KEGOC, which were the object of initial public offerings in 2012 and 2014 respectively, a number of firms are expected to have part of their equity sold in the stock market. In both cases, minority stakes of 10% minus one share have been sold to the public. While benefits in terms of increased transparency can be expected, strategic decisions will remain in the hands of the state as a shareholder. In strategic companies, foreign buyers can purchase stakes after approval by the government.

The governance and management of SOEs in Kazakhstan departs in several ways from the OECD Guidelines on Corporate Governance of State-owned Enterprises. While some encouraging recent measures have been taken to improve the governance of individual SOEs, Kazakhstan does not have an ownership policy that would define the rationales of state ownership, the role of the state in the governance of SOEs and the roles and responsibilities of government offices involved in the implementation of the policy. The Kazakhstan authorities point out, however, that in their opinion the Law on State Property and the recently promulgated Entrepreneurial Code form together an ownership policy. Moreover, the playing field is not level between private firms and SOEs. Enterprises with foreign ownership have experienced that SOEs often enjoy better access to resources, markets, credit and licences. Access to finance is challenging in Kazakhstan, but SOEs have explicit or implicit state guarantees and can tap in some cases internal funds from national managing holdings.

There is no single ownership entity in charge of exercising ownership on behalf of the state. The Committee of State Property exercises authority on behalf of the government and has property rights on all republican entities. The committee has, by government decisions, delegated the rights of use and possession to a number of responsible sector ministries, which exercise the owner’s rights over the entities. In addition, there is a structure of legally independent national managing holding companies, which are outright owners of dozens of enterprises, including the most important industries. All this deviates from the principle of unified ownership. Moreover, no emphasis has been put on separating ownership and regulation functions. The Ministry of National Economy, the Ministry of Finance and the Ministry of Agriculture exercise ownership of SOEs and are responsible for regulation in relevant sectors (taxation, industrial policy, competition, public procurement). The corporate governance of national management holdings involves high-level officials, which increases political control. At the same time, these organisations control significant public wealth without direct parliamentary oversight.

Main recommendations:

The privatisation programme is an opportunity to bring ownership policies and practices more into line with the OECD Guidelines. This entails developing an ownership policy, which is particularly important in countries like Kazakhstan that have high state participation in the economy. Kazakhstan should also reduce the dispersion of the organisation of SOE ownership, clearly identify the body exercising ownership rights and separate ownership from regulatory functions to ensure the playing field is even between SOEs and private enterprises.
A centralised ownership entity would be appropriately located in the Office of the Prime Minister, given the importance of SOEs in the economy of Kazakhstan. It should also have shareholder powers over the boards of national managing holdings. These boards should be reorganised with professional corporate leaders taking over from political decision makers. The ownership entity should be held accountable to parliament and develop a consistent system of reporting on state ownership and publishing an aggregate report at least annually.
The ultimate objective of privatisation should be clearly stated and monitored. A dashboard of indicators could be developed to improve upon the objective set in terms of book value to GDP (all the more so, given the recognised overvaluation of certain assets included in the privatisation programme). Since privatisation efforts aim to revitalise the private sector in Kazakhstan, reform of state ownership is of major importance for privatisation efforts because of the need to ensure that the playing field is even and that SOEs with private equity participation strive to meet objectives of all shareholders.
The privatisation process should be controlled ex post, by an independent body reporting to the parliament. The requirement of maximum transparency and accountability in all aspects of the privatisation process is essential. The appointment of a single co-ordinating unit would help reduce the dispersion of privatisation. Its accountability would also limit political interventions which could damage credibility for investors and ultimately reduce privatisation revenues or thwart privatisation plans. Progress in the privatisation process should be regularly disclosed to parliament and the general public.
Owners, or the office responsible for privatisation, should be given adequate time and resources to prepare the assets for privatisation. Such preparation entails due diligence, but also adjustments to the capital structure of the entity, on one hand to ensure its viability and on the other hand to strip out excess cash holdings. Concerns over the viability of the companies should be addressed. A number of enterprises (e.g. Kazakhstan Temir Zholy) have public service obligations. The obligations and any compensation should be disclosed in connection with the listing or privatisation, which would otherwise compromise minority shareholders’ rights. Environmental liabilities should also be identified and costed.
Identifying buyers will prove challenging in the current conditions. When direct sales take place under conditions – e.g. for strategic investors to agree to specific undertakings, investments, or operations – those conditions, their method of monitoring and the consequences of non-observance should be clarified. For smaller entities, which are more likely to find buyers in the domestic market, the possibility of management buy-outs should be introduced and encouraged, as they can lead to more favourable outcomes for smaller firms, given the specific knowledge of managers.

Towards better environmental regulations in Kazakhstan

Notwithstanding the recent global financial crisis, Kazakhstan’s gross domestic product (GDP) doubled over the past decade while export earnings increased correspondingly over the same period. Yet, much of this growth was based on the extractive and heavy industries and on the use of electricity which is produced mostly from coal. Consequently, Kazakhstan today is one of the most energy-intensive countries in the world and the energy intensity has not improved during the last decade. The environmental damage inherited from the Soviet era was exacerbated by the impacts from energy production, pollution from heavy industry, accelerated extraction of oil, gas and other mineral resources, as well as from agriculture and from growing road traffic in urban areas.5

Kazakhstan has undertaken steps to move towards a more sustainable mode of development which were outlined in two key strategic documents: the 2012 “Kazakhstan 2050 Strategy” and the 2013 “Green Economy Concept” (GEC) which outlined the path to long-term growth based on climate-friendly technologies, energy efficiency measures, and the restoration and sustainable management of natural resources. The GEC, in particular, envisaged modernising deteriorating environmental infrastructure, and set ambitious environment-related targets for the power generation, mining, industry and agriculture sectors and for energy, soil and water use. It stated that “. . .by successfully achieving these targets, the country will recover its water and land resources by 2030, and its resource productivity will largely be on par with the average indicators of the OECD members and other developed countries”.

However, the implementation of the GEC faces serious challenges, including:

“top-down” and “command-and-control” approaches based often on the Soviet standards or regulation, combined with frequent incidents of corruption to avoid heavy handed non-compliance response,
limited use of market-oriented, compliance promotion and information-based instruments to incentivise companies to invest in pollution reduction and technology modernisation,
lack of willingness by local authorities to implement green reform because of fear of the reallocation of revenue from environmental payments away from local budgets; and
strong vested interests in the energy-intensive sectors, such as domestic electric power, mining or chemical industries not to allocate their own resources to the improvement of their environmental performance.

In order to meet its ambitious targets, Kazakhstan urgently needs to develop and implement a set of measures and policies defined in the GEC and other key policy documents. Among many, one of the most important steps that could unlock vast green growth opportunities is the expeditious reform of a basic environmental regulatory framework. Despite recent progress, the uncoordinated implementation of environmental requirements together with the high volume of complex environmental regulations based on unrealistic assumptions have resulted in a regulatory environment that is complicated, burdensome and costly to both the administration and industry. What is more, the evidence suggests that it does not lead to actual environmental improvement. To address these fundamental flaws, further efforts to streamline and simplify these requirements are needed in a way that realistic objectives are set and environmental ambitions are not compromised.

Extensive preparations by the government of Kazakhstan for the upcoming EXPO 2017: Future Energy, the emphasis on green technologies and the overall business case for a green economy are promisingly timed for new policy breakthroughs.

Main recommendations include:

Environmental quality standards need to be revised in the light of international best practices and domestic capabilities to technically feasible and enforceable levels, striking a balance between what is desirable from an environmental point of view and what is feasible from a technical and economic standpoint. The government should make the best use of limited technical capacity and prioritise the provision of the financial and human resources to regulate effectively those polluting substances that pose the greatest risk to human health and/or the environment.
The present environmental permitting and compliance control requirements need to shift the focus of environmental requirements from “end-of-pipe” solutions to integrated pollution prevention and control. For the largest and “high impact” polluters there should be a shift away from the mentality of command-and-control regulation, which just penalises non-compliance, and re-incentivise it through integrated pollution prevention and control. Integrated environmental permits are one of the most effective ways of achieving better pollution control since the permit is linked to best available techniques (BATs) which are associated with lower emissions.
Building on the reform and improvements of Environmental Impact Assessments (EIA) and State Environmental Experts’ Examination (SEEE) there is a further need to simplify and shorten the procedures for medium and small-scale projects. Where possible the EIA/SEEE procedures should be combined with integrated environmental permitting. Further efforts are also needed by the public authorities to open the procedures to the public’s active participation, especially at the regional and local levels. This should assist in building the procedures for more regular reporting on environmental pollution (and their impacts) in a consistent and standardised format.
The OECD country experience shows that Kazakhstan should abandon fault-based concepts for damages that tie liability to exceeding a pre-determined limit in an emissions permit and instead adopt the strict liability/polluter-pays model based on evidence of actual harm to the environment. By contrast, environmental liability for pollution in Kazakhstan applies only if the emission permit limits have been breached (the fault standard), even in the absence of proof of environmental damage.
Although some important legal changes are being introduced, environmental liability in Kazakhstan remains focused on calculating and collecting monetary compensation for the state (essentially serving as a revenue-raising penalty) rather than on preventing and correcting the damage, reducing emissions over time and incentivising the use of BATs. Credibility in the regulatory system needs to be restored by reforming the laws governing environmental taxes, fines and damages so that they are aligned exclusively and transparently with environmental policy objectives and the international commitments Kazakhstan has made. The state should eliminate discrimination against specific industrial sectors, set rates for taxes and fines which are uniform for all industry sectors and set rules for assessing damages which are also non-discriminatory. The rates applicable to taxes and fines should be realistic and consistent with international practice. Enforcement should also be transparent and even-handed. More regulatory guidance should be provided on how to assess the extent of the damage, needs and costs of remediation, and how to select clean-up measures
Kazakhstan should be applauded for taking steps toward better use of market-based environmental policy instruments, e.g. in relation to the reduction of greenhouse gases (KazETS) and making commitments under international treaties to reduce its carbon footprint. Implementation will be critical to modernising the country’s economy and integrating it into the international community of developed countries. Consistent with the trend across all environmental reform initiatives in Kazakhstan, the state should match its ambitious commitments with real legislative reforms. Authorities should work jointly with relevant stakeholders to clarifying the regulations. The competent authority in charge of the KazETS should be strengthened in order to provide adequate training, clarification and guidance to entities regulated under the KazETS.

Anticipating trends and preparing for future challenges: Scenarios for the future of Kazakhstan

This chapter has so far detailed some of major challenges that Kazakhstan faces in realising its goal of becoming one of the world’s 30 most developed countries by 2050. It has also detailed the severe and long-lasting impact of shocks in the global economy on Kazakhstan’s economy and growth prospects. Kazakhstan’s exposure to the external environment, because of the reliance of its economy on natural resource extraction, means it needs to be prepared for major shifts or shocks that could have an impact on its prospects for development.

The pace and composition of the global economy is changing rapidly, and many economic, social, environmental, political and technological trends will shape development opportunities in the future. Identification of these trends and anticipation of their impacts should be integrated into policy planning to enable decisions that will make the Kazakhstani economy more resilient. To ensure that the recommendations in this report are relevant in the face of these trends, scenarios were developed to test those recommendations against global developments, and foresee their consequences in terms of policy contexts, incentives and trade-offs.

This section details four scenarios for Kazakhstan developed with a time horizon of 2030. The scenarios aim to anticipate different contexts and challenges which Kazakhstan could face in 2030, based on trends in the global economy and Kazakhstan that have been identified today. In the light of Kazakhstan’s recent growth and development patterns, the scenarios were specifically developed to consider and test recommendations against trends and assumptions related to the economic diversification and dependence on natural resources.

Recommendations detailed in each of the following chapters in this report are discussed in the light of these scenarios. The scenarios aim to illustrate how shifts in the policy context may affect incentives as well as scope for reform, and the economic incentives of pursuing different strategies relating to diversification, finance mobilisation, privatisation and the move toward better environmental regulation in Kazakhstan.

Box 1.1. Why use scenarios?

Strategic foresight and scenario-based approaches are used as a fast and flexible method to analyse alternative plausible futures to traditional forecasts. They are often used to complement forecasting exercises, by integrating unquantifiable trends (political, social, behavioural), “shocks” to the system (e.g. financial crises or environmental disaster), or as a means of reducing the complexity of multiple interactions to explore the implications of a specific trend or combination of trends.

While scenarios often use data-based research and quantifiable trends, they are not constructed by means of projections. However, like projections, scenarios are explained by means of a storyline. Scenarios are stories, developed by considering how different trends can combine to create a different context, and thinking through the policy implications, be it in terms of policy options, new policy incentives or trade-offs, that emerge which could affect implementation.

Scenarios are a useful tool when formulating recommendations. They are user-driven, so account for stakeholder perspectives and assumptions, and ensure that a wider array of policy contexts is considered in the formulation of recommendations.

These scenarios were elaborated in consultation with an array of local stakeholders in Kazakhstan, from the public and private sectors as well as academia and civil society. The selected trends used are the following:

Shifting wealth: Continuing increase in the relative contribution of emerging economies to global GDP growth (especially India): this trend was selected as emerging economies are expected to drive global growth in the next decade and affect demand for natural resources.
Sluggish growth: Global growth slowdown continues, driven by modest growth in developed economies: this trend was selected as uncertainty surrounding global growth and the composition of the global economy may affect decisions surrounding diversification for the economy as well as the make-up of the region’s trade networks.
Increasing Chinese investment and partnerships on its Western borders: China increases its focus on Central Asia and the old Silk Road: this trend was selected as it opens new economic opportunities and partnerships for Kazakhstan, and impacts on its infrastructure, trade and territorial development.
Increasing pace of innovation in green technology: Increased investment and innovation in green technology: this trend was selected as it could affect demand for natural resources but also decisions regarding economic diversification, investment, innovation, education and skills.

Box 1.2. Scenarios for the future of Kazakhstan 2030

Scenarios with a 2030 horizon were developed for the Kazakhstan MDCR to highlight the implications of endogenous and exogenous shocks on the policy context in which Kazakhstan will pursue its developmental strategy. The scenarios were developed following strategic foresight approaches in a series of participatory workshops in Astana in December 2014, hosted by the Ministry of National Economy, and in November 2015 hosted by the Ministry of National Economy and Nazarbayev University.

Over the course of these workshops participants carried out a visioning exercise and trend analysis, to identify the assumptions underpinning Kazakhstan’s development model, and various exogenous and endogenous shocks which could affect the country’s development strategy. The scenarios were subsequently developed in consultation with local stakeholders from different backgrounds including government officials, representatives from the public and private sectors, academia, think tanks, and civil society, and discussed in the light of emerging recommendations on diversification, financing development, privatisation, and environmental regulation. Four scenarios emerged from the exercise:

1. The New Commodity Super-cycle

The rise of India creates a large new source of increased demand for oil and other commodities, and prompts a new global commodity super-cycle. The oil sector attracts foreign investment, and financial and human resources flow to petroleum and away from the sectors that produce other tradeable goods and services such as agribusiness or manufacturing, which also suffer from reduced competitiveness in the Eurasian Economic zone and other export markets. Kazakhstan accelerates the development of its financial service centre and Astana becomes a financial services hub for the region. However, as the exchange rate appreciates with increased investment export inflows, Kazakhstan’s strong revenues from oil create symptoms of “Dutch disease” for the larger economy and the oil and financial sectors create only limited employment, mostly high-wage, creating pressures around the inclusiveness of growth. To counter this, the government considers various income transfer schemes, which in turn support household spending and domestic consumption. Investment is focused on Astana, as the new financial hub, which accelerates urbanisation. An international agreement to curb emissions is ratified and Kazakhstan’s increased revenues need to support its adaptation to a lower carbon economy. However, this means Kazakhstan is not eligible for financial aid to facilitate the transition.

2. The Great Dissipation

Global growth is weaker than projected and below the pace achieved over the last decade. Demand for oil and other commodities stagnates, while trade in manufactures and services also weakens. Regionalism takes hold and global economic integration recedes. While global interest rates are low, investors’ risk appetite is also subdued, with continued uncertainty about the trajectory of the global economy. This translates into weaker export receipts, income and investment for Kazakhstan, constraining fiscal space for public investments and services. However, the associated weakness in the exchange rate makes it easier for Kazakhstan’s non-resource exports to compete with its oil sector for investment and domestic financial and human resources. This allows for a strategy to stimulate dynamism in other sectors of the economy, targeting the Eurasian Economic Zone as an export destination. Kazakhstan’s relative stability and ongoing improvements in the quality of governance and the business environment make the country an attractive island for foreign investors looking to access the domestic market and the Eurasian Economic Zone.

3. The New Silk Road and Central Asia Resurgence

As the centre of global of economic activity continues to shift eastwards, China formalises and expands its “Belt and Road Initiative” (BRI), strengthening economic and cultural ties in East and Central Asia and beyond. Kazakhstan’s stability and good co-operation make it an ideal partner as a transit country for the BRI. This draws Kazakhstan into deeper association with China, which is accompanied by investment but also stronger cultural ties. Kazakhstan engages more with the economic take-off occurring to its south in Kyrgyzstan, Tajikistan, Uzbekistan, and Turkmenistan. The opportunities along the BRI railway and the areas bordering the emerging countries to the south support a series of towns and secondary cities. This favours policies pursuing regional integration. Intra-regional trade and institutional reforms improve the business environment and attract foreign direct investment (FDI) for industries catering to the regional market. While wages in Kazakhstan are higher than elsewhere in the region, it can compete with the skills, expertise and productivity of its workforce and through the relative quality of its institutional environment.

4. New Green Technology Solutions

An international agreement on climate change is ratified, which generates a market for significant investment in green technologies. These investments result in revolutionary improvements in green energy storage and other green technologies, reducing demand and prices of hydrocarbons (although significant carbon taxes increase the cost of using high-emission fuels). These developments raise global demand for low-carbon and energy-efficient goods and support new growth in mature economies. Demand for oil weakens but is stronger for other commodities, including agricultural goods, and for services. Overall these developments maintain export and fiscal revenues for Kazakhstan, but support the non-oil tradeable goods sectors. This supports investment, employment and economic activity across more of the country, although the competitiveness of Kazakhstan’s non-resource exports remains under pressure.

References

Behar, A. and A. Fouejieu (2016), “External adjustment in oil exporters: The role of fiscal policy and the exchange rate”, International Monetary Fund Working Paper WP/16/107, Washington, DC.

IMF (2016), World Economic Outlook (database), http://www.imf.org/external/pubs/ft/weo/2016/01/weodata/index.aspx.

IMF (2015), 2015 Article IV Consultation Staff Report, International Monetary Fund, Washington, DC.

IMF (2014), 2014 Article IV Consultation Staff Report, International Monetary Fund, Washington, DC.

Ministry of Finance of the Republic of Kazakhstan (2006-2015), “Статистические бюллетени” [Statistical bulletins], www.minfin.gov.kz/irj/portal/anonymous?NavigationTarget=ROLES://portal_content/mf/kz.ecc.roles/kz.ecc.anonymous/kz.ecc.anonymous/kz.ecc.anonym_budgeting/budgeting/reports_fldr/statistical_bulletin_fldr (accessed 15 December 2016).

NBK (2016), Statistical Bulletin, National Bank of Kazakhstan, various editions, www.nationalbank.kz (accessed December 2016).

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OECD (2016b), Multi-dimensional Review of Kazakhstan: Volume 1. Initial Assessment, OECD Development Pathways, OECD Publishing, Paris. https://doi.org/10.1787/9789264246768-en.

OECD (2016c), OECD Economic Outlook, 2016(1), OECD Publishing, Paris, https://doi.org/10.1787/eco_outlook-v2016-1-en.

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Notes

← 1. Ministry of National Economy, State Revenue Committee monthly revenue data.

← 2. The rate and composition of spending growth various between data sources, particularly with respect to the treatment of financing transaction. To facilitate comparison with other economies, this report follows presentation that are consistent with the International Financial Statistics where possible.

← 3. The OECD Guidance documents around sovereign wealth funds are collected at: http://www.oecd.org/daf/inv/investment-policy/oecdguidanceonsovereignwealthfunds.htm

← 4. IMF Country Reports and authors’ calculations.

← 5. For a detailed description of environmental challenges in Kazakhstan see OECD (2016), “Multi-dimensional Review of Kazakhstan - Vol. 1 - Initial Assessment”.