Ministry of Science and Education of Republic of Kazakhstan

SÜLEYMAN DEMİREL UNIVERSITY

FACULTY OF ECONOMY

(Department of Master Programs)

Toraigyrova No: 19, Almaty, 050043 Kazakhstan

WORKING CAPITAL MANAGEMENT

The case of small businesses in Kazakhstan economy during

financial crisis

Dissertation;

By:

BERIK SABDENALIYEV

SDU University: Kazakhstan

berik_sabden@mail.yahoo.com

Background:

Background Information: Berik Sabdenaliyev has completed a BA, degree in

Kokshetau State University named after Sh. Ualikhanov, Faculty of

Management . He is presently working towards a MBA on (Management of

Business Administration) at SDU University in ALMATY- KAZAKHSTAN.

ACKNOWLEDGEMENTS

The research described in this thesis was written at the Suleyman Demirel University,

Faculty of Economy. The co-operation and support of many people during the course of this

work has been very valuable to me. There is a known saying which states: "to those who help

you, if you can, you have to help them, otherwise tell other people about their help". Therefore,

at least I owe those who helped me many thanks and I would like to express my sincere

appreciation. I would first and foremost like to express my gratitude to my dissertation advisor:

Mr. Osman SHAHIN, Dean of our Economy Faculty for his continuous patience and support

during the time it took to write this dissertation. I thank you for the professional guide and

critical comments, which became the corner stone of my work.

CONTENTS

CHAPTER 1: INTRODUCTION...............................................................................

1.1. Relevance of working capital.................................................................................

1.2. Research problem, purpose and questions...............................................................

1.3. The Research methodology...................................................................................

1.4. Organization of the book......................................................................................

CHAPTER 2: INTERNAL WORKING CAPITAL MANAGEMENT................

2.1. Introduction..........................................................................................................?

2.2. Definition of Working Capital................................................................................

2.2.1. Working capital concepts..................................................................................

2.2.2. Sources of working capital..................................................................................

2.2.3. Effective Small Business Working Capital Management.....................................

2.3. Managing working capital investment..................................................................?

2.3.1 General considerations........................................................................................?

2.3.2. Cash Management.............................................................................................?

2.3.3. The importance of Cash management...............................................................?

2.3.4. Inventory Management......................................................................................?

2.3.5. Receivable management....................................................................................?

2.4. Managing working capital finances......................................................................

2.4.1. Components of working capital financing.........................................................

2.4.2. Short-term loan financing..................................................................................

2.5. Managing the purchase and cash payment operations..........................................

2.5.1. Purchase operations...........................................................................................

2.5.2. Cash payment operations...................................................................................

2.6. Managing sales and cash collection operations....................................................

2.6.1. Sales operation...................................................................................................

2.6.2. Cash collections.................................................................................................

2.7. Performance management of working capital levels and operations....................

2.7.1. Performance evaluation of working capital investments....................................

2.7.2. Performance evaluation of working capital financing.......................................

2.7.3. Performance evaluation of working capital operations.....................................

2.8. Conclusion............................................................................................................

CHAPTER 3: KAZAKHSTAN ECONOMY AND FINANCIAL CRISIS...........45

3.1. Introduction..........................................................................................................45

3.2. Kazakhstan Economy watch

3.3.

Chapter 1

Introduction

1.1. Relevance of working capital

Important theoretical developments in finance during the past decade have provided the

potential for improved decisions in business organizations. Unfortunately, developments have

not been uniform across all areas of financial decision making within and between business

organizations. Working capital appears to have been relatively neglected in spite of the fact that a

high proportion of the business failures is due to poor decisions concerning the working capital of

the firms. Of interest in this book is therefore the area of intra and inter-firm working capital

management, which generally encompasses short-term investment and financing decisions of

firms.

In a perfect world, working capital assets and liabilities would not be necessary

because there would be no uncertainty, no transaction costs, and no scheduling costs of

production or constraints of technology. The unit costs of producing goods will not change with

the amount produced. Firms would borrow and lend at the same interest rate. Capital, labor and

product markets would reflect all available information and would be perfectly competitive.

In such an ideal business world there would be little need to hold any form of

inventory other than a limited amount of goods in process during production. But such an ideal

business assumes that demand is exactly known in advance, that suppliers keep to their due

dates, production can be smoothed and orders executed directly without costs and delays. There

would be no need of holding cash for working capital other than for the initial costs, because it

could be possible to make the payment from every receipt of sales. There would also be no need

for receivables and payables if customers pay cash immediately and the firm would also make its

payments promptly. However, problems of working capital exist because these ideal

assumptions are never realistic and therefore working capital levels make a significant part of a

firm's investment in assets and these assets have to be financed implying that investments may

have benefits as well as costs.

Working capital investments and related short-term finances originate from three main

business operations - purchasing, producing and selling. They can be considered as

consequences of business operations. However, as much as the operations affect the balances

of working capital investments and finances, the later also determine the cost and flexibility with

which the operations are performed. Efficient management of working capital investments and

related short-term debts can be used to make the purchasing, producing and selling operations

cheaper and more flexible. In the latter sense they are used as instruments for the management

of business operations, which in the mean time create benefits and costs. Therefore, the relevance

of working capital investments and short-term debts originate from these benefits and costs.

Beyond doubt efficient management of both items can help the success of firms in generating

value. Operations are results of inter-firm transactions. Therefore, managing working capital

investments, finances and operations internally within firms and the efficiency with which firms

co-operate among themselves determine their end result.

The historical perspective of working capital management

Historically, working capital management has passed through different stages, mainly -

the control, optimization and value measurement. Working capital management originally

started as a systematic approach of controlling the incoming, outgoing and remaining balances

of cash, receivables and inventories. At this stage the main objective is that working capital is

not misappropriated for personal benefits of those who are entrusted with its management. To

this end both researchers and practitioners developed various control measures over the receipts

and collections of cash, receipts and issuance of inventories as well as the increase of receivables

through credit sales and decrease of receivables through cash collection.

Under the optimality management phase, the main focus was not only on the physical

safety of working capital items but also on the minimization of related costs and maximization of

related income. At this stage particular models were developed to ensure that firms do not get

problems due to a lack of liquidity or incur too much cost by holding excesses of working

capital levels. Under the control and optimality approaches the amount of accounting profit is

taken as a main measure of managerial efficiency.

Under the value measurement approach working capital management concentrated on

how to help managers in the creation and measurement of value without disregarding the above

two objectives. Particularly, the cash flows approach is used as a main tool to measure the value

created by firms.

The control, optimality and value measurement approaches more or less concentrate on

the internal management of working capital. In our study, we introduce a new dimension to

these approaches - the external management of working capital. We argue that to have a

maximum impact on value, firms should manage working capital in co-operation with their

backward linkages (suppliers) and forward linkages (customers). By doing so firms can

internally minimize the costs of the levels of working capital investment and short-term

financing and externally minimize the costs of inter-firm transactional relations and thereby

create more value.

Internal working capital management

The benefits of holding working capital Each of the working capital items (i.e. cash,

receivables and inventories) helps in the management of firms in its own particular way.

Cash is used to keep the firm liquid so that it is able to pay its obligations when they are due

for payment and therefore it protects the firm from bankruptcy. Under investment in cash bears

the danger of being unable to pay back both short-term and long-term debts when they are due.

Every business needs also adequate levels of cash to maintain day-to-day operations. For

instance it needs enough to pay wages and salaries as they fall due and enough to pay creditors to

ensure its supplies. The different types of inventories are used to satisfy different purposes.

Raw material inventories are used to make production scheduling easier, to take advantage of

price changes and quantity discounts, and to hedge against supply shortages. If raw material

inventories were not held, purchases would have to be made continuously at the rate of

production. This would not only mean high ordering costs and less quantity discounts, but

also production interruptions when raw materials cannot be procured in time. Therefore, the firm

has an interest in buying enough raw materials to provide an effective cushion between purchases

and production. Work-in-process inventories serve to make the production process smoother

and more efficient: they provide a buffer between the various production processes. Inventories

of finished goods have to be held to provide immediate services to customers and to stabilize

production by separating production and sales activities. Most firms cannot produce immediately

when customers demand goods. Failure to supply products to customers when demanded would

mean the loss of sales to competitors. Therefore, holding finished goods inventory helps to serve

customers on a continuous basis and to meet their fluctuating demands. Finally, receivables are

used to attract customers and increase sales.

Investments in working capital assets can be financed by short-term debts, which include

mainly trade credits and bank loans. Trade credit and short-term bank loans have usually

lower interest charges compared to long-term loan and can be useful to maintain a firm's

liquidity position.

The costs of holding working capital The benefits to firms arising from an increased

volume of working capital, however, do not come without their own costs. Investment in

working capital is expensive. The more funds accumulated in working capital assets the more

the costs of the investment. Over investment in cash, receivables and inventories ties-up

capital and results in the opportunity costs of lost profits. Over investment in cash deposited in

bank checking account results at paying service charges while depositing in a saving account

does not generate large revenue. Over investment in receivables can result at debts, which may

not be collected. Over investment in inventories result at loss due to physical deterioration and

obsolescence of the inventory items. Financing working capital investment with short-term debts

(though it is cheaper compared to long-term debts) is also riskier for the firm, because short-term

creditors give less time to pay back the loans. Therefore, the trade-off between the benefits and

costs of holding the working capital investments and short-term debts must be evaluated and

managed.

The trading-off between working capital benefits and costs the management of working

capital has to do with the trading off between the benefits and cost of holding working capital

items. Working capital investments and short-term debts do not only arise as a by-product of

purchasing, producing and selling but also are manageable variables. Management can

manipulate purchasing, production and selling using working capital investments and short-term

debts. The ways in which managers try to cope with the problems of working capital investments

and short-term debts are very relevant for the evaluation of firms' performance.

The volume of working capital investment The importance of working capital also originates

from its size. It is a large portion of a firm's investment in assets. It amounts usually to 40%

in manufacturing industries and 50% - 60% in retailing and wholesales. Therefore, firms can

save relatively large amounts by economizing on working capital investments and short- term

debts.

The management time working capital operations take Most business operations affect or

are affected by working capital operations (purchase of materials for production, production

of finished goods and sales of finished goods to customers). Purchases of materials result in

increasing the investment in materials inventory, payment of cash, or increasing payables.

Production results in increasing work-in process inventory and finished goods inventory. Sales

end-up in decreasing finished goods inventory, and increasing cash or receivables. The

management of these activities is very time consuming and may even demand more time if the

working capital investments and short-term financing are actively managed. It is therefore

normal for managers to spend much of their time in activities directly or indirectly related to

working capital investments and short-term debts.

1.2. Research problem, purpose and questions

The research problem Research begins when a researcher's curiosity is aroused and

motivated to formulate a problem demanding an answer. The idea of this research originated from

the actuality of role of working capital for small businesses. However, preliminary studies

showed that many of the firms had inappropriate working capital management. This resulted in a

number of problems, both internal and external that this research study uses as main research

background. Internally: (a) the firms hold inappropriate levels of working capital - resulting in

uncontrolled costs of holding the working capital items or in deficient working capital levels. (b)

The firms inappropriately manage their purchases and sales activities and have a defective

credit policy. Externally, the firms lack proper policies and practices of co-operation with their

suppliers and customers.

The research purpose The purpose of this research has its origin from the problems

mentioned above. We therefore try to explain the reasons for the problems mentioned and search

solutions to them. Our main objective is therefore to investigate and to have a critical analysis at

the firms' internal working capital management practices and then to give relevant policy

recommendations helpful to enhance firm value to both the firms and the government. In order

to realize this objective we reviewed relevant literature in the developed world and formulated a

conceptual framework, which we used to determine the relevant issue of our study collect

relevant data and analyze the findings. However, the existing literature in the developed world

does not fully address the issues in a developing environment.

1.3. The Research methodology

Research is a process - a series of linked activities moving from a beginning to an end.

Bauman and Atkinson propose an outline of three phases in the research process. The first phase is

the essential first step requiring a researcher to clarify the issues to be researched and select a

research method. In this phase the researcher has to select, to narrow and to formulate the

problem to be studied. Here the researcher has also to select the research design, to devise

measures for variables, and selects the samples or the units of analysis. This is what this section

on research methodology aims to achieve. Management behavior cannot also be manipulated in

the same way as experiments are manipulated. The focus of the research is on finding

contemporary working capital management, relevant to the financial crisis.

Case research studies can be exploratory, descriptive, hypothesis testing or

explanatory in nature. An exploratory case study explores new areas of organizational research

by making a complete investigation. It is used when the researcher does not know much about

the situation at hand or when s/he has no information on how similar problems or research

issues have been solved in the past. Before a model is developed extensive preliminary work is

done in order to get familiarity with the phenomena and to understand what is happening. It is

useful to get a good grasp of the phenomena of interest and for advancing knowledge through

good theory building. A descriptive case study involves describing certain characteristics of the

phenomena that the researcher is interested in. It is undertaken in order to ascertain and to

describe the characteristics of the variables in the situation. An explanatory case study is

concerned with explaining why the variables under study behave in a certain way.

Hypothesis testing is used to explain the nature of certain relationships or to establish the

differences among groups.

This research basically focuses both the descriptive and explanatory case study. First, we

review literature in order to search for what conceptual internal working capital management

approaches are available. Second, we search and describe what internal working capital

approaches the government, transition and privatized firms use. Finally, we compare and

explain how our conceptual expectations and empirical findings differ and forward possible

recommendations on how the government, transition and privatized firms can use internal and

external working capital management approaches in search of creating value. Internally, we

study the value creating characteristics of working capital.

Traditionally, it is believed that objectives of managing working capital can be achieved by

managing the internal affairs of a business firm. Managerial rewards were based on how firm

managers organize their internal affairs. In the contemporary period of globalization,

managers concentrating only on the efficiency of their internal operations forget an important

element: that of managing the external linkages, which can make a difference in the race for

business success. Management in general and that of working capital in particular, has become a

two-edged sword - internal and external. Internally various working capital approaches are used to

maximize the benefits and reduce the costs of working capital.

Documentary information - includes letters, memoranda and other internal

documents, studies of a similar case, articles and information appearing in the mass media.

Direct observation - refers to collecting data where the researcher makes a study on the case by

direct physical observation of the subjects of the case. Physical artifacts as a data collection

mechanism relates to collecting a technological device, a tool or instrument, a work of art, or

some other physical evidence. Interviews are personal contact questions put to key respondents.

Interviews can be structured or unstructured and can be conducted either face to face or by

telephone . In the case of unstructured interviews the researcher does not approach the respondent

with planned sequence of questions that he will be asking to the respondent. Its objective is to

formulate a conceptual framework for variables that need further in-depth investigation.

Structured interviews are conducted when the researcher has a pre-determined list of questions

and refers to this list while conducting the interview. Structured interviews are used when the

researcher knows what information is needed. They can take the form of open-ended or

focused interviews. Open-ended interview questions refer to respondents' opinion about events.

In a focused interview the researcher follows certain set of questions derived from the conceptual

framework of the case study. A questionnaire is a pre-formulated written set of questions to

which respondents record their answers, usually from defined alternatives. A questionnaire is

suitable when the researcher knows what is required and how to measure the variables of

interest and it can be administered personally or mailed to the respondents. Archival records

include financial statements, customers' and suppliers' service records, organizational records

etc. Archival records have the advantage of providing stable data, getting data not collected for

the case study, exact information and broad coverage. Because of their relevance to our research

we have used archival records, interviews and questionnaires. Focused and open-ended

interviews have been conducted with 45 respondents (managers of firms, their suppliers and

customers). Interviews enabled us to target directly at the case study topic and to perceive

causal inferences. Questionnaires have also been personally administered and collected from

the 45 managers. As archival records, the audited (as much as it is possible) financial

statements of the firms for seven years were collected and are used in this research. Taking

audited financial data of five consecutive years has the advantage of irretrievability, unbiased

selectivity (by both researcher and provider) and accessibility.

1.4. Organization of the book

This book contains five parts sub-divided into ten chapters. Part I contains chapter 1 and

introduces the research work. Part II contains chapters 2 where we deal with the literature review

on the internal working capital management and issues of effective working capital. Part III

contains chapter 3 where we decide on our research approach overview of Kazakhstan Economy

during Financial Crisis. Part IV incorporates chapters 4 we analyzed the empirical data in view

of the literature reviewed and conceptual framework developed.

PART II

LITERATURE REVIEW

Chapter 2 Internal Working Capital

Management

"While long-term decisions, involving plant and equipment or market strategy, may well

determine the eventual success of the firm, short-term decisions on working capital determine

whether the firm gets to the long term".

2.1. Introduction

Business firms are established by investments in the form of assets that can be classified on

the basis of liquidity - as current or fixed. Firms finance the total investment in assets with

debt and/or owners' equity, the supply of which is limited. The principles of financial

management form the basis of managing investments and related financing with current debt,

long-term debt, owners' capital contributions or retained earnings. The investment in current

assets is a working capital and the related financial management approach is working capital

management. Working capital management is defined here as a process of planning and

controlling the levels of investment and financing current assets as well as related operations

of purchasing and selling. Specifically, working capital management requires managers to decide

on what levels of current assets the firm will hold at any point in time and on how these current

assets are to be financed.

This research divides the management of internal working capital into levels and operations.

Levels refer to investments in working capital assets (cash, inventories, accounts receivable) and

short-term financing instruments (payables: trade credit, bank loan and accruals). Operations

include activities related to the purchase of materials and the sales of finished goods. It is worth

noting here that, internal working capital management refers only to the levels and operations

which are directly connected with the with the firm's external linkages (that is suppliers and

customers). This implies that we do not refer to internal operations such as production operations

and other internally performed administrative activities.

We argue here that working capital investment is mostly a result of purchase and sales operations.

As figure 2-1 reveals, there is a working capital cycle that starts with financing (for the

purchase of materials), continues to operations (purchases, production and sales) and ends-up

at investment (in cash, inventories and receivables). According to Moyer, McGauran and

Kretlow, (1998), a firm's operating cycle consists of three primary activities - purchasing

resources from suppliers, producing the product internally, and selling the product to

customers. This operating cycle determines a firm's working capital investment and its

financing needs. The purchase and sales operations create cash inflows and outflows, which are

both unsynchronized and uncertain. They are unsynchronized because cash disbursements (like

payments for resource purchases) usually take place before cash receipts (for example collections

of receivables). They are uncertain because future sales and costs, which generate cash receipts

and disbursements respectively, cannot be forecasted with complete accuracy. Therefore,

besides managing the flow of materials and goods, working capital also plays an important

role in the management of these unsynchronized and uncertain cash flows from purchase of

materials and sales of goods.

Figure 2-1 Working capital cycle

Financing Operations Investment

InternalExternal Purchases Materials

Production Finished goods

Sales Receivables

1 ̂Cash collectionCash

Cash payment

Figure 2.1 explains the functions of working capital management using the working

capital financing, operations and investment cycle. The flow starts with cash obtained from

internal sources such as collections from operations and retained earning as well as

externally from suppliers of capital (creditors or owners) which is used to finance the

purchase of materials. The purchase and cash payment operations result in the investment

of materials inventory, which is used in the production process. The production

operation ends-up in the investment of finished goods inventory, which is sold either for

cash (resulting in investments in cash) or credit, (which results in accounts receivable

which is eventually turned into cash). The cash generated is then used to settle the short-

term debts - trade payables, bank loans and unpaid government tax. Finally, because the

ultimate objective of a firm is the creation of cash value to the owners, all or part of this

cash is paid to the suppliers of capital in the form of dividends or retained in the firm. This

makes the end of a cycle and the start of another. We now consider the levels of investment

and financing and then the operations of purchasing and selling.

2.2. Working Capital Definition

Current assets minus current liabilities. Working capital measures how much in liquid

assets a company has available to build its business. The number can be positive or negative,

depending on how much debt the company is carrying. In general, companies that have a lot of

working capital will be more successful since they can expand and improve their operations.

Companies with negative working capital may lack the funds necessary for growth. Also called

net current assets or current capital.

In simple words working capital is the excess of current Assets over current liabilities. Working

capital has ordinarily been defined as the excess of current assets over current liabilities.

Working capital is the heart of the business. If it is weak business cannot proper and survives. Sit

is therefore said the fate of large scale investment in fixed assets is often determined by a

relatively small amount of current assets. As the working capital is important to the company is

important to keep adequate working capital with the company. Cash is the lifeline of company. If

this lifeline deteriorates so does the companies’ ability to fund operation, reinvest to meet capital

requirements and payment. Understanding Company’s cash flow health is essential to making

investment decision. A good way to judge a company’s cash flow prospects is to look at its

working capital management. The company must have adequate working capital as much as

needed by the company. It should neither be excessive or nor inadequate. Excessive working

capital cuisses for idle funds laying with the firm without earning any profit, where as inadequate

working capital shows the company doesn’t have sufficient funds for financing its daily needs

working capital management involves study of the relationship between firm’s current assets and

current liabilities. The goal of working capital management is to ensure that a firm is able to

continue its operation. And that is has sufficient ability to satisfy both maturing short term debt

and upcoming operational expenses. The better a company managers its working capital, the less

the company needs to borrow. Even companies with cash surpluses need to manage working

capital to ensure those surpluses are invested in ways that will generate suitable returns for

investors.

The primary objective of working capital management is to ensure that sufficient cash is

available to”

-Meet day to day cash flow needs.

-Pay wages and salaries when they fall due

-Pay creditors to ensure continued supplies of goods and services.

-Pay government taxation and provider of capital – dividends and

-Ensure the long term survival of the business entity.

Needs for working capital. The prime objective of the company is to obtain maximum profit

thought the business. The amount of profit largely depends upon the magnitude of sales.

However the sale does not convert into cash instantaneously. There is always a time gap between

sale of goods and receipt of cash. The time gap between the sales and their actual realization in

cash is technically termed as operating cycle. Additional capital required to have uninterrupted

business operations, and the amount will be locked up in the current assets. Regular availability

of adequate working capital is inevitable for sustained biasness operations. If the proper fund is

not provided for the purpose, the business operations will be effected. And hence this part of

finance to be managed well.

Determinants of working capital. Working capital requirements of a concern depends on a

number of factors, each of which should be considered carefully for determining the proper

amount of working capital. It may be however be added that these factors affect differently to the

different units and these keeps varying from time to time. In general, the determinants of

working capital which re common to all organization’s can be summarized as under:

Nature of business. Need for working capital is highly depends on what type of business, the

firm in. there are trading firms, which needs to invest a lot in stocks, ills receivables, liquid cash

etc. public utilities like railways, electricity, etc., need much less inventories and cash.

Manufacturing concerns stands in between these two extends. Working capital requirement for

manufacturing concerns depends on various factors like the products, technologies, marketing

policies.

Production policies. Production policies of the organization effects working capital requirements

very highly. Seasonal industries, which produces only in specific season requires more working

capital. Some industries which produces round the year but sale mainly done in some special

seasons are also need to keep more working capital.

Size of business. Size of business is another factor to determines the need for working capital

Length of operating cycle. Operating cycle of the firm also influence the working capital. Longer

the orating cycle, the higher will be the working capital requirement of the organization.

Credit policy. Companies follows liberal credit policy needs to keep more working capital with

them. Efficiency of debt collecting machinery is also relevant in this matter. Credit availability

form suppliers also effects the company’s working capital requirements. A company doesn’t

enjoy a liberal credit from its suppliers will have to keep more working capital

Business fluctuation. Cyclical changes in the economy also influence level of working capital.

During boom period, the tendency of management is to pile up inventories of raw materials and

finished goods to avail the advantage of rising prove. This creates demand for more capital.

Similarly during depression when the prices and demand for manufactured goods. Constantly

reduce the industrial and trading activities show a downward termed. Hence the demand for

working capital is low.

Current asset policies. The quantum of working capital of a company is significantly determined

by its current assets policies. A company with conservative assets policy may operate with

relatively high level of working capital than its sales volume. A company pursuing an aggressive

amount assets policy operates with a relatively lower level of working capital.

Fluctuations of supply and seasonal variations. Some companies need to keep large amount of

working capital due to their irregular sales and intermittent supply. Similarly companies using

bulky materials also maintain large reserves’ of raw material inventories. This increase the need

of working capital. Some companies manufacture and sell goods only during certain seasons.

Working capital requirements of such industries will be higher during certain season of such

industries period.

Other factors. Effective co ordination between production and distribution can reduce the need

for working capital. Transportation and communication means. If developed helps to reduce the

working capital requirement.

2.3. Managing working capital investment

2.3.1. General considerations

The major policy issue encountered in the management of working capital is related to

levels of investment and its financing. Therefore, we consider first the main components of

working capital investment and liquidity management, and then we continue describing the

main issues of managing working capital investment and financing. The components of

working capital investments are categorized in terms of liquidity and stability of balances.

Liquidity is a term used to describe the ease with which the assets can be converted into cash

within a year during the normal course of business operations. Current assets include cash,

marketable securities, accounts receivable, and inventories. Short-term debts or current

liabilities are credit falling due within a year, and include accounts payable, accruals, tax

payable, dividend payable, short-term loans, and long-term loans maturing within a year. Cash

consists of coins, currency, bank deposits, and negotiable instruments such as money orders,

certified checks, cashiers' checks, personal checks, and bank drafts. Cash is the most liquid of all

assets and it is the medium of exchange that permits management to carry on the various

functions of the business organization. In fact the survival of the firm can depend on the

availability of cash (liquidity) to meet financial obligations on time. Near-cash liquid assets are

marketable securities. Marketable securities consist of short-term investments that a firm makes

with its idle cash, which can be sold quickly and converted into cash when needed. Unlike

cash, marketable securities provide a firm with interest income. Accounts receivable include

trade credit and/or consumer credit. A trade credit originates when a firm sells goods or services

to another firm with an agreement that cash will be paid in some future period. Firms may also

sell goods to final consumers. These consumer credits make up the remainder of accounts

receivable. Inventories consist of raw materials, work-in-process and finished goods. Raw

materials are inventories waiting to get into the production process, work-in-process inventories

are materials in various stages of production and finished goods inventory are goods whose

production process is completed and ready for sale. Inventories in retail and wholesale firms

include the merchandise kept for sale.

Stability of balances On the basis of the stability of balances compared to changes in the

volume of sales and production, current assets can also be divided into permanent and

fluctuating. The balance of permanent current assets remains constant regardless of the change

in sales volume or production capacity, while fluctuating current assets vary with a change in

sales volume and production capacity. Permanent current assets include the safety stocks of cash

and inventories. They are often used to meet the long-term minimum needs of investment in

current assets. Their balance is constant over a longer period of time and is therefore comparable

with the firms fixed assets because investments in permanent current assets remain within the

firm. The main difference between permanent current assets and fixed assets is that permanent

current assets constantly change in physical terms, while fixed assets do not.

Managing liquidity According to Moyer, McGauran and Kretlow, firms have two goals -

liquidity and profitability. Many types of costs are related to the excesses and shortages of

working capital levels of investment and financing. Managing these costs can increase the

profitability of a firm's operations. Firms have to determine the individual and joint impact of the

levels of short-term investment and financing on the dual objectives of working capital

management. These goals imply that decisions that tend to maximize profitability tend not to

maximize the chances of adequate liquidity. Conversely, focusing almost entirely on liquidity

will tend to reduce the potential profitability of the firm. Liquidity is the ability to pay all

expenditures and short-term debt obligations. Firms can remain liquid by either selling assets

or borrowing. When liquidity is maintained by selling assets, the convertibility of assets into

cash (or liquidity) matters. Assets in general have varying degrees of liquidity. For assets other

than cash liquidity has two dimensions: the time required to convert the assets into cash, and

the degree of certainty to convert the assets into cash without loss. When liquidity is

maintained through borrowing, there will be a trade-off between the interest costs paid to

creditors and the income earned from the investment in the assets financed from the borrowing.

Therefore, both too much and too little liquidity have costs. Now we consider the costs of

keeping too much (costs of liquidity) and too little (costs of bankruptcy) liquid assets.

Liquidity and bankruptcy costs According to Yeager and Seitz, the cost of excess liquidity is

the interest on credits and loans used to finance investment in liquid assets and opportunity cost

or profit lost due to investing in less profitable current assets, compared to fixed assets. The cost

of too little liquidity is the cost of additional borrowing needed as well as the loss experienced

when assets have to be sold too quickly and the damage done by a failure to meet payment

demands which may end up in bankruptcy (so the bankruptcy costs). If a firm does not keep

proper amounts of working capital, it will be forced to go bankrupt on technical grounds leading

to liquidation, in which case the primary claimants of a firm are its creditors while investors of

the firm's capital have a residual claim on the assets. According to Van Horne, the eventual

liquidation and realization of assets into cash has two types of bankruptcy costs - out of pocket

costs and interest costs. The direct or out-of-pocket costs are associated with the bureaucratic

procedures of liquidating the non-cash assets and distributing it to the claimants. These costs

include the time that the management spends dealing with the creditors of the bankrupt firm,

legal expenses, court costs and advisory fees. Interest costs of bankruptcy are costs of

compensating creditors’ ex-ante. Van Horne argues that since creditors are primary claimants of

firm's assets at bankruptcy, they charge the firm a default premium on the interest rate, which

reflects the probability of the firm's bankruptcy. Grinblatt and Sheridan also add a third type - the

indirect costs of bankruptcy, which is created due to a firm becoming financially distressed

and close to bankruptcy but which may actually never go bankrupt. These indirect costs

include the losses due to the fact that the firm may be unable to get or give credit when demand

for its products decreases. Therefore, liquidity decreases bankruptcy costs. However, investment

in liquid assets has a cost of financing. Therefore, there is a trade-off between the benefits

associated with liquidity and the cost of maintaining liquidity. Management can optimize this

trade-off using investment and financing policy decisions.

Working capital management and profitability - liquidity risk trade-off from the point of

view of working capital management, firms have dual objectives, that is, maximize profitability

and minimize liquidity risk. In this case risk as defined by Walker means, (a) risk of not

maintaining adequate liquidity, (b) the risk of having too much or too little inventory to

maintain production and sales and (c) the risk of not granting adequate credit to support the

proper level of sales. Profitability has to do with the overall objective of owner wealth

maximization. Liquidity on the hand has to do with ensuring that the firm is able to satisfy all its

financial obligations and has adequate funding to carry on its long-term activities of the firm.

Thus the liquidity goal is closely aligned with working capital management while the

profitability goal reflects both short-term and long-term decision making. The difficulty with

the dual objectives of profitability and liquidity is that, one tends to be a trade-off of the other.

In other words, decisions that tend to maximize profitability tend not to maximize the chances of

adequate liquidity and vice versa. Moreover, the way in which working capital is managed can

have a significant impact on both the profitability and liquidity goals of the firm.

Moyer, McGauran and Kretlow argue that, there is an optimal level of working capital

investment, which changes with the variability of output and sales that a firm must maintain. For

a given level of output or sales there is certain working capital level that results in the highest

profit. Other factors that affect the optimality of working capital include the variability of cash

flows, the degree of financial leverage and the degree of operating leverage. The issue of

profitability and liquidity risk trade-off is based on the argument that short-term investment and

financing have opposing effect on liquidity and profitability. Investment in current assets

though useful to achieve the objectives of liquidity, but it does not generate as much profit as

investing in fixed assets. Financing with current liabilities though it is cheaper and therefore

more profitable it is risky because it gives less time to pay.

In order to minimize liquidity risk and maximize profitability, management can have differing

risk attitudes, by comparing the levels of current assets against volume of sales or production.

These are called "conservative", "moderate" and "aggressive". Conservative working capital

management policy implies that at the given volume of sales or output the firm has a high level

of current assets. The conservative policy prepares the firm for all conceivable liquidity needs

and gives the lowest liquidity risk position. However, at this level profitability will be low.

Aggressive working capital management policy implies that at the given volume of sales or

output the firm has the lowest current asset level. Aggressive working capital policy exposes

the firm to any conceivable liquidity risk and therefore gives the highest liquidity risk position.

It is the riskiest and supposedly the most profitable working capital management policy.

Moderate working capital management policy is, of course in between these two extremes. If

other things remain the same, decreasing the levels of current assets held will increase

potential profit. However, profit increases only if the firm's investment in current assets can be

reduced if the firm is still being able to properly support output and sales while it also is able to

settle its short-term debt becoming due for payment. Hence, management should search for an

optimal proportion between the level of current assets and the volume of output and/or sales those

results in the best optimal point in the profitability and liquidity risk tradeoff. To solve the

problem of profitability and liquidity risk trade off, Smith suggests that parallel monthly

forecasts of profitability and required borrowing be made. This Smith argues will have the

benefit of making trade-offs between profitability and liquidity risk objectives of the firm,

estimating the impact of certain working capital policies on profitability and liquidity risk trade-

offs and reflecting the uncertainty of the future.

2.3.2. Cash Management

The importance of cash management Cash management is concerned with how a firm

manages its cash levels and operations (cash collections and payments), cash investments and

disinvestments, and cash borrowing and lending. According to Scherr, cash management deals

with determining the optimal level of cash, the appropriate types and amounts of short-term

investments in cash as well as the efficient methods and controls of cash collections and

disbursements. Because many transactions of a company involve the receipt or disbursement of

cash, it's efficient management has a great significance for the management's success in the

process of achieving organizational objectives. Efficient cash management can be instrumental in

preventing losses from fraud or theft, to maintain a sufficient amount of cash, to make necessary

payments and to have a reasonable balance for emergencies. It also prevents unnecessarily large

amounts of cash from being held idle in bank accounts that produce little or no revenues. Cash

and short-term interest bearing investments are the firm's least productive assets. Unlike the

firm's other liquid assets (inventories and accounts receivable), cash is not required for

producing goods or services. When firms hold cash in currency and in non-interest bearing

accounts they obtain no direct return. So, why hold cash and marketable securities at all?

Couldn't the firm's resources be better used elsewhere? Despite the seemingly low returns,

there are several good reasons why firms hold cash and marketable securities and we consider

each of these motives with some detail.

The reasons for holding cash. Cash normally would not be needed if it were not for the

market imperfections and resulting transaction costs of urgently needing cash at short notice if

the need arises and there is no enough cash. The reasons for holding cash are divided into

four main categories, transactions, precautionary, speculative, and compensating.

Transactions The transactions motive refers to the cash held in the form of non-interest

bearing currency and checking deposits for paying bills, making changes for customers, paying

for salary and other day-to-day operating activities. The transactions demand comes from

the normal cash collection and disbursement activities which are not always perfectly

synchronized. Therefore, transaction demand is related to the volume of transactions. The

more payment the company expects to make, the greater will be its transaction demand for

cash. If the firm maintains too small cash balance it may run out of cash. In that case, it must

sell marketable securities or borrow in the short-term, which both involve considerable costs.

Also, liquid assets help a firm handle seasonal fluctuation in cash flows, for example a firm may

keep a large amount of liquid assets during surplus months and withdraw it during deficit

months. The amounts needed and the timing of payments for transaction demand may be

known in advance. For example, the payment for long-term loan principal and interest as well as

periodic wages and salaries can more or less be forecasted in advance.

Precautionary At times, a firm's future cash needs for transaction purposes are quite

uncertain. The major causes of uncertainty about cash available for paying bills are uncertainties

about the amount and timing of sales and the collections from accounts receivable. If the

expected collections do not materialize, the firm will not have enough cash to pay its bills.

Therefore, the firm holds additional cash for precautionary purposes in excess of its transaction

needs. The size of precautionary balances is positively related to the extent of uncertainties about

the timing and the amount of cash inflows and outflows. Other things remaining constant, the

greater the uncertainties of cash inflows and outflows the greater would be the precautionary

balances. Precautionary balances are usually held in highly liquid marketable securities,

which provide interest income. The more of this precautionary balance held in near cash assets,

the less cash kept and the greater the interest earned. However, there is a trade-off between the

interest revenue and the transaction costs involved in purchasing and selling such near cash

assets. Therefore whether, it is economical to invest part or all of the precautionary reserve in

near cash assets depends on the trade-off between these transaction costs and the related

income earned.

Speculative. Speculative cash balances are held to take advantage of yet unknown temporary

investment opportunities. If firms intend to grow by acquiring other firms or to take advantage

of a sudden decline in prices of raw materials they may hold cash in reserve waiting for the

opportunistic condition. As with precautionary demand, cash for speculative purposes could be

invested in income-earning securities.

Compensating Banks may require a minimum compensating balance to be kept in the firm's

bank account in order to give lending services. Therefore, another motive to keep cash is for the

purpose of bank compensating balances, where cash balances are kept at commercial banks to

compensate for banking services rendered to the firm.

All the four reasons of holding cash result in the costs related to liquidity. Therefore, cash

decisions require managers to consider explicitly the "profitability and liquidity risk trade-off”

of alternative decisions. So, in order to get the benefits of cash management, the periodic

balance and flows of cash has to be properly managed and planned well in advance.

Planning cash requirements - the cash budget forecast or cash budget is a statement of the

firms expected cash inflows and outflows over a projected time period, usually a quarter, a

month, a week or a day. It is primarily used to estimate a firm's borrowing and lending needs,

and as an input to prepare for the uncertainties and mismatches between cash inflows and

outflows. It can also be used for various other ways like planning the impact of reductions of

short and long-term debts. A cash budget is also useful in determining the minimum balances

to be maintained and to negotiate short-term financing arrangements with banks.

If a firm does not plan its cash requirements, the resulting cash deficit or surplus can be

unforeseen. If there is an unexpected cash deficit, cash shortages would occur and the firm

would have to slow down its cash outflows, for example by delaying payments to its

suppliers or to use its cash reserves or to get emergency financing. Delaying payments to

suppliers may result in suppliers retaliating by holding the supply of critical materials and

thereby cause extensive production interruptions. This may force the firm to act on an

emergency basis, such as selling at rushed prices, selling fixed assets or borrowing from its

bank. Under these conditions, the bank might be reluctant to grant such a loan on favorable

terms and reflect this by increasing interest charges. So the firm's relation with its suppliers

and bank will be put in jeopardy. If an unexpected cash surplus occurs, the firm will have no

way of knowing for how long the surplus will exist and it will not be able to make investment

plans for a longer period. Thus cash forecast is a critical tool for effective financing of temporary

deficits and for investing surpluses. The types of cash forecasts are categorized on the basis of

the length of the period that cash is forecasted and the approach to cash flow forecasts.

The length of the cash forecast period This refers to the units of time into which the cash

forecast is divided. Cash forecasts can be made in terms of yearly, quarterly, monthly, weekly

and even daily flows. The most popular - in particular for small firms - is the monthly cash

forecast. Because of the transaction costs involved in the short-term investment and

disinvestment of near-cash assets, the length of the shortest forecast period depends critically

on the volume of the firm's cash inflows and outflows. If the timing of cash flows is frequent

and the volume large, the firm can use shorter cash forecast period. For smaller firms with a

lesser amount to invest in the short-term, cash forecast on a monthly basis can suffice.

Another issue related to time is the breakdown within the periods. One method is the distribution

approach, which starts with yearly data and breaks them down into quarterly, monthly, weekly

and even daily data. The other approach is the scheduling method, which starts with a shorter

period, for example with weekly data then, aggregates it to monthly, quarterly and yearly.

The approach used to forecast cash flows Forecasting cash flows can have two approaches -

the receipts and disbursements approach and the adjusted net income approach. The receipts and

disbursements approach estimates the amounts of cash expected to be received and paid by the

firm over the forecast period and traces the detailed movement of cash. This method is

preferred to exercise close control over cash in the short term (daily to monthly). The adjusted

net income approach (also called sources and uses) starts with projected net income on an

accrual basis and adjusts it to a cash basis. The adjusted net income approach forecasts a

change in assets and liability accounts and it is therefore useful to forecast cash flows over a

longer period of time. However it does not trace the individual inflows and outflows for any

given period.

Cash optimality models In order to decide whether it is worthwhile to make short-term

investments of cash in marketable securities, the interest income earned is compared with

related transaction costs including the out-of-pocket costs such as: commissions, postage,

telephone charges, the opportunity cost of diverted management time and effort. In this case

specific cash management models are used to determine the most economic amount and the

appropriate time that cash will be held, invested and disinvested. Cash management models

show that transaction costs play a central role in determining the cash balance to be held. If

transaction costs were zero, the firm would require no working cash balance at all; it simply

would sell its short-term income earning assets or borrow to pay every bill.

Hedging for uncertainties of cash levels During each cash forecast period, the firm most

likely will end up with a cash deficit or a surplus, the exact timing and amount of which is

uncertain. The cash level uncertainty is due to the variation between forecasted and actual

factors affecting cash levels, such as the volume and rate of cash payment and collection, sales,

production cost etc. If the firm gets cash inflows that are smaller than expected and reaches the

maximum bank borrowing limits, it will face a number of problems discussed earlier in this

chapter. Without some kind of hedge against the uncertainties of future cash flows, the firm may

incur costs that could be avoided by the use of a hedging strategy. There can be a number of

hedging arrangements that include depositing temporary extra cash surpluses in saving accounts

or checking accounts, investing in near-cash assets and the arrangement of extra borrowing

capacity with the bank. However, these hedging arrangements have their own costs, and there is

a trade-off between the cost of the hedge and the expected cost that it avoids. Therefore, it would

not be cost effective to hedge against all possible future costs if the probability of occurrence is

very small.

Cash control Cash is more susceptible to misappropriation and theft because it can easily be

concealed and because it is not readily identifiable. Therefore, it is essential, that firms establish

procedures of cash safeguarding controls through every phase of its cash receipt and payment

operations. The effective control of cash transactions begins at the moment that cash is received

by the business. A basic rule of effective internal control over cash collection is that receipts are

deposited in the bank, intact and on a timely basis. Other basic principles of controlling cash

receipts also include separation of duties for sequential cash operations, handling and recording.

In order to exercise the necessary control over cash payments, all disbursements should be made

by check, with the exception of certain small payments that can be made from a petty cash fund.

The functions of handling cash receipts and cash disbursements should also be separated or

divided among employees to the greatest extent practical. The following are procedures that

may be used to establish effective control over cash disbursements. All checks should be

sequentially pre-numbered, controlled and accounted for on a regular basis. Checks that are

avoided or spoiled should be retained and marked "void" or mutilated to prevent any possible

unauthorized use. A voucher that has been approved properly should support each

disbursement. Invoices and vouchers should be indelibly marked as "paid" or otherwise

cancelled in order to prevent their use for duplicate payments. The bank statement and returned

checks should be routed to the employee charged with the preparation of the bank

reconciliation and this employee should be someone other than the person responsible for making

the cash disbursements.

The Importance of Cash Management

Cash Management. Business analysts report that poor management is the main reason for

business failure. Poor cash management is probably the most frequent stumbling block for

entrepreneurs. Understanding the basic concepts of cash flow will help you plan for the

unforeseen eventualities that nearly every business faces. Cash is ready money in the bank or in

the business. It is not inventory, it is not accounts receivable (what you are owed), and it is not

property. These can potentially be converted to cash, but can't be used to pay suppliers, rent, or

employees. Profit growth does not necessarily mean more cash on hand. Profit is the amount of

money you expect to make over a given period of time, while cash is what you must have on

hand to keep your business running. Over time, a company's profits are of little value if they are

not accompanied by positive net cash flow. You can't spend profit; you can only spend cash.

Cash flow refers to the movement of cash into and out of a business. Watching the cash

inflows and outflows is one of the most pressing management tasks for any business. The

outflow of cash includes those checks you write each month to pay salaries, suppliers, and

creditors. The inflow includes the cash you receive from customers, lenders, and investors.

Positive Cash Flow. If its cash inflow exceeds the outflow, a company has a positive cash flow.

A positive cash flow is a good sign of financial health, but is by no means the only one.

Negative Cash Flow If its cash outflow exceeds the inflow; a company has a negative cash flow.

Reasons for negative cash flow include too much or obsolete inventory and poor collections on

accounts receivable (what your customers owe you). If the company can't borrow additional cash

at this point, it may be in serious trouble.

What Are the Components of Cash Flow?

A "Cash Flow Statement" shows the sources and uses of cash and is typically divided into

three components:

Operating Cash Flow. Operating cash flow, often referred to as working capital, is the cash flow

generated from internal operations. It comes from sales of the product or service of your

business, and because it is generated internally, it is under your control.

Investing Cash Flow. Investing cash flow is generated internally from non-operating activities.

This includes investments in plant and equipment or other fixed assets, nonrecurring gains or

losses, or other sources and uses of cash outside of normal operations.

Financing Cash Flow. Financing cash flow is the cash to and from external sources, such as

lenders, investors and shareholders. A new loan, the repayment of a loan, the issuance of stock,

and the payment of dividend are some of the activities that would be included in this section of

the cash flow statement.

How Do I Practice Good Cash Flow Management?

Good cash management is simple. It involves:

-Knowing when, where, and how your cash needs will occur

-Knowing the best sources for meeting additional cash needs

-Being prepared to meet these needs when they occur, by keeping good relationships with

bankers and other creditors

The starting point for good cash flow management is developing a cash flow projection.

Smart business owners know how to develop both short-term (weekly, monthly) cash flow

projections to help them manage daily cash, and long-term (annual, 3-5 year) cash flow

projections to help them develop the necessary capital strategy to meet their business needs.

They also prepare and use historical cash flow statements to understand how they used money in

the past.

2.3.4. Inventory Management

Inventory management is the art of managing the amount of stock held in various forms of

inventories within a firm in order to efficiently and economically meet the demands for

products. It includes the principles and techniques for deciding what, when and how much to

purchase and sell as well as how and where to store. Inventory management supports the

achievement of organizational objectives by attaining the desired levels of customer service at

a minimum cost of inventory carrying and ordering.

The objectives of inventory management Due to the large size of inventories maintained,

firms commit a considerable amount of funds to inventories. Therefore, in order to avoid

unnecessary investments it is absolutely imperative to manage inventories efficiently.

Neglecting the management of inventories will jeopardize a firm's short and long-term

profitability. Inventories are the least liquid of all current assets; it should therefore provide the

highest yield to justify investment. Both excessive and inadequate inventories are not desirable.

Therefore, the main objective of inventory management should be to determine and maintain

optimum level of inventory level that lies between these two undesirable situations related to

meeting two conflicting needs. First, to maintain a large size of inventory for efficient and

smooth production and sales operations. Second, to maintain a minimum investment in

inventories in order to lower ordering and carrying costs and to maximize profitability. In line

with these objectives argues that each inventory type serves different purposes.

Raw material inventories are used to make production scheduling easier, to take advantage of

price changes and quantity discounts, and to hedge against supply shortages. If raw material

inventories were not held, purchases would have to be made continuously at the rate of

production. This would not only mean high ordering costs and less quantity discounts, but also

production interruptions when raw materials cannot be procured in time. Therefore, the firm has

an interest in buying enough raw materials to provide an effective cushion between purchases

and production. The level of raw materials inventories would depend not only upon the level of

co-ordination between the firm's purchases and production but also between the firm and its

supplier. If there is a closer link between the firm and its supplier, a small raw materials

inventory could be maintained and production needs could still be met.

Work-in-process inventories are needed because there is no perfect synchronization among

production processes - they do not all produce at the same rate at all times. Each production

station needs its own inventory of work-in-process. Thus work-in-process inventories like the

raw materials inventories serve to make the production process smoother and more efficient -

they provide buffers between the various production processes. Under normal conditions, the

longer the production process and the more production stations, the higher the work-in-process

inventories.

Finished goods inventory has to be held to provide immediate service to customers and to

stabilize production. Production and sales are not instantaneous. Most firms cannot produce

immediately when customers demand goods. Failure to supply products to customers when

demanded would mean a loss of sales to competitors. The basic objective in holding finished

goods inventory is therefore to separate production and sales operations. Finished goods

inventory is maintained to serve customers on a continuous basis and to meet the fluctuating

demands. The level of finished goods inventories would depend upon the level of co-ordination

between the firm's sales and production as well as the efficiency of firm-customer linkages. If

there is a close link between the firm and its customers, it is possible to know early when goods

will be needed, therefore, a small finished goods inventory could be maintained and

customers' needs could still be met. Overall, in line with that of cash there are three motives for

holding inventories - the transactions motive, the precautionary motive and the speculative

motive. The transaction motive emphasizes on the need to maintain inventory in order to

facilitate smooth production and sales operations. Inventory held for precautionary motive

guards against the risk of unpredictable changes in inventory price, demand and supply

factors. The speculative motive refers to carrying inventory in order to take advantage of

unpredictable changes in inventory price. To be effective, management has to apply a system to

keep track of inventory on hand and on order, knowledge of lead times and its variability, a

reliable forecast of inventory demand and reasonable estimates of inventory holding, ordering

and shortage costs .

Planning inventory requirements inventory planning helps to match inventory requirements to

sales and production needs. It also helps to know inventory acquisition and usage during lead-time,

quantity on hand and on order as well as the levels of safety stock. There are different methods of

planning inventory needs including managerial opinion (or judgmental) and time series data.

Some contends that forecasts based on opinion relies on the analysis of subjective inputs obtained

from various sources, such as, opinions of sales staff, managers and executives as well as

consumer surveys. Forecasts on time series data are based on observations taken at regular intervals

over a period of time (daily, weekly, monthly etc) and are made on the assumption that future

inventory demand can be estimated from past. The accuracy of inventory planning depends on

whether the forecast is made in conditions of relative certainty or uncertainty.

Inventory optimally models Inventory optimality models can be used to determine the

optimal, reorder and safety levels of inventory. Inventory optimality models include economic

order quantity model, just-in-time inventory management and materials requirement planning

(MRP). All models deal with four basic questions - (a) how much inventory to order, at any given

time, (b) at what point of inventory level to order, (c) whether to hedge changes in inventory costs,

and (d) to what inventory items to give special attention and selectively control. Answering these

questions helps to manage the levels and costs of inventories efficiently.

Inventory costing and valuation As inventories move from storeroom to production and

from production (or stores) to customers, the unit and total costs may be computed to know the

cost of production and the cost of goods sold respectively. The most common methods of

costing inventories assume cost flows such as, first in first out, average cost, and last in first

out. Different from its costing approach, inventory can be valued at cost, or cost or market

value whichever is lower. The later approach is based on the accounting principle of

conservatism, which in order not to overstate the value of the firm requires the choice of an

approach that provides the lower value of an asset.

Inventory control No matter how perfect an inventory plan is, it can rarely be equal to the

actual outcome. Therefore, there should always be a monitoring mechanism to check

whether what has been expected also approximates reality. The starting point in developing a

control system is an analysis of the objectives of the intended system and determining the critical

activities in the operation where control can be most effective. Effective inventory controls

should (a) provide a supply of required materials for efficient and uninterrupted operation and

assure adequate inventory for prompt delivery to customers. (b) Provide ample stock in periods

of short supply and anticipate price changes. (c) Store inventories with a minimum cost and

maximum protection from loss. (d) Keep inactive, surplus and obsolete items to a minimum

by systematically reporting on product changes, which affect inventories. (e) Maintain the

amount of capital invested in inventories at a level consistent with operating requirements and

management plan. In order to achieve these objectives management can use alternative inventory

control approaches including the quantity limit systems (periodic, perpetual optional

replenishment, two bin and mini-max), money limit systems and time limit systems.

Inventory turnover reflects how frequently a company flushes inventory from its system

within a given financial reporting period. The measure can be computed for any type of

inventory—materials and supplies used in manufacturing or service delivery, work in progress

(WIP), finished products, or all inventory combined. With the exception of finished product

inventory, the measure applies to service and manufacturing businesses. The guidance below

addresses whatever type of inventory you choose to measure—however, the benchmarks for

good performance will vary by type of inventory and industry.

How to Compute Inventory Turnover

Calculate Inventory Turnover by dividing the cost of goods sold (COGS) for the

reporting period by average value of inventory on hand during the period. The reporting period

can be any time interval you select—monthly, quarterly, or annually, for example.

Inventory Turnover = COGS / Average Dollar Value of Inventory On-hand

If your cost of goods sold 1 during the period is $100 and your average finished products

inventory during the month is $10, then your finished products inventory turnover ratio is 10

($100 / $10 = 10). This implies that you are able to sell out your inventory ten times during the

reporting period.

Counting the units sold and multiplying them by the cost to produce one unit could

compute COGS. However, accountants may compute COGS in a different manner that

approximates the same result but is simpler to execute. They take the dollar value of inventory

on hand at the beginning of the period, add purchases of production materials and supplies, and

subtract the dollar value of inventory remaining at the end of the period.

Turnover for Different Types of Inventory

As you know, inventory may consist of raw materials and supplies used in production,

work in progress (WIP), and finished goods. We recommend the same approach to calculating

turnover for each of these. Always compute the average dollar values of the type of inventory

whose turnover you seek to measure and divide it into COGS. Some people use total sales, not

COGS to measure turnover in WIP. We recommend against that. In our opinion, sales can distort

ratios due to the profit margin built into the selling price. The inclusion of profit in the value of

sales inflates the size of the numerator in your ratio. That means that you can get a larger

turnover rate based on how large your profit margin is, not how rapidly you flush inventory from

your system. Whenever computing turnover on a dollar basis, use COGS as your numerator, not

sales.

Desired State of Turnover

In a truly Lean system, there is no inventory as raw materials flow in and through the

production system to produce finished products that are flushed continuously—meaning that as a

product is produced, a customer buys it. This outcome is consistent with a production system that

produces outputs to takt time, the rate at which a customer demands them. Given this

understanding, what then is the ideal inventory turnover rate?

If we assume that the average inventory is zero, then the average dollar value of

inventory is zero dollars ($0). When zero divides any number, the result is infinity (bigger than

big!). Since turnover is the result of COGS (any number) divided by the average dollar value of

inventory (zero), inventory turns in a truly Lean Enterprise are infinite. This would mean that

each day, all raw materials are transformed into finished products that are bought by a customer.

According to the Industry Week/Manufacturing Performance Institutes 2003 Census of

Manufacturers, the top 25% of all manufacturers achieved only 25 inventory turns for finished

product inventory in a year. Clearly, there is a very long way to go before any company claims to

be truly Lean. Also, as you will read later, there are ways you can get high inventory turnover

that would not be considered waste free. Perhaps the best way to state goal for this measure is:

To achieve infinite inventory turnover in a business that is waste free and profitable.

Interpreting Inventory Turnover

Generally, a higher inventory turnover ratio is considered a positive indicator of operating

efficiency, since inventory that remains in place produces no revenue and increases the cost

associated with maintaining those inventories. However, a higher inventory turnover ratio does

not always mean better performance. You need to analyze it in conjunction with other trends

within the financial statements to ensure that operations are truly business beneficial.

Dangers1.Advanced sales – An increase in sales in a given reporting period usually

results in increased inventory turnover, but that increase in sales (and turnover) may be due to a

temporary factor. If it were, then you would be wrong to conclude that the increase in inventory

turnover means you are operating more leanly. For example, a sales jump in one period may

reflect advanced purchase of items that are usually bought in the next reporting period.

Failsafe: Check several reporting periods to be sure that the increase in turnover resulting

from increased sales is not due to advance sales or some other temporary factor. If the increased

sales and improved turnover rate hold over several reporting periods, then it is probably not due

to advance sales.

Phantom sales – Sales made to a customer with the understanding that they will be

returned for credit before payment is due.

Failsafe: To avoid this danger, you need to take two steps. First, check several reporting

periods to be sure that the increase in turnover is not due to phantom sales. Also look for

improvements in turnover in one period that are offset by a decrease in turnover in a subsequent

reporting period as goods sold in the prior period are returned and re-entered into inventory. In

addition to abnormal inventory turnover fluctuations, these phantom sales will typically result in

an increase in accounts receivable as a percentage of sales. Thus, the improved inventory

turnover will be offset by a decrease in accounts receivable turnover or the ratio of accounts

receivable to sales.

Discount-driven sales - Offering large discounts may also generate a boost in sales. Such

discounts erode the company’s profit margins, but will boost revenue and rate of inventory

turnover. The company might look like it is becoming more Lean, when in fact it may simply be

pushing products into the marketplace using artificially low pricing.

Failsafe: Watch the gross margins reported by the business. Gross margin is the

difference between the dollar value of sales and cost of goods sold (also termed cost of sales). If

inventory turnover is increasing, but gross margins as a percentage of sales are decreasing, then

this may indicate a problem.

Supplier-financed inventory – It is possible to reduce materials and supplies inventory

and show improved inventory turnover by forcing your supplier to carry the inventory for you.

The supplier assumes the cost of maintaining inventory and passes that cost on. Or, you may

reduce inventory by use of express shipment or other costly means of delivery to ensure the

availability of materials and supplies when you need them. Improved materials and supplies

inventory turnover, in these cases, would not mean that you were operating more leanly.

Failsafe: To detect this shift of cost to suppliers, monitor changes in the unit cost of

products that result from the increased cost of materials and supplies. Solutions to maintaining

inventory that simply shift cost to suppliers return the cost in added mark-ups to the materials

and supplies you purchase. This results in a rise in your product's unit cost.

Customer financed inventory solutions – Depending on your marketplace, it is possible to

maintain low finished product inventory at the expense of your customer. In many marketplaces,

competition is still not keen. You can survive— even grow, based on not being worse than your

competitors. You can, for example, maintain low finished product inventory by having your

customer wait for products forcing your customer to maintain higher inventory so he or she can

sustain operations while waiting for your deliveries. In essence, you produce to order, not to

need.

Failsafe: Use information on customer satisfaction with the availability of products and

timeliness of delivery to balance your judgment about whether improving inventory turnover

reflect true lean operations. If it is leanness that has produced the improvement, then customer

satisfaction with availability and timeliness will remain high.

Waste inflated COGS – The cost of goods sold can increase due to total sales or because

of increased rework or scrap. In other words, the same number of sales occurs but the cost

associated with producing the products sold increases due to waste (defects, scrap, spoilage).

When finished products are discarded because defects are discovered, the cost associated with

that waste is captured in COGS. Consequently, the numerator of the Inventory Turnover ratio

increases. Since the defective products are not in inventory, this waste also decreases the average

cost of inventory, the denominator of the Turnover ratio. As the numerator increases and the

denominator decreases, the ratio goes higher. It looks like you are operating more Lean— yet,

you are actually operating LESS Lean.

Failsafe: A remedy for this distortion is to extract from the COGS any expense due to

manufacturing wastage. The formula would be as follow: (Cost of Goods Sold – Cost of

scrapped and damaged items due to manufacturing) / average dollar value of inventory.

How to Improve Inventory Turnover

First, take an end-to-end view in addressing inventory. You need to optimize your supply

chain, make your production processes lean, and optimize your relationship to your customers.

When you solve the inventory turnover issue correctly from a Lean perspective, everyone

benefits in real terms. Your supplier is enabled to produce and deliver materials in a timely, low

cost fashion that allows you to minimize your inventory and cost of materials while elevating

your supplier’s competitiveness as a business. When you establish partnering relationships with

your customers, you can enable them to make their demand for products more predictable

thereby allowing you to minimize finished product inventory without failing to meet their needs

for volume and timeliness.

Second, perfect your value stream operation by following the precepts of Lean. Define

value from your customer’s perspective, map your value stream, flow the process, establish pull

by the customer, and perfect all operations by eliminating waste from the value stream. These

steps shrink lead-time, minimize inventory at every point, and drive wastage out. Margins

improve, not shrink, as unit cost is reduced. If you follow these guidelines, your improvements in

inventory turnover will truly reflect efficient management and the emergence of a Lean

enterprise.

2.3.5. Receivable management

Control over credit sales and accounts receivable Credit sales create accounts receivable

because firms give more time before their customers are required to pay. Allowing credit

increases sales but it has also costs of managing accounts receivable and the possibility of bad

debts. Therefore, management needs to install control mechanisms over credit sale policies and

credit customers. The controlling process is intended to detect deviations from policy and to

provide signals of deviations from expectations. Some of the deviations may be due to

uncontrollable random external factors but others may be controllable. So, the main objective of

credit and accounts receivable control is to give signals when (non-random) deviations in sales,

collection expenses, receivables turnover and bad debts occur. Firms need to compare the

outcomes of credit sales policy and the trend in the balance of accounts receivable with what was

estimated. In establishing policies regarding terms of sale and credit granting standards,

management makes expectations on accounts receivable turnover and resulting bad debts. In

order to control the collection of account receivable, the deviation from expected payment

patterns has also to be observed. If expectations are not realized or there are deviations, it

may signal problems like changing customer characteristics, inaccurate policy forecasts or

improper policy implementations. Common signals include receivables ageing, days sales

outstanding and average collection period. When a signal is detected, it is up to the managers

to investigate and to assess the reason for the deviation. Managers must then take the necessary

corrective action, which will vary with the cause of the deviation and which may include

applying collection efforts and changing sales policies.

Collection policy Once the firm decides to sell its goods on credit it should establish control

policies to check if any debtor is falling behind schedule, in which case the firm will have to

make collection efforts. Collection policy refers to obtaining payments of past-due accounts.

Receivable collection management begins by developing an information system for

monitoring outstanding receivables in order to check if customers are taking more time. In case

any credit customer is found to be overdue for more than the receivables monitoring criteria

established, different types of collection efforts can be applied. A firm can use the following

procedures for customers that are overdue and may refuse to grant credit in the meantime:

First: send a letter informing the customer of the past due status of the account. Second: make a

telephone call to the customer. Third: employ a collection agency. Fourth: take legal action

against the customer.

2.4. Managing working capital finances

Any working capital investment needs to be paid at the time of acquisition (cash

purchase) or at a later time (credit purchase). This ability to make cash payments or the

assumption of credit is a source of financing. Due to many factors (the firm being a high

liquidity risk, culture, linkages), the availability of credit as a source of financing may or

may not be an alternative to the management. We consider now the financing dimensions and

start with the main components.

2.4.1.Components of working capital financing

Working capital investments can be financed with internally generated or externally

acquired financing alternatives. Some firms solve their financing problems by borrowing or

securing their current assets (external financing) and others by selling their current assets

(internal financing). When firms borrow on the strength of their current assets, the major sources

of short-term finances include trade credits, accruals, short-term bank loans, collateral papers,

commercial papers, and factoring accounts receivable.

Trade credit financing Firms would rather sell for cash than on credit, but competitive

pressure forces most companies to offer trade credits. Unlike credit from financial institutions,

trade credit does not rely on formal collateral but on trust and reputation. Trade credits create the

accounts payable. Accounts payable is a form of short-term financing common to all businesses

with a credit purchase policy. It originates when buyers are not required to pay for goods upon

delivery but are allowed a short deferred period before payment is due, which may or may not

include discount for earlier payment. During this period the seller of the goods extends credit

to the buyer. There are three types of credit: open account, promissory note payable and trade

acceptance. The most common type is the open account arrangement, where the seller ships

goods to the buyer along with an invoice that specifies the goods shipped, the price, the total

amount due and the terms of sale. Promissory note payable is a statement where debtor writes

a note or letter of IOU. It is required if the creditor has not yet developed full confidence on the

creditworthiness of the debtor or the value of the transaction is too large for an open account

and therefore the risk of loss is very large. Trade acceptance is a supporting letter written

by a bank addressed to a creditor guaranteeing a debtor's credibility with regard to a specific

transaction. It is usually used in international transactions.

Accrual accounts Accruals are short-term non-trade credit obligations. Accruals represent an

interest free source of financing. The most common accrual accounts are wages and taxes. Firms

pay employees on a weekly, bi-weekly, or monthly basis. The longer the payment interval, the

greater the amount of the accrual funds. Although firms do not have much control over the

frequency and magnitude: interest to be paid and taxes can also be an important source of accrual

financing.

Short-term bank loans When the bank loan is approved, the agreement is executed by signing

a promissory note specifying the amount borrowed, the interest rate, repayment schedule and

any other terms or conditions. Very often the loan takes the form of line of credit or overdraft.

This is an arrangement between the bank and its customers with respect to the maximum

amount of unsecured credit the bank will permit the borrower firm. There are also other forms

of short-term financing like collateral papers, commercial papers and factored accounts

receivables.

Collateral paper Borrowings can be secured or unsecured. If the firm's borrowings are

secured, the firm can pledge a non-cash current asset as collateral securing for borrowed fund.

Borrowings can therefore be secured with marketable securities, accounts receivable or

inventories as collateral. This gives the lender such as banks advantage over the unsecured

lenders if the firm is forced to liquidate.

Commercial paper Commercial paper is usually short-term unsecured debt security sold

by larger firms. It can effectively be used to finance short-term investments. For firms with less

liquidity, banks can guarantee the issue of commercial paper by allowing lines of credit or bank

guaranteed letters of credit, which obliges the bank to pay if the issuing firm cannot pay.

Factoring accounts receivable is a form of borrowing funds from a factor. The factor takes

over the firm's credit granting function and the firm sells the face value of the accounts

receivable to the factor. It takes moreover not the full amount because the factor calculates a

service charge and interest.

2.4.2. Short-term loan financing

Current assets financing - profitability-risk trade-off the short and long-term financing

sources have differing effects on the trade-off between profitability and liquidity risk. For the

purpose of working capital financing, the profitability of short and long-term debt is considered

from the point of interest cost. The higher the interest cost the lesser the profitability and vice-

versa. From a lender point of view a long-term loan has in general higher interest charge

compared to a short-term loan due to the risk involved in lending for a longer period of time.

Short-term loans are more risky from borrowers’ point of view, because of the problem to get

cash in the short-term, and the higher variability of interest rates compared to that of the long-

term loans. To the borrower, long-term loans are more expensive but less risky, while short-

term loans are more risky but less expensive. Therefore, management must get an optimum

point between the two. Empirically, Fisman (2001) showed short-term credit; particularly

supplier credit is positively correlated with capacity utilization because firms lacking credit face

inventory shortages leading to lower capacity utilization. Petersen and Raj an (1997) argue that

even in the United States, with extremely well developed financial markets, trade credit is the

largest single source of short-term financing. Fisman particularly claims in developing countries

where formal lenders are limited; trade credit plays an even more significant role in funding

firm's activities.

Short and long-term debt mix The financing logic is that, temporary current assets are

financed with short-term loans and the permanent current assets with long term debt or equity

capital. However, the actual investment and financing mix match-up depends on management's

approach towards risk and profitability. Based on the interest cost and liquidity risk,

management can use maturity matching, conservative, or aggressive approaches to financing

working capital investments.

Maturity matching The maturity matching approach to working capital considers the maturity

structure of the firm's assets and liabilities. The maturity structure of the firm's liability is

made to correspond exactly to the life of its assets by matching current assets life and balances

it with that of current liabilities, so that each asset is offset with a financing instrument of the

same maturity. Temporary current assets will be financed with current liabilities while the

permanent portion of current assets and fixed assets are financed with long-term debt and

equity capital. This financing approach suggests that apart from the current portion of long-term

debt, a firm would need no short-term borrowings when sales are low. As the firm goes to

seasonal asset needs, it borrows on the short-term and later it pays off the borrowing with the

cash released by the decrease of current assets when sales are again low.

Aggressive approach Risk taking in search of higher profits requires an aggressive approach

using the less costly but more risky short-term debt. This means financing a portion of the

permanent current assets and all temporary current assets with short- term debt. This approach

puts the firm at a considerable risk of technical insolvency. The frequency of refinancing the

short-term debt increases the risk that the firm will be unable to obtain new financing as it is

needed. However, there is a better chance for the firm to earn a higher rate of return, because

interest on short term debt is less costly.

The Conservative approach The third option of financing working capital investment requires a

conservative approach to risk and profitability. Under this approach all the fixed assets and

permanent current assets as well as a certain portion of the temporary (or fluctuating) current

assets are financed with long term debt and equity capital. This puts the firm at a minimum

risk of not being able to reschedule its short-term debt. However, the firm will have little

opportunity to earn a premium rate of return due to the excessive use of long term debt.

2.5. Managing the purchase and cash payment operations

Working capital management on operations concerns purchases, sales and related activities,

namely cash payments and cash receipts. The argument here is that by managing the sales and

purchase operations efficiently we can effectively increase the benefits and reduce the costs of

working capital levels and maximize a firm's value creating potential. The purchasing and sales

policies, like credit purchasing and payment as well as credit selling and collection policies also

have other direct effect in a firm's external value chain. For example, a policy of speeding-up

collections and slowing down payments may have negative effects in the value chain and on the

confidence and trust building with transaction partners.

2.5.1. Purchase operations

Purchases affect the inventory of materials. How much and at what cost materials have to be

purchased will depend on various factors like cost of purchasing the materials, the cost of

transportation, the discounts and the costs of holding. So, firms have to use materials purchase

budget to plan the cost, source and timing of their purchase. The materials purchase budget

depends on the management's inventory policy. The amount of materials to be purchased is

based on the available inventory of materials at the beginning of each period, the production

requirements and the inventory at the end of each period. Management also has to apply proper

procedures of purchasing materials. It must specify who should initiate the purchase requisition

and who should evaluate the purchase order and shipments.

2.5.2. Cash payment operations

The firm has to slow-down cash disbursements and pay debts as late as it is consistent with

maintaining its credit standing with suppliers so that it can make the most efficient use of the

money it already has.

Slowing down cash payments: Some of the methods used to slow-down cash disbursements

include: control of disbursements, using payable through drafts, zero base account, and

managing payroll and dividend disbursements and playing the float.

Control of disbursements refers to controlling the build-up of excess cash in the firm's bank

accounts. There must be control of disbursements that will slow down cash outflows and

minimize the time that cash deposits are idle. If daily information is available on collections and

disbursements, excess funds may be transferred to disbursement bank accounts either to pay

bills or to be invested in marketable securities. One procedure for strict control for

disbursements is to centralize payables into a single account so that payments are made at a time

they are needed. If cash discounts are allowed on accounts payable, the firm should make

payment at the end of cash discount period, otherwise the firm should not pay until the end of

the due date in order to have a maximum use of the cash. Payable through draft requires the

bank to present it to the issuer for acceptance, therefore unlike ordinary checks, payable

through draft is not payable on demand. Then the issuing firm transfers the funds used to cover

the payment of the draft, thereby taking time. Slowing down cash payment through payroll and

dividend disbursement refers to maintaining separate cash accounts for disbursements of

payroll and dividends in order to minimize the balance kept in these accounts. The firm has to

forecast when the checks issued to these accounts will be presented for payment so that to have

funds enough to cover only that period's needs, and not to keep the entire amount of payroll or

dividend for a longer period. Under the Zero Base Account system agreement will be reached

with the bank such that one main or master disbursing account services all other subsidiary

disbursing accounts (payroll, payables etc.). When payroll is cleared at the end of each day, the

bank automatically transfers just enough funds from the master account to each disbursement

account to just cover the checks presented. So, a zero ending balance is kept in all accounts

except for the master account. This reduces the cash balance in the master account by

eliminating idle balance from all subsidiary accounts. Overdraft is a check written for an

amount in excess of funds on deposit. The check overdraft, will be honored by the bank

according to a prearranged set of rules and credit limits. The bank extends a loan to the writer of

the check for the amount necessary to cover the payment. So, the firm does not hold cash

balances; it simply borrows whatever cash it needs for transaction purposes from the bank and

pays the market interest rate, as transaction costs on borrowings. Playing the float refers to

managing the net float, (also called "play the float"), that is the difference between the firm's

bank balance and its book balance, which is a result of delays between the time checks are

written and their eventual clearing by the bank. It is possible to use this net float, if a firm can

have a negative cash balance on its books and a positive bank balance, because checks just

written by the firm may still be outstanding. If the size of the float can be estimated, the bank

balances can be reduced and the funds invested to earn a positive return.

2.6. Managing sales and cash collection operations

2.6.1. Sales operation

There is a close relationship between sales and working capital policies such as credit terms and

standards, finished goods inventory levels and cash collection policies. Relaxing credit terms

and standards and holding an appropriate level of finished goods inventory can enhance the

possibility of more sales for the firm. A sale is made on cash or credit. When a firm sells on cash, it

requires its customers to pay at the time they buy their purchases, in which case the firm will

have no problem of cash collection. However, cash is limited so buyers would like to take time

before they pay. Therefore, the buyers who are willing to pay cash are only those who get no

alternative choice. Credit sales give more time to buyers to pay and that makes buying from a firm

that extends credit interesting and sales might increase. However, it has its own costs of

management and risk of making bad debts. We concentrate on the credit sales more than on buying

on cash because comparatively it needs more managerial skill. Moreover, with credit sales,

management has to set alternative sales terms, standards and it has to evaluate customers' relations.

The case of credit sales Like the product's price, quality and service, credit granting

policy determines the products attractiveness and affects its sales volume and profit. If credit

granting is properly made it can enhance the firm's performance, sales and profitability. Trade

credit policies have a number of important functions: (a) for small firms: to minimize the effects

of market imperfections. (b) For sellers: to guarantee the quality of their products and to

overcome information problems with a buyer. (c) For buyers: to increase and control the

purchase of goods. Credit sales policy and management of accounts receivable deals with

decisions related to terms of sale, credit-granting standards, credit analysis and control of

accounts receivable. A term of sale is concerned with the credit period, the cash discount and

type of credit instrument. Credit standards refer to the criteria used to screen credit applicants.

Credit analysis is the use of a number of devices and procedures to determine the probability

of a customer payment to proposed credit sales. Credit collection and control refer to the

establishment of policy and control procedures for collecting the cash when the credit is due.

Before a firm grants credit to its customers, it has to establish a credit policy, the establishment

of which involves three stages. First: establishing the terms of credit sale policies. Second:

formulating credit standards, which will be used to analyze and evaluate individual applicant's

credit worthiness. Third: establish accounts receivable collection and control policies.

Terms of credit sale policies A firm's credit terms specify the conditions under which the

customer is required to pay for the credit extended. It includes terms related to the mode of

payment and to ownership transfer (outright transfer, consignment or conditional sale).

Mode of payment: cash and credit terms: Cash terms refer to terms of sale where firms

demand payment before or on delivery of the product sold. It is normally used when the buyer

represents a high credit risk or if the product is a special order with significant asset specific

expenditures. Credit terms refer to the sale of goods on the basis of an open account, promissory

note or special conditions like seasonal dating. An open account is used when the buyer buys

on a continuing basis from the same seller and it may also include discounts for early payment.

The only formal credit instrument is the invoice - a document sent along with the shipment of

the goods and which the customer signs as evidence for receiving the goods. If the order is large

and the firm anticipates a problem in collections it may require the customer to sign a

promissory note or IOU, in order to eliminate controversies later about the existence of a credit

agreement. Within credit terms the credit period, the cash discount terms and credit instruments

such as drafts and letters of credit are of prime importance.

Analyzing the credit terms and assessing the risk of credit sale: For any firm, selling its

products in a competitive situation, there is a set of optimum terms of sales. Decisions on

terms of sale involve the setting of three parameters: the rate of discount, the discount period, and

the net date. Management has to analyze the effects of changes in these parameters. If the

proposed changes in these parameters increase the value of the firm, then the change should be

implemented. When changes in the terms of sale policy occur, the decision rule is made by

comparing the difference between incremental profit margin of the sales and incremental

carrying cost of receivables.

Ownership transfer - consignment or conditional sales: With open account and seasonal

dating (where sales is made during low sales season and collection made during or after the

high sales season), ownership is transferred to the buyer at the time of sales. With consignment

sales, the buyer collects and holds the cash from the sale of the goods and pays to the seller

according to the pre-arranged terms, so the buyer acts as an agent to the seller. Consignment

sales refer to the term of sales where ownership remains with the seller until the goods are sold

to the ultimate buyer. With conditional sale or installment loan contracts, the seller also retains

ownership and the buyer signs a promissory note to make payments on an agreed-upon time.

When all payments are made ownership passes to the buyer and if the buyer defaults, the seller

can repossess the goods.

Credit standards and analysis Credit standards are the criteria a firm uses to screen credit

applicants in order to determine which of its customers should be offered credit and how much.

The process of setting credit standards helps a firm to exercise control over the quality of the

accounts accepted. When granting credit, a firm evaluates the credit worthiness of customers

and distinguishes between customers that may pay and the customers that may not pay.

Formulating credit standards Among the policy issues that must be addressed while formulating

credit granting standards are: (a) How to estimate the credit related parameters of a credit

applicant. (b) The amount of information that the firm should collect on each credit applicant to

solve the credit investigation problem, (c) The method of analysis the firm should use in order to

determine which applicants should be granted credit. Credit standards mainly focus at the

establishment of policies to measure two factors : The time it takes a customer to repay the

credit obligation and the default risk or the probability that a customer will fail to repay the

credit. Based on the result of time and default risk analysis a decision will be made to accept or

reject a buyer’s credit application. The time a customer takes to repay the credit obligation is

measured by the average accounts receivable collection period which indicates the average

number of days a firm must wait after making a credit sale before receiving the customer’s

cash payment. The longer the average collection period the higher the firm's investment in

receivables and by extension, its cost of extending credit to a customer. The default risk or the

probability that a customer will fail to repay the credit is measured by the bad debt to the

average accounts receivable ratio. The higher a firm's bad debt loss ratio, the greater are the

costs of extending credit.

Once a firm has established its credit standards and collection policies, it can use them to evaluate

a credit applicant in four steps. First: gathering relevant information on the credit applicant.

Second: analyzing the applicants credit worthiness using the information collected and

standards established. Third: making the decision to grant or not to grant credit after

determining the probability that the applicant will or will not pay. Fourth: follow-up and

control its receivables. Sources of credit information may include the seller's and other firms'

prior payment experience with the customer, the applicant's financial statements, customer visits

and personal contact with the applicant's banks and other creditors. After acquiring

information, the firm can use it to analyze the credit applicant and to make an informed

judgment. All these sources of credit information differ in reliability and cost of acquisition. In

general it is advised that credit-granting approaches be developed systematically and applied

with care.

Credit analysis. Capital indicates the buyer's financial reserves and liquidity position. This

approach requires computing liquidity and leverage ratios in order to know whether the

applicant is stronger or weaker compared to other firms in its industry that the seller believes are

creditworthy. Character refers to the customer's willingness to pay. In order to make payments

to trade creditors, an applicant must have both the funds (as measured by the capital dimension)

and the willingness to pay the debt (as measured by a character dimension). The applicant's

character is assessed by answering questions on its history of payments, that is, if the

applicant has defaulted before and if he or she makes efforts in good-faith to pay debts as they

come due. Collateral refers to the existence of a pledged asset in case of default. If the credit

applicant gets financial difficulty, it may be forced to liquidate. If the firm liquidates, the

recoveries will go first to the secured debt-holders. So, the existence of earlier commitment of

secured financing to others means lower credit worthiness to new creditors. Information on

secured borrowings may be obtained from the applicant's financial statements, the bank, credit

reports on the applicant and directly from conversations with applicant. Capacity refers to the

buyer's managerial and production capacity, which may indicate the ability to meet credit

obligations out of operating cash flows. Managerial capacity refers to management's ability to

run the firm's business. The firm's history of success (or failure) and the number of years that

it has been in business measure managerial capacity. The value and technology of the

applicant's production and service facilities measure the firm's plant capacity. Conditions refer

to the economic situation in the applicant's industry and the general economy. There will be a

danger of non-payment if there is strong domestic and foreign competition or if the economy is

undergoing a contraction. Instead of either granting or refusing to grant credit to an applicant, a

firm can also grant a limited amount of credit, which is a form of line of credit or credit limit.

The costs of credit policy. The costs of credit standards arise due to enlarged credit

administration, increased volume of bad debt losses and the opportunity costs of committing

funds in receivables. The costs of establishing and changing the firm's terms of sale include the

cost of printing new invoices, preparing and printing manuals and price specifications, as well as

the cost of notifying the firm's customers and sales personnel about the new terms. If a firm

grants credit, it will incur the costs of the credit policy and in the absence of credit there is the

possibility of opportunity cost of lost sales due to refusing to offer credit. As the levels of credit

increase the credit costs increase while the opportunity costs of the loss of sales decrease.

Therefore, management must compare the costs of credit granting against the opportunity cost

of lost sales and set an optimal credit policy.

2.6.2. Cash collections

Almost every transaction of a business enterprise will eventually result in either the receipt or

disbursement of cash. A firm can create value to shareholders by managing cash collections.

Managing cash collections requires speeding-up and controlling cash collections.

Speeding-up cash collections A firm has to speed-up the collection of sales so that it earns

income and uses the money sooner, for investment or paying bills and save future expenses. The

methods that can be used to speed up the cash collection process include earlier billing, a lock-

box system and concentration banking. Earlier billing is used to expedite the preparation and

mailing of sales invoices internally and shorten the processing floats. It also accelerates the

mailing of payments from the customer to the firm and shortens the mail float. A lock-box

system is used to reduce the time during which payments received by the firm remain

uncollected and to reduce the deposit or processing float. Concentration banking refers to

firms, which use one central bank account instead of many small accounts in many banks. Firms

that use a lock-box networking system and those receiving funds over the counter may

normally have bank deposit balances at a number of banks. It is advantageous for the firm's cash

concentration if all of these funds are held in one central location or concentration bank.

2.7. Performance management of working capital levels and operations

Working capital management requires managers to decide what quantities of cash, near cash

assets, account receivable, and inventories the firm will hold at any point in time and must decide

how these current assets are financed. Managers have also to plan and evaluate whether actual

performances are as per their expectations.

There are techniques of measuring and evaluating a firm's performance in managing working

capital operations and levels. Some of these performance measurements relate to financial and

others non-financial criteria. The non-financial performance indicators include customer

satisfaction and product quality, while the financial accounting related performance indicators.

For the purpose of this study we emphasize on the later because they are to be derived from the

financial statements of firms and it is possible to make inter-firm comparisons. We divide the

financial accounting related performance indicators into those that help us to study working

capital investment composition (asset structure), financing (liquidity and leverage) and

operations (efficiency of activities and overall profitability). The interpretation of the financial

statement ratios can be made by comparing ratios of the same firm of different years or ratios

of the same year of different firms.

2.7.1. Performance evaluation of working capital investments

We can evaluate the performance of working capital investments by analyzing asset structure and

working capital investment composition. Asset structure ratios are used to investigate the

composition of asset investment in terms of quality and quantity. There are three asset

structure ratios which are very often used - working capital to total assets, inventory to

working capital and receivables to working capital. Working capital to total assets is

expressed in percentages and shows the amount of working capital in total assets. It is used to

investigate whether such a composition is sound given the nature of the activities the firm is in,

for example a wholesale firm should have a higher current asset composition compared to a

manufacturer. The inventory to working capital ratio is expressed in a percentage and measures

the composition of inventory in the current assets. A higher ratio may indicate slow moving or

obsolete inventory. Receivable to working capital ratio indicates the composition of

receivables in the total current assets. A higher ratio may indicate problem in credit policy or

lack of collection efforts.

2.7.2. Performance evaluation of working capital financing

We can evaluate the performance of working capital financing by studying a firm's liquidity

position and short-term financing composition. Liquidity position measures the relative degree

of certainty and ease with which an asset is converted into cash at no discount from full value. A

weak liquidity position shows the inability of a firm to meet its current obligation and excessive

liquidity ties up funds in current assets, which earn relatively less value. Liquidity ratio analysis

is one of the most important devices used to study liquidity position and short-term debt

financing. Liquidity ratios measure a firm's ability to pay its current debt by converting its

most liquid or current assets into cash. It is also used to evaluate management's attitude towards

liquidity risk. Liquidity ratios include mainly current ratios and quick or acid test ratios. The

current ratio measures the firm's ability to pay its current liabilities by converting all current

assets into cash, including, marketable securities, receivables and inventories. It is expressed in

terms of the number of times the current assets can cover the current liabilities. A preferred

current ratio is between 1 and 2 with a global norm of 2. If it is less than 1 the firm may face a

high risk of technical bankruptcy and if it is more than 2, the firm will be foregoing the

opportunity of investing in more productive long-term fixed assets. The problem with the

current ratio is that it mixes current assets and current liabilities of different maturity period. The

quick ratio is an improvement over the current ratio because it excludes the least liquid assets

(the inventories) from the current assets. Inventory is excluded because it has to be converted to

sales (usually very uncertain as to the occurrence and amount) to receivables and then to cash -

a very long process. The preferred quick ratio is between 1 and 1.50 with a global norm of 1. We

can also evaluate the performance of working capital financing by analyzing leverage or short-

term financing structure (short-term debt to total assets ratio) and working capital financing

composition. Working capital financing composition can be evaluated by studying the

composition of each short-term financing element (trade creditors, short-term bank loans, bank

overdrafts and others such as accruals of taxes, salaries, interest etc.) in the total current debt

2.7.3. Performance evaluation of working capital operations

We can evaluate the performance of working capital operations by studying the efficiency of a

firm's working capital activities (with activity ratios) and overall profitability (with profitability

ratios). Activity ratios show the efficiency of working capital activities. They give insight into

how fast the receivables and inventories are converted (turned over) to cash. They are also used

to analyze the operational efficiency of a firm from the point of view of sales volume,

inventory, credit terms, and types of assets and volume of assets used. Frequently used ratios

include, inventory turnover, receivables turnover, average receivables conversion period,

working capital (or current assets) turnover and overall assets turnover. Inventory turnover is

expressed in terms of times, this ratio indicates the rapidity with which inventory is turned over

to cash through sales, a higher turn over indicates a better efficiency, a quick moving inventory

and less capital tied-up. Low inventory turnover shows slow moving inventory possibly due to

inefficient working capital management and/or poor buying and selling practices. Receivables

turnover is expressed in times, it measures the number of times credit sales or receivables is

turned over to cash. High turnover indicates quick collection or a strict credit policy and low

turnover indicates slow collection or a liberal credit policy.

Average receivables collection period is expressed in number of days. It is the inverse of

receivables turnover multiplied by 365 days. It measures "every how many days" receivables are

collected. The smaller the collection period the quicker the collection. The inventory conversion

period is the length of time required to produce and sell the inventory. A smaller inventory

conversion period means efficient and a faster sales operation. Operating period is a sum total of

inventory and receivables conversion periods. It is expressed in terms of days and measures the

total length of time it takes to produce the inventory as well as to turn it into credit sales and

then collect cash from the receivables. A shorter operating period shows an efficient working

capital management and less capital tied up. An increase in the operating cycle without a

corresponding increase in the payables deferral period, lengthens the cash conversion period and

creates further working capital financing needs for the firm. Payables deferral period is

expressed in terms of number of days and measures the length of time the firm is able to

differ payment on its various payables on purchase of materials, wages and taxes. The longer

the period payables remain unpaid the better.

Cash conversion period is expressed in the number of days and represents the net time interval

between the collection of cash receipts from product sales and the cash payments. The cash

conversion period is the length of time that elapses from the period when the firm pays for

materials it uses in its production cycle until it receives cash from the sale of its products. The

length of time is important because the amount of working capital needed to finance the firm is

related to the speed with which "input" is converted to "output" and payment is received

from the sale of this "output". A shorter cash conversion period shows efficient management of

the firms purchase and sales operations. Overall working capital turnover is expressed in

times and it measures the capacity of working capital to generate the sales volume. A high

turnover shows efficient utilization of working capital investment, effective marketing

management efforts, and favorable business conditions.

Profitability of overall operations Profitability ratios relate a firm's profit to sales, costs,

assets, capital invested and financing costs incurred. They interlay include: gross profit

margin, operating profit margin, return on total assets and return on equity. Gross profit

margin measures the margin at the factory level and can be refined to operating profit margin

by deducting operating expenses from the gross profit and dividing by sales to measure the

overall profitability of the firm. Return on total assets is expressed in a percentage; it measures

the profitability of all assets financed by both debt and equity. The return to equity can also be

computed similarly by replacing total assets with equity.

Problems with ratio analysis Financial performance analysis using ratios has some

shortcomings. Particular problems occur on the standardization and objectivity of the resultant

information. It is difficult to make intra-firm comparisons at different periods because the

information may not be comparable because ratios being exceptionally good or bad as a

result of exceptionally good or bad economic condition, the firm's inter-period changes in

accounting policies and seasonality of operations. Inter-firm ratios may not be comparable due

to differing accounting policies and other firm specific characteristics like the types and number

of products, production technology and production capacity, size in terms of number of

employees and sales volume. The differences that arise as a result of differing accounting policies

can be solved using cash flow based evaluation. Though there may thus be problems to use the

ratios in comparisons, it may be better to use some information on the ratios than no information

at all.

Cash flow based valuation and performance analysis Cash flow from operations reported

on the statement of cash flows, indicates the excess amount of cash that a firm derives from

operations after funding working capital needs and making required payment on current

liabilities. The ratio used for this purpose is the cash flow from operations to average current

liabilities, which has a global norm of 0. Cash flow based valuation gives a better picture of a

firm's operating efficiency. This is mainly because of two reasons. First, cash is the ultimate

source of value, that is, when firms invest in resource they delay current consumption and it is

the medium of exchange that will permit them to consume various goods and services in the

future. He argues that a resource has value because of its ability to provide future cash flows.

Second, cash serves as a common measuring unit of future benefits and to compare future

benefits of alternative operating and investment opportunities. Therefore, cash flow accounting

becomes a viable alternative to traditional historical cost statements. This is so because cash

flow statement is based on matching periodic cash flows and outflows, free of credit transaction

and arbitrary accounting allocations. The change in firm values is dependent on the change in

actual and expected cash flows. Future firm value can best be predicted by changes in current

cash flows than current earnings. By using cash flow from operations it is also possible to

overcome the deficiencies in using current assets as an indication of a firm's liquidity or ability

to generate cash in the short-term.

2.8. Conclusion

Firms are created to generate revenues for their owners in the long-term. However, the

long-term value is a sum-total of short-term values. Working capital management takes care of

the short-term value creation. Working capital management requires managing the short-term

levels of investment and financing as well as operations of purchasing and sales. Managing

working capital levels refer to the investment in cash, inventories and receivables as well as

short-term financing sources such as trade credits and bank loans.

Managing cash levels can assist in creating firm value because it is important for

transactions, precautionary and speculative purposes as well as for controlling the costs and

the physical safety of cash collections and receipts. In order to manage cash, a firm needs to plan

and properly implement the above needs as well as the control mechanisms. It is only then that

cash management can contribute to the creation of firm value. Materials and finished goods

inventory management play similar roles. Managing materials inventory is useful to separate

production and purchases so that there will be no need to purchase each time a good is

produced and because it can help to hedge against supply shortages and for taking advantage of

price changes and quantity discounts. Work-in-process inventory helps to make the production

process smoother and more efficient by providing buffers between the various production

processes. Finished goods inventory is used for two reasons. First, to provide immediate

services to customers. Second, to stabilize the production process by separating production and

sales. Both materials and finished goods inventory are important for purpose of transaction (for

regular purchases and sales), precautionary (for unforeseen inventory shortages) and speculative

(for reasons of price changes). But a firm needs to control the carrying and ordering costs of

inventory as well as its physical safety. In order to manage inventory efficiently firms need to

plan their needs and control mechanisms. Receivables management is, directly related to the

credit sales policy. If a firm has credit sales policy it creates accounts receivables, in which case

it needs efficient plans and controls using a number of alternative techniques and collection

efforts.

Working capital management also includes managing short-term financing sources

mainly accounts payable and bank loans. Accounts payable results due to a firm's credit policy

and bank loans mainly include overdrafts and short-term loans. Accounts payable may include

the provision of discounts, in which case the firm should compare the benefit of the discount

due to making early payments and the costs related to financing the payments. With regard to

the bank loans, the bank service charge and interest costs of overdrafts and short-term loans have

to be compared with the benefits generated by their financing.

However, liquidity and profitability management comes to the picture when a firm is

faced with the dilemma of using short-term financing sources and investing in working

capital levels. Liquidity and profitability management requires fine-tuning because they have

offsetting risk-profit effects. The combination of liquidity and profitability depends upon

management's risk attitude, based on which it can use maturity matching, aggressive or

conservative approach. In addition to managing working capital levels a firm will also be

concerned with managing working capital operations of purchases and sales. Purchase operations

can be made on the basis of cash or credit. Cash purchases result in cash payments and its

management is related to cash management. However, credit purchase needs a separate

managerial issue that of establishing credit terms and standards as well as credit payment policy

which is considered earlier in this section. Sales can also be made on cash or credit. While

credit sales requires a firm to establish credit terms and standards, cash sales results in cash

collection and its management is related to cash management. Credit sales results in accounts

receivable, which may include a provision for discounts to motivate customers to pay early.

This needs considering the costs (or income lost) due to the discount that could be taken by

customers, the costs of financing the investment in the receivables and the costs of collection

efforts and/or eventual bad debts.

Overall, management should evaluate the efficiency of its internal management of

working capital levels and operations. In order to do this, it can use financial and non-financial

criteria. The non-financial criteria could be based on product quality and customer satisfaction.

The financial criteria could include financial ratio and cash flow analysis and be used to

evaluate the efficiency of managing working capital operations (activity and profitability) and

levels (investment composition and liquidity).

We therefore conclude that firms create value when the objective of working capital

management is tailored to taking the necessary risk in the process of aspiring for value creation.

Managing working capital levels and operations can emphasize on custody or value creation.

Custody management is safeguarding a firm's assets and operations from theft and

misappropriation as well as applying the operations as prescribed by control measures.

Managing for value creation refers to management's ability to use the firm's working capital

levels and operations such that they are applied in an efficient cost minimizing and revenue

maximizing manner. Value management presumes management of working capital levels to

decrease the holding costs of cash, receivables and inventories, investing any short or long-term

surplus cash as long as the firm does not use it.

CHAPTER 3

Kazakhstan Economy Watch

The commodity-rich state that is purported to host 95 percent of the periodic table of

elements - including substantial reserves of oil gas, uranium, copper, chromium, lead, zinc,

manganese, coal, iron ore and gold. The country's principle resort shortage would seem to be in

terms of the available working population.

Kazakhstan's government has announced that it may well buy stock valued at around $5

billion in the nation's four biggest banks to boost capitalization and liquidity amid the global

financial turmoil. The state expects to buy 25 percent of voting stock in the four biggest banks -

BTA Bank, Kazkommertsbank, Halyk Savings Bank and Alliance Bank sell new shares,

according to a statement from the prime minister's office today. The measures are designed ``to

keep the volumes of lending for the domestic economy, and increase financing of small and

medium enterprises,'' the statement said.

Kazakhstan also passed laws last week aimed at preventing defaults at ailing banks as the

global financial crisis deepens. Kazakh banks posted a 61 percent drop in profit in the first nine

months as they set aside cash to cover bad loans as the economic growth rate slows.

Kazakhstan is also willing to discuss "similar initiatives'' in the case of shares of Italy's troubled

UniCredit SpA, which owns Almaty-based ATF Bank, and South Korea's Kookmin Bank, which

is a shareholder in Bank Centercredit.

Combined net income at the Kazakhstan's 36 banks dropped to 71 billion tenge ($593

million) from the 184.4 billion tenge reported by 33 banks a year earlier, according to a recent

report from the Financial Supervision Agency.

State purchases of shares in banks and the ability to remove managers, halt dividend payments

and limit new deposits were the key measures identified under new laws published last week.

Despite The "Sudden Stop" Kazakhstan Won't Be Calling On The IMF For Help

"The Kazakh government is ready to step in,'' Kazakhstan's Prime Minister Karim Masimov said

this morning in a telephone interview with Bloomberg "The Kazakh banking system with the

support of the government and central bank will fulfill all obligations to international

investors.....We have our own specific plan to survive without any external support....I don't

think we need support from the International Monetary Fund or overseas.''

Well that is good news, so at least we know that one of the CIS and CEE economies

won't be looking to the IMF for bail-out support in this crisis which is presently growing by the

day. So Kazakhstan, that country which is reputedly host to reserves of approximately 95% of

the elements in the periodic table, with a population of around 15 million housed on a surface

area greater than the whole of Western Europe, is going to be able to look after itself. But hang

on a minute, just where is Kazakhstan, and just what have they been getting up to over there, and

why the hell should I take Karim Masimov's word for it, when just about all the other Iceland

Look-alike show contestants seem to be saying the same? After all, didn't those extremely bright

and able young people over at RBC Capital Markets in Toronto say in a report only last week

that, along with Latvia, the country's $100 billion oil-led economy is among the most vulnerable

to the present global credit crisis and the skid-row economic trajectories that go with it simply

because of its excessive reliance on short-term foreign borrowing. And isn't it the case that the

cost of protecting Kazakhstan government debt against default has more than doubled this month

- to over 1,000 basis points (or 10%), the level for borrowers that investors term ``distressed,''

according to CMA Data vision credit-default swap prices. Only Ukraine, which as we know is

already seeking IMF support, is classified as being a bigger risk among European emerging-

market governments. Surely all those highly dedicated, bright, and extremely able young people

who are doing all that trading know what they are about, don't they?

Kazakhstan, officially known as the Republic of Kazakhstan, could with some accuracy

be described as "no mans land" since it actually lies between two worlds, straddling as it does

both Central Asia and Europe. It could also be described as a form of no-mans land in another

sense, since a large part of its historic population has been nomadic, and rural, and up to very

recently the majority of the countries urban population have been migrants who have arrived

from "elsewhere"

Ranked as the ninth largest country in the world by size, it is also the world's largest

landlocked country, with a territory of some 2,727,300 km² (which is greater than the whole of

Western Europe). It is bordered by Russia, Kyrgyzstan, Turkmenistan, Uzbekistan and China.

On the other hand, and despite its enormous size, Kazakhstan has a comparatively small

population. No one actually has an exact idea of the actual size of the Kazakhstan population

(not to mention the thorny issue of just how many foreign migrants live and work there), but the

US Census Bureau International Database list the current population of Kazakhstan as 16.763

million, while sources drawing their data from the United Nations (like the IMF which I have

relied on for the chart below) give a 2008 estimate of 15.135 million. In any event the current

population level, after falling in the early 1990s as ethnic Russians left, has now stabilized, and is

virtually stationary. This virtually stagnant population constitutes, as we will see, a significant

problem for a country with such a massive resource base, and such enormous economic and

development potential as Kazakhstan would seem to have.

Record Oil Revenue Boom

Kazakhstan is the biggest energy producer in Central Asia and the country's $100 billion

economy has in fact grown at an average of 10 percent a year rate since 2000 (see chart below),

in particular as the price of oil has surged. This rapid GDP growth produced a rapid increase in

per capita income as well as national creditworthiness, and these in turn sparked in their wake a

substantial construction boom. Indeed it has precisely been the bursting of this boom in the

autumn of 2007 - on the back of the seize-up in global wholesale money markets which followed

August's financial turmoil in the USA - which lies at the heart of Kazakhstan's current growth

slowdown. Kazakhstan's economy expanded at a 'mere' 5.3 percent rate in the first quarter of

2008, half the pace achieved in the same period a year earlier, following a dramatic curtailment

in bank lending, and if Kazakhstan is still able, despite all the problems we will see below, to

maintain some sort of growth momentum at this point it is undoubtedly the result of the oil and

other commodity resources which the country has at its disposal, and indeed as part of its initial

response to the present crisis the country increased crude production by an annual 6.3 percent in

the first four months of the year, according to official government data.

Now one of the most curious details about the present slowdown in Kazakhstan, has been

the fact that at the very same time as the economy started to lose velocity the central bank found

itself busy struggling to curb an inflation rate which was steadily shooting onwards and upwards

towards the outer stratosphere, as revenue from record oil prices pushed up domestic demand,

and the resulting construction and consumption boom drove up wages far beyond normal

"productivity-gain" rates of increase (remember, there are not THAT many people in the

country, and much of the population is rural and unskilled in relation to the needs of a modern

technological and services economy). In fact inflation hit year-on-year rates of increase

approaching 20% in the autumn of last year (see chart below), although it had dropped by to an

annual 18.2% by September.

So, as well as containing the property bust, the Kazakh authorities have also had to

conduct an inflation fight (more details below). So far from lowering rates like the US Federal

Reserve has been able to do, Kazakhstan’s central bank was forced to raise the key interest rate

to 11 percent in December 2007, at a time when annual inflation was riding at almost 19 percent,

the highest for the country in over eight years. The refinancing rate was then maintained at the

11% level until it was finally lowered to 10.5% at the last central bank meeting in July.

Not Just Energy - Vast Resource Potential

The fact that Kazakhstan's industrial output growth has lost a lot of momentum in 2008 as

the slowdown in the building industry provoked a slump in cement and other materials

production should not take our minds too far away from the fact that the underlying potential in

Kazakhstan is enormous. In fact while industrial output growth was reduced to an annual 3.8

percent growth rate in the January-June period, it was at least still growing.

The low point seems to have been hit back in January, when cement production which,

not surprisingly, was among the hardest hit sectors, was down 26 percent year on year, the

sharpest January fall in five years, as growth in the construction industry stalled, brought to a

halt by the fact that the Kazakh banks, who had been struggling to borrow from abroad following

the collapse of the U.S. supreme mortgage market, virtually stopped lending to homebuyers and

builders.

Copper and rolled-iron output also declined an annual 13 percent in January while output

from oil refineries and manufacturing industry decreased an annual 2.9 percent as the problems

rolled in. Thus there is evidence of a very sharp shock initially hitting the local economy. On the

other hand, since the country is resource rich and the given that first half of 2008 saw a very

significant global commodities boom, there were other economic sectors to fall back on, and

mining production was up 6 percent from a year earlier in the first quarter, bolstered by an

increase in natural gas and coal output, which climbed 15 percent and 11 percent respectively. At

the same time crude oil production went up by an annual 5.4 percent.

Apart from oil and gas Kazakhstan has a huge array of potential resource reserves just

waiting to be tapped. Among these there is copper. London-listed Kazakhmys accounts for the

bulk of Kazakh copper output - and this was down 17.5 percent year-on-year in January-April.

Industrial output in Karaganda region, home to Kazakhmys and Arcelor Mittal mines and

smelters, declined 5.5 percent year-on-year in January-April.

Kazakhmys reported that their first-quarter output fell 9.9 percent on "severe winter

weather'' and repairs at its Balkhash smelter. Production of finished copper plates, or cathodes,

from the company's ore fell to 75,500 metric tons, from 83,800 tons a year earlier. These drops in

output are, of course not entirely associated with the credit crunch, but they do give an idea of

the challenging and volatile environment in which the mining and extraction industries work in

Kazakhstan. Realistically speaking it seems quite likely that output in these sectors will return to

more normal levels during the second-half of 2008, having already rebounding significantly from

the low point reached in the first-quarter.

On the other hand industrial output in capital Astana and commercial hub Almaty, where

most construction activities are based, was down 13.2 percent and 8.6 percent, respectively, in

January-April, and this activity may well take much longer to recover.

Kazakhstan has also had to cut its 2008 oil production forecast to 67.6 million tones (1.35

million barrels per day) from a previous estimate of 70 million tones citing maintenance works

and transport bottlenecks. The country is able to produce a lot of oil, but it does have a large

problem getting that oil to the places where people want it. Three major pipeline routes - the

Atyrau-Samara and Caspian Pipeline Consortium (CPC) links to Russia, and the Atasu-

Alashankou pipeline to China - carry Kazakh crude off towards its end destinations, but none of

these are proving sufficient to the demands on them.

"It is impossible to transport crude out of Kazakhstan without some difficulties," Senior

Associate Klara Nurgaziyeva from law firm Dewey & LeBoeuf told an oil and gas conference

last week in the Kazakh financial capital Almaty.This means output is likely to remain roughly

stationary since the country produced 67.5 million metric tons of oil and gas condensate in 2007.

Kazakhstan has 3.3 percent of the world's proven oil reserves and 1.7 percent of its gas,

according to BP's Statistical Review of World Energy.

Kazakhstan also has around 15 percent of world's uranium, most of which is processed at

the Ulba Metallurgical Plant in Oskemen, a formerly secret city south of Siberia known in

Russian as Ust Kamenogorsk. Management at the Ulba plant are currently planning to invest

$850 million, 6.5 times the plant's projected annual cash flow - and offering to trade domestic

mineral rights to joint-venture partners in China, Japan and Russia in return for the technology

they need in a bid to make Kazakhstan the world's biggest supplier of atomic fuel for civilian

nuclear reactors. If successful, Kazatomprom would consolidate the market for its 983 million

pounds of recoverable uranium deposits, second in importance only to Australia's, and become

less reliant on the raw ore's spot-market price by supplying higher-value products needed to fuel

the next generation of reactors.

However one more time let us not forget the natural environment in which all this is

situated, since Kazatomprom's East Mynkuduk mines, which are 1,180 kilometers (733 miles)

west of Almaty, lie beneath a semi-desert, where camels idly graze is surface temperatures which

range from minus 30 degrees Celsius (minus 22 Fahrenheit) in winter to 60 degrees Celsius (140

degrees Fahrenheit) in summer. Kazakhstan is currently uranium ore's third-largest producer,

behind Canada and Australia, both of which it plans to surpass by 2010.

On top of oil and uranium Kazakhstan also has 38 percent of the global supply of

chromites, used to produce corrosion-resistant steel; 22 percent of all lead; and 16 percent of

known silver reserves, according to Renaissance Capital, a Moscow-based investment bank. And

on top of all that there is its bauxite, copper, iron and gold. Indeed, while it is not entirely true

that Kazakhstan is home to 95% of the elements in the periodic table, the statement isn't that

much of an exaggeration.

But what is obvious if we look at the large swings in output which followed the financial

shock of last autumn is that the institutional environment is all important. A simple gung-ho

"you've got the resources, we've got the money" investment plan won't work without both

serious structural reform and systematic inward migration, as we have been seeing. Kazakhstan

looks in many ways like the United States did in the middle of the nineteenth century, with lots

of spare land and huge resources to be developed, but where the "carrying capacity" of the

country in a modern globalize economic environment far exceeds the resources of the native and

nomadic peoples who constitute the historic population. Above all Kazakhstan needs the skilled

labor force to leverage these resources and it needs to management and infrastructural support to

make things work.

In a smoke-filled bar in the Kazakh financial capital Almaty, the laughter of Scottish ex-

pats is loud and boisterous. More than three thousand miles (5,491 km) separate the Scottish

Highlands and the Central Asian steppe, but a mutual interest in oil and gas has created a

surprising alliance. Residents estimate that around 400 Scots live in ex-Soviet Kazakhstan, a

resource-rich country roughly the size of Western Europe.

Most come from Aberdeen, Britain's northeastern oil hub, and they bring with them their

technical expertise.” We’re going to try attracting Kazakhs to Aberdeen over the next few years

and looking at initiatives, and create further investment in Scotland from Kazakhstan," Lord

Provost Peter Stephen of the Aberdeen City Council told an energy conference last week in

Almaty. He said over 100 companies from in and around Aberdeen is active in Kazakhstan, and

the Scottish oil town even has a Kazakh consulate to serve the hundreds of Kazakhs who go to

Scotland to train up for the oil business. The Kazakh-British technical university, set up by a

group of Scottish universities seven years ago, occupies a grandiose columned building in the

centre of leafy Almaty, which housed parliament before the capital was moved to Astana.

Despite these evident problems there was, however, no shortage of "ready, willing and

able" funding available during the boom, and foreign investment flooded the country after the

discovery of the Kashagan oil field in 2000. At the time of discovery it was the largest new field

unearthed in 30 years, containing 13 billion barrels of recoverable crude, according to Rome-

based Eni, Italy's largest oil company, which is currently contracted to develop the Kashagan

field along with Exxon Mobil and Royal Dutch Shell.

However, the local authorities have not been totally irresponsible with the new found

wealth from the commodities boom, and buoyed by the surging prices, Kazakhstan's National Oil

Fund has been busily soaking up the government's share of the new petroleum revenue. As of

November 2007, it had amassed $20.1 billion, according to central bank data.

Kazakhstan is also the world's fifth-largest wheat exporter, and even though on April 15

the government placed a temporary ban on wheat exports in an attempt to control inflation, it

made it clear that it would once more allow unlimited grain exports after the ban expired in

September (a promise which was subsequently kept).

Apart from manpower all these resources also need, as I have been saying, infrastructure,

and Kazakhstan is keeping itself busy building roads as well as pipelines. The Kazakh

government is currently out looking for investors to build or maintain 1,000 kilometers (620

miles) of roads at a projected cost of 541 billion tenge ($4.5 billion), and doing it in the

extremely practical way of accepting financed construction in exchange for operating

concessions. One of the planned roads will connect the capital Astana with the regional mining

center Karaganda to the southeast, while two more will run from the financial capital Almaty to

Kapchagai Lake and Khorgos on the Chinese border. The government also plans to build a ring

road around Almaty. The state may build a fifth road from Astana to the Borovoye forest in the

north and again seems likely to seek an investor to maintain the road in exchange for operation

concessions.

The government also plans to upgrade 2,552 kilometers of roads at a cost of 900 billion

tenge to create a highway that would allow freight from Chinese manufacturers to be delivered

directly to European markets. The first phase of the upgrade will cost 789.3 billion tenge and is

scheduled for completion by 2013. A second phase will be finished in 2016. Kazakhstan has

announced it already has agreed finance of 472 billion tenge ($3.93 billion) from banks to start

the works.

The Financial Sector

Banks dominate the financial system in Kazakhstan, accounting for 80 percent of total

assets. They are mostly locally and privately owned, although foreign participation has increased

recently. The system is highly concentrated, with the largest five banks accounting for 78 percent

of market share. Banks are very reliant on external financing, with external liabilities making up

about 45 percent of the aggregate balance sheet. Easy access to external funding fueled very

rapid domestic credit growth, which expanded at an annual average rate of 70 percent from end-

2004 to August 2007, bringing bank credit to around 75 percent of GDP by end-2007. Lending

was mainly to the household, trade, and construction sectors (the oil sector is not reliant on

domestic banks for its financing). But then, just as the good times were really letting themselves

roll, and as does tend to happen with all fairy-tale, too-good-to-be-true-type, stories reality

pocked its ugly nose yet one more time into other people's business, and all that lending came to

a "sudden stop", almost as quickly as it had started, and confidence in Kazakhstan's banks

suddenly plummeted, as investors got nervous that something similar to what had been going on

in the US sub-prime case might have been happening. Or perhaps it was just the speed with

which the debt had raised, the speculative nature of a lot of the activity that followed from it, and

the front loading of much of the debt towards short term maturities that frightened people.

Anyway the consequence was that household deposits contracted sharply during the August–

October period while nonresidents sold about $4 billion worth of tenge assets — mostly held in

central bank notes — putting in the process significant downward pressure on the value of the

tenge.

Credit Downgrades

However, at the heart of the present economic slowdown in Kazakhstan, and just behind

the sudden drop in confidence about Kazakhstan's ability to meet its obligations, we should not

be surprised to find the construction slump which the imposition of last autumn's credit crunch

last gave rise to. Concern about the rate of Kazakhstan's domestic credit expansion does, in fact,

go all the way back to an IMF report of October 2006 which argued that the rapid pace of "credit

growth and external borrowing in Kazakhstan was making lenders more vulnerable to external

shocks such as a reduction in the availability of financing".

As is so often the case, such early warnings were not heeded, indeed quite the contrary,

and when the credit crunch finally did arrive the consequences were always going to be pretty

severe. Basically the European wholesale money markets, which had during the boom times

been looking so favorably on each and every project which the wonders of the mind made it

possible to dream up in Kazakhstan suddenly slammed their doors closed, and a number of local

banks, who were in the uncomfortable situation of struggling night and day to try to borrow from

overseas financial institutions (just like the Hungarian and Ukrainian banks in the last two

weeks), had little alternative but to effectively cease lending to homebuyers and builders in

September 2007. Obviously the blame here can be shared out around a number of parties.

Domestic authorities who did little to restrain the property and lending boom, and the

international investor community who, it seemed, only needed to hear the long list of

Kazakhstan's undoubted natural resources to drool and march up to put their money on the table

without any kind of serious due reflection as to the serious infrastructural and institutional

problems the country was almost bound to have. And when the stop came, it came abruptly.

Kazakhstan bank sales of Eurobonds and syndicated loans, which had totaled $8.63 billion

during the first eight months of 2007, suddenly plummeted to an estimated $300 million in the

three months from October to December. Hence my references throughout this post to

Kazakhstan's "sudden stop". And the list of those who had previously been busying themselves

arranging the deals for Kazakhstan's banks looks just like a who's who of international finance:

New York-based Citigroup Inc., the largest U.S. bank by assets, edged out Amsterdam-based

ING Groep NV (you know, the ones who have just been bailed out by the Dutch government), as

the top underwriter. New York-based JPMorgan Chase & Co., the third-largest U.S. bank;

Frankfurt-based Deutsche Bank AG, Germany's largest lender; and Zurich-based Credit Suisse

Group, Switzerland's second-biggest, were all at the front of the queue.

Kazakhstan banks also attracted international equity investors. In November 2006, JSC

Kazkommertsbank, Kazakhstan's biggest bank by assets, sold $846 million of global depositary

receipts in London. JSC Halyk Savings Bank, majority owned by President Nazarbayev's

daughter Dinara and her husband, followed in December with a $748 million sale. JSC Alliance

Bank, the country's largest consumer lender, sold $704 million of global depositary receipts in

July 2007. All three are based in Almaty, the country's financial center. The outside money

helped the country's banks grow their assets 10-fold between 2002 and 2007, to $94.7 billion as

of Nov. 1 2007. It also left the banks vulnerable when investors began retrenching.

From August through October 2007, $6.8 billion in foreign currency flowed out of the

country - 28 percent of the central bank's total reserves. With the country's banks largely shut off

from international borrowing, the ratings agencies started to get nervous. Standard and Poor's

started the ball rolling by lowering Kazakhstan' foreign currency rating in October. By

November the cracks were becoming visible, with the construction industry slowing rapidly. The

evolving situation lead to an ongoing series of "reappraisals" of Kazakh bank creditworthiness

on the part of the ratings agencies, with Standard and Poor's following its initial October

downgrade of the country's foreign currency-denominated debt rating (by one level to BBB-) by

a revision on the outlook on Kazakh banks to negative in December. Fitch Ratings also changed

its outlook on Kazakhstan's long-term issuer default ratings to negative in December, and even

the Kazakhstan sovereign rating outlook was revised to negative by S&P in late April 2008.

Moody's Investors Service joined the act, and reduced the credit ratings of six Kazakh banks,

including TuranAlem, in November because of concerns they wouldn't be able to refinance about

$40 billion of international debt. Kazkommertsbank and Bank TuranAlem were cut to Ba1, one

step below investment grade. Halyk was lowered to Baa3, the lowest investment grade, while

TemirBank dropped to Ba2 from Ba1.

In an attempt to stop the hemorrhage the government stepped in and provided lenders

with almost $11 billion of emergency cash, reducing in the process central bank reserves by

almost a quarter. The government also moved to place new limits on local banks' foreign debt

(according to the new regulation they will now be able to accumulate only up to a maximum of

four times their capital base - beginning July 1, 2009). This move is expected to cut dependence

on borrowing from abroad, although as a result commercial lending growth may slow to 13

percent this year according to central bank estimates, possibly reaching as much as 8.22 trillion

tenge ($68.4 billion), compared with 7.26 trillion tenge in 2007. However - in a "worst-case-

scenario" - the central bank warned that banks may post a 9.5 percent drop in commercial

lending in the country this year, should access to foreign capital markets not be made available

again. At the same time the Kazakhstan government indicated during the summer that it was

prepared to lend $4 billion to banks to ensure liquidity. The banks also were expected to get

"about 300 billion tenge ($2.48 billion) of free money" due to a decision to reduce the size of

bank reserve holdings with the central bank. The government has also said it will continue to

purchase shares of Kazakh companies listed on foreign exchanges until they reach pre-August

2007 levels. Looking at the MCSI Kazakhstan core index, it would seem to me that they still

have some distance to travel if this objective is to be achieved.

Kazakhstan banks' foreign liabilities rose 490 percent in dollar terms between 2004 and

the start of 2008 - to $13.5 billion - as they used their investment-grade ratings to borrow abroad

and lend to consumers and real-estate developers, according to CreditSights. This debt has now

become impossibly difficult to refinance because of investor wariness about all but the highest-

rated debt. Kazakhstan's central bank holds about $20 billion of reserves and the country's oil

fund has about $15 billion, so if push comes to shove they should be able to ensure Kazakh

banks have sufficient funds to meet their obligations. By June, credit-default swaps on

Kazkommertsbank had surged to 694 basis points from an earlier 225 basis points, according to

CMA Data Vision. CDS contracts, which are used to speculate on a company or country's ability

to repay debt, increase when perceptions of credit quality worsen. But this was very small beer,

and the position has recently deteriorated quite alarmingly, with the cost of protecting bonds

issued by BTA Bank, Kazakhstan's biggest lender, have more than doubled in the past month to

3,685 basis points (or 36.85%), while credit-default swaps on AO Kazkommertsbank cost 2,800

basis points (or 28%), according to prices at the time of writing from CMA Data vision.

All kinds of assets and revenue flows have been used as collateral in a desperate attempt

to secure refinance for the debt, and one of the most innovative examples of this is the package

that Bank TuranAlem JSC, Kazakhstan's second-largest lender, put together last October - via

ABM Amro and Standard Chartered - to sell $750 million of bonds in a DPR (diversified

payment rights) securitization scheme backed by foreign currency remittances from migrants.

The deal is the largest bond sale of its kind ever by a Kazakh bank. The bonds were sold in four

portions. Three were guaranteed by bond insurers and carried top ratings from Moody's Investors

Service and Standard & Poor's. The other bond, which isn't guaranteed, is rated Baa3 by

Moody's, the lowest level of investment grade, and an equivalent BBB- by S&P.

Construction Slump

After several years of rapid rises, Kazakhstan property prices are now declining, most

notably in Almaty where the prices of existing homes are reportedly down (on IMF estimates) by

anything up to 40 percent from their peak. This decline has partly corrected previous

overvaluation; although the price adjustment may have further to go, particularly if credit

availability and household incomes continue to weaken. As well as the banks, Kazakh

homebuyers also found themselves suddenly left out in the cold by the global credit shortage. In

Almaty, the Kazakhstan's biggest city, about 30 people were to be seen on March 18 in protest at

the hole in the ground which was to be found where their new apartments were supposed to have

been. Work stopped on the project after builder AO Corporation Kuat declared it was unable to

get further funding.

About 29,000 people had prepaid for apartments which were uncompleted when the

September squeeze arrived, and credit for Kazakh builders suddenly dried up. More than 140

housing projects were halted in Almaty alone, forcing the government to say it was going to

provide $4 billion of emergency funding to get contractors working again. Kazakh construction

companies had sold 280 billion tenge ($2.32 billion) of unfinished apartments by September,

including 170 billion tenge financed by mortgages, according to government statistics.

Homebuyers have been receiving some help from the government, which in March 13 agreed to

provide $500 million to help banks finance loans to builders in Almaty, although many are

vociferous in saying that the money has not been arriving to them as promised. The governments

announced $4 billion emergency investment program also includes funds to purchase 6,000

uncompleted apartments in Astana, the capital. Prices for residential property soared 30.2 percent

in 2007, reaching a record average mid-year high of 161,300 tenge ($1,338) per square meter, up

from 123,900 tenge in 2006, according to the Astana-based state statistics agency. In the

financial capital, Almaty, the average price was 345,200 tenge.

The drop in prices from these peaks and the sudden drying up of credit has caused

numerous problems for would-be buyers, and Bank TuranAlem, Kazakhstan's second-biggest

bank by assets, received $81.2 million last December from the state emergency investment

program simply to finance the completion of unfinished construction projects. The most recent

government bailout of the construction sector was announced during the summer - just two

weeks before the celebrations of Nazarbayev's 68th birthday and the 10th anniversary of the

founding of the new capital Astana on July 6 - following the announcement by a group

representing people who had purchased apartments in the unfinished buildings that they were

planning a protest march to be held in Astana bang in the middle of the official festivities.

The Industry and Trade Ministry have said that there were 939 residential buildings, with

45,130 apartments pre-paid by homebuyers, under construction as of last January. Minister Edil

Mamytbekov said in July that the cases of 4,558 homebuyers in 18 buildings "remain

problematic'' because of conduct for which the builders in question had been "charged with

crimes.'' The Kazakh Prosecutor General's Office said 123 construction companies that received

104 billion tenge ($865 million) in pre-payments from homebuyers were behind schedule or

haven't even begun work on new apartment buildings. Assets of "careless construction

companies,'' including buildings and vehicles, have been seized to compensate lost investments

of homebuyers and the government, according to the Prosecutor General's Office. Criminal

investigations have been opened into eight companies. A total of 285 companies are building 407

residential projects in Kazakhstan and have received 231 billion tenge in pre-payments from

more than 50,000 individuals and companies, prosecutors said. Of 200 ``problem'' projects

delayed by at least six months, 110 are located in the capital Astana and 42 in Almaty.

The July rumpus was provoked by the fact that at the start of the summer the Kazakh

government had spent only 51 billion tenge to complete stalled residential projects, a fraction of

the bailouts promised by Prime Minister Karim Masimov in the autumn of 2007, according to

data made public by the Ministry of Industry and Trade on June 23. The government had said on

Nov. 14 2007 that it would spend $1 billion by the end of 2007 and another $3 billion in 2008 to

"provide economic stability and growth'' by supporting the real estate market and small and

medium-sized businesses. Following publication of this data, and some international press

coverage, Masimov said that his original emergency investment program was in the process of

being expanded, and his government announced plans to spend 17.2 billion tenge to complete

residential projects in Astana. President Nursultan Nazarbayev instructed the state to step in and

finish projects, ``which have no source of financing,'' to ``help to reduce social tension,''

according to Edil Mamytbekov, a deputy minister of industry and trade, on June 20. President

Nursultan Nazarbayev also said it was necessary to take ``tough measures against careless

builders". As a result the Almaty mayors’ office announced on July 26 that another 46.4 billion

tenge had been allocated to support residential projects in Almaty. The state had already invested

22.4 billion tenge and was going to spend the remaining 24 billion tenge by year's end, according

to the announcement.

In April, however, the government had announced that the state development holding

Kazyna would distribute 59 billion tenge to commercial banks during 2007 to finish 131

buildings in Almaty. Sergey Kasyanov, spokesman for Almaty Mayor Akhmetzhan Yesimov,

declined to comment on the discrepancy between the numbers when question by journalists in

July. Whatever the complications of the present situation and the ins-and-outs of putting the

construction and banking problems straight, we should not lose sight of the fact that Kazakhstan

has, large financial resources which will surely help it weather the current situation. Official

foreign currency assets totaled $46 billion in early June, comprising NBK reserves of $21 billion

and oil fund (NFRK) assets of $25 billion. Commercial banks also have foreign assets of which

about $3.5 billion are thought to be liquid. Total foreign assets broadly match foreign liabilities

when the intracompany debt of the oil sector is excluded, while liquid foreign currency assets

comfortably cover potential short-term foreign currency drains.

Favorable Demographics But Migrants Needed, and With Them Modern Citizenship

Rights

The chart you will find below is known as a “heat chart”. It depicts the ongoing changes

in Kazakhstan's age structure. Each dot represents the number of people in any given age group

at any given point in time. A dark red dot represents the largest concentration of people, by age,

in a particular year while deep blue dots show the lowest concentrations. A single dark red dot is

the equivalent of almost 406,000 people while each deep blue dot represents nearly 23,000

people. In the upper left-hand corner of the chart the bright reds and yellow areas depicts the

population boom that started in the mid 1970s and lasted until the late 1990s. The remnants of

that boom extend downward from left to right across the chart. The band also narrows as this

population segment ages. This is simply a reflection of the reduction in the total numbers in the

population bulge cohorts as out-migration has taken its toll.

Many ethnic Germans and Russians, for example, left Kazakhstan during the years

following the end of the Cold War. In the lower left-hand side of the chart there is a

preponderance of dark blue dots, indicating a relatively small number of people over the age of

60 years. Over time these dark blue dots are replaced by light blues and greens, a pattern

reflecting a gradual but steady increase in the number of elderly people.

Kazakhstan’s population has fluctuated notably over time, rising during the 1980s and

then declining during the 1990s (mainly due to outward migration). A low point occurred in

2001 but population has been rising since, with the upward trend expected to continue through

2020 when total population is projected to reach an all-time high of 16.7 million – reflecting a

natural increase of 1.8 million between 1980 and 2020 - before the long run impact of below

replacement fertility locks-in, and the population starts to decline. The number of potential

workers (those between 15 and 64 years of age) will gradually "peak" - after having increased by

a total of 1.9 million between 1980 and 2020 , while the number of those over 60 will nearly

double, growing by more than 1 million in absolute terms. The Kazakh government, being aware

of the country's enormous resource wealth and the need for a labor force large enough to exploit

it, is taking a different view on this situation from its CEE peers, and is actively promoting the

idea that the country's population should rise to around 20 million by 2015. Clearly given the

fact that Kazakh fertility (1.89 tfr 2007) is already below replacement, and heading downwards,

this target is only achievable via significant inward migration. However, while much of

Kazakhstan's large surface area is desolate and uninhabitable, the densely populated urban areas

currently lack the physical and social infrastructure necessary to accommodate any such increase

in numbers. So to hit its "optimum" level of economic and social development the country needs

both a positive migration policy and substantial infrastructural development in order to be able to

adequately accommodate the new population.

Migration is nothing new for Kazakhstan, since its "no mans land" type location has

meant that it has long been a transit point on the migration route of people back-and-forth

between Asia and Europe. Kazakhs tans importance was only enhanced by the fact that

historically it was used by Moscow as destination point to which colonists, dissidents, and other

minority groups could be sent. Such groups included Volga Germans, Poles, Ukrainians,

Crimean Tartars and Kalmyks. Soviet-era policies were also designed to encourage the

movement of ethnic Russians to the periphery of the then Soviet Union. As a result, by 1980

Russians had the largest nationality (exceeding even the Kazakh population), and constituted

slightly over two-fifths of the total.

After the fall of the Soviet Union, Kazakhstan's German population emigrated en masse,

lured by better economic prospects, ethnic ties to their original homeland and Berlin’s generous

programs for resettlement. More than a quarter of Kazakhstan's ethnic Russian population

returned to Russia during the 1990s, and the departure of such a large number of Russians had a

particularly dramatic impact owing to their concentration in key urban areas (particularly in the

then capital Almaty) and in specific occupations. In Almaty and a few other cities, Russians

significantly outnumbered ethnic Kazakhs; they had their own cultural life, spoke their language

freely and never even stopped to learn the local language. They also enjoyed a privileged

occupational status, accounting for a disproportionate number of managers, scientists, professors,

engineering-technical specialists, and other high-wage, high prestige professions. Filling the gaps

created in Kazakhstan’s human capital resource base by the subsequent exodus of this population

now constitutes one of the most important development challenges facing the country. In order

to facilitate the rapid population growth the government understands that the country needs, they

have, as I say, set targets to increase the population from 15 million in 2005 to 20 million in

2015, including introducing programs for the return migration of 4.5 million ethnic Kazakhs - so

called "oralmans" - from neighbouring countries in Central Asia, Turkey, Mongolia, and China.

Although 374,000 oralmans have returned to Kazakhstan in recent years, this is not proving to be

a hugely successful program and the bulk of Kazakhstan’s current population growth is rather

the result of illegal migration from other neighbouring countries in Central Asia.

At the present time the majority of migrant workers coming to Kazakhstan are Uzbeks

and Kyrgyz nationals, although the number of Tajik migrants currently working in Kazakhstan is

small in comparison compared with the size of their presence in Russia. Since the mid-1990s,

Tajiks have been fleeing their country in significant numbers and the have mainly entered

Kazakhstan either as refugees or externally displaced persons. Tajik migrant workers in

Kazakhstan are engaged mainly in seasonal agricultural employment. Many of them often work

irregularly. According to some sources around 12,000 Tajik citizens were residing illegally in

Almaty in 2006. Many Tajiks are working as traders in markets, selling agricultural products.

Large numbers of migrants from the other Central Asian countries are drawn to Kazakhstan quite

simply because it is easier to move there than it is to move to Russia; xenophobia is much less

rife; and the rhythm of economic development makes it very attractive in salary terms.

According to official estimates, about 500,000 migrants from other Central Asian Republics

work in Kazakhstan. At the CIS summit in October 2007, the Kazakh government distinguished

itself by promoting a resolution which involved a series of legal and social protection measures

for migrants. According to a recent study by Marlène Laruelle of the Central-Asia Caucasus

institute, more than half of Kazakhstan’s Central Asian migrants are comprised of Uzbeks, while

around 200,000 are Kyrgyz and around 50,000 Tajiks. The majority of migrants are concentrated

in four regions: Almaty, Astana, Atyrau and southern Kazakhstan. In the first two regions,

migrants are chiefly employed in the construction industry, while in Atyrau, several tens of

thousands of workers (according to some sources, at least 30,000 Uzbeks) work in the oil

industry. In southern Kazakhstan, predominantly Uzbek migrants are employed in the

agriculture, especially in cotton fields. In Kazakhstan, a kilogram of cotton pays US$0.40

compared with only US$0.05 in Uzbekistan. As for the Kyrgyz, a large number of them work on

tobacco plantations. According to Laruelle, nearly a third of the migrants work in the

construction industry, another third in convenience services (the food service industry, small

business, home repairs services), and the other third in agriculture. The highest salaries are in the

construction sector (about US$200 per month), whereas those in agriculture earn a lot less (about

US$80 per month). Although the overwhelming majority of migrants are male, there are now an

increasing number of female migrants: in 2002, women made up only 15 percent of Uzbek

migrants to Kazakhstan, but by 2004 they were nearly a quarter. Kazakhstan has had labour

shortages in sectors largely staffed by women, such as agriculture, the tertiary sector of the food

service industry, and domestic services.

Central Asian migrations to Kazakhstan can be divided into three categories: daily,

temporary, and permanent. The first takes place notably in the border regions of southern

Kazakhstan, where an increasing number of Uzbeks commute to work on the Kazakh side of the

border during the day, and return home at evening. Regular border closures and administrative

complications at customs often trigger tensions among villagers who have become economically

dependent on being able to cross the border.

The border post at Zhybek Zholy, for instance, is crossed by more than 4,000 Uzbek

migrants every day. But for the majority of migrants, leaving for Kazakhstan is temporary. The

length of stays thus vary largely depending on available opportunities: mostly they last between

two and eight months, with construction work being seasonal, mainly in spring and summer, and

while work tends to be concentrated in the autumn. Many hope to return to their own countries

after accumulating sufficient capital to construct a house or start up a small business. However,

there are a growing number of migrants who decide to stay on a permanent basis. Between 1999

and 2004, more than 130,000 Uzbeks, drawn by higher living standards (an average Uzbek

salary is around US$40 dollars, compared to 250 in Kazakhstan), moved to Kazakhstan

permanently.

The Kazakh authorities are fully aware of the size of the migratory phenomenon and do

nothing to actively resist these flows. Indeed the government has stated on multiple occasions

that its citizens are not in competition for the work done by migrants because the latter fill a

specific social niche, as they tend to take the poor paying jobs normally refused by Kazakhstan

citizens. The authorities nevertheless are seeking to reduce illegal immigration and to encourage

legal migration. Thus, in 2006, the Minister of the Interior finally legalized 164,000 migrants

from other CIS countries, despite having initially announced that the number would be only

100,000. Out of these, nearly 120,000 were from Uzbekistan, 23,000 from Kyrgyzstan, 10,000

from Russia and nearly 5,000 from Tajikistan. Astana’s open policy on migration has also led to

the naturalization of many migrants: in 2005, more than 20,000 persons were granted

Kazakhstan citizenship, three-quarters of these from Uzbekistan, 10 percent from Kyrgyzstan,

and 5 percent from Tajikistan. Although migratory relations between Kazakhstan and

Kyrgyzstan are good, managing migratory flows between Kazakhstan and Uzbekistan has

proved more difficult. Tashkent refuses to acknowledge the scale of the phenomenon. The Uzbek

state has a monopoly on the legal dispatching of workers abroad, meaning each migrant is

obliged to obtain official authorization from the Uzbek Agency of Work Migration. Since 2006-

2007, the Uzbek government has also sought to hive off some of the financial flows of its

“Gastarbeiters”. According to a government resolution “On registration of citizens seeking

employment abroad”, Uzbek labor migrants have to come back to Uzbekistan, go through

registration and pay customs dues before returning to work abroad. As a result, the majority of

Uzbeks leave without legal permission and thereafter are unable to seek protection from their

home state. This situation promotes human trafficking and the organization of mafia networks by

recruiters who go from door to door asking for volunteers to work in Kazakhstan.

Working conditions for Central Asian migrants in Kazakhstan are still relatively poor, a

fact which is not that surprising given the kind of work they do. And legislation dealing with all

this immigration continues to be largely inadequate, being light on penalties for those employers

who abuse the system while failing to guarantee minimum social rights for newly arrived

migrants.

Main Risk Factors

Returning now to the economic front, and to Karim Masimov's assurance, the principal

short-term risks to Kazakhstan's slow landing would seem to be threefold: (i) a prolonged period

of tight conditions in global financial markets; (ii) a substantial drop in oil prices and other

commodity prices, and/or; (iii) a major domestic event that triggered a loss of confidence in the

banks. All or any of these could easily cause a process which was now largely under control to

become much less so. Looking forward, growth is expected to remain relatively subdued.

Assuming limited bank access to external financing and only modest deposit growth, credit

within the economy is likely to decline in real terms. Nonoil GDP growth is forecast by the IMF

to slow to 4.7 percent this year, from 9.2 percent in 2007, with spillovers from the oil sector

partly mitigating the impact of the credit crunch. Oil output should support somewhat stronger

overall growth of close to 5 percent in 2008. A strengthening in growth to 6.25 percent is

projected next year assuming global financial conditions improve and pressures on bank balance

sheets are reduced. The current account is even projected to move into surplus in 2008, following

the large deficit last year, due to higher oil and commodity prices and much slower import

growth. With banks repaying debt, the external debt/GDP ratio is projected to fall sharply this

year, and appears to be on a sustainable path under a range of scenarios, while the overall

government budget surplus is projected to increase to 6.75 percent of GDP in 2008 due to strong

oil revenue growth.

Exchange rate stability is a central policy objective of the NBK. At present, exchange rate

stability is viewed as essential for maintaining depositor confidence, limiting the risks from the

large foreign currency exposure of the corporate sector, and helping reduce inflation. The central

bank noted that downward pressures on the exchange rate had abated since the turn of the year,

and its foreign currency reserves have been rising, in part due to the decision to delay the

automatic conversion of oil fund revenues into foreign currency assets. The country’s official

foreign assets (NBK reserves and NFRK assets) are now well above the level reached prior to

the onset of market volatility in August 2007. Intervention in the foreign exchange market has

been substantially scaled back (as a share of total transactions) in recent months, although the

NBK stands ready to intervene in the market if downward pressures on the exchange rate re-

emerge. The authorities continue to view the exchange rate regime as a "managed float with no

predetermined path for the exchange rate."

The NFRK continues to be managed prudently, and the government does not

expect to draw on the Fund beyond the amount of the guaranteed annual transfer to the

budget. The assets of NFRK consist of a stabilization portfolio of about $5 billion (invested in

short-term debt securities) and an investment portfolio (invested in longer-term debt and equity

securities). While the NFRK fulfils both a stabilization and savings role, at present the

government has no intention to use the Fund’s assets to help cushion the downturn. Indeed, the

government spent only 86 percent of the guaranteed transfer from the NFRK last year, and

expects the mandated transfer to be adequate to meet spending needs this year. The exchange

rate regime in Kazakhstan has been reclassified from a managed float to a conventional peg

under the IMF’s de facto classification system. This is due to the very limited movement of the

tenge against the U.S. dollar since last October. At present, the IMF take the view that there is no

clear evidence of either over or undervaluation of Kazakhstan’s real exchange rate when

compared to its estimated equilibrium level.

Kazakhstan fiscal position is very strong. It has a large budget surplus and low public

debt. And external debt has been reduced from 92.8% of GDP in 2007 to an estimated 67.9% in

2008, with the IMF forecasting a further reduction to 59.6% in 2009. The IMF said the following

in their most recent concluding Mission statement in September:

The strong budget position in Kazakhstan has provided scope for the government to use fiscal

policy to support the economy as growth has slowed. We believe that the increase in spending in

the recent supplementary budget is appropriate, and that the automatic fiscal stabilizers should be

allowed to work, with any revenue shortfalls due to a weakening economy being accommodated

in the near future rather than offset with expenditure cuts to meet budget targets. Going forward,

the government's recently announced three-year budget plan maps out a transparent path for

fiscal policy over the medium-term. We believe, however, that it is important that the

government not commit to further large increases in public sector wages and pensions in future

years given uncertainties about budget revenues—particularly from the oil sector—and the stage

of the macroeconomic cycle in two or three years time. The Kazakh government is to buy as

much as $5 billion of distressed assets from banks in the next two years and will seek to spur

growth by spending up to $10 billion from the National Oil Fund on agriculture and development

projects. The government is also going to release 52 billion tenge ($430 million) for a bank-

rescue fund. However, not everything is going to be plain sailing. Oil has now tumbled to as

little as $72 a barrel, down is down $75 — or 51 percent — since catapulting to a record high of

$147.27 on July 11.

Commodity prices continued their downward march last week, with the Reuters/Jeffries

CRB Index of 19 raw materials from coffee to silver, dropping 3.6 per cent amid concerns that

the global economy was heading into recession. The abrupt falls in commodities - the RJ-CRB

index hit its lowest level in four years - even engulfed gold, which closed last Friday at a one-

month low of $775 a troy ounce, And property prices continue to fall, which prices in the

Kazakhstan's largest city Almaty are now down at 15 percent from a year ago (according to the

national statistics agency) and more like 40% according to sources cited by the IMF. Net income

at Kazakhstan's 36 banks fell 47 percent the first eight months of this year as lenders put aside

more money to cover bad loans. So there should be no doubt that conditions in Kazakhstan at

this point are "tight". However, in contrast with Iceland, Kazakhstan has $49.5 billion of reserves

to weather its crisis in the short term. That includes $27.6 billion in the National Oil Fund

created eight years ago to guard against a drop in oil prices. The existence of this fund means

that the Kazakh government could repay all $13.7 billion of foreign debt due in the second half

this year, including $9.3 billion owed by banks. The reserves would also cover the $16.9 billion

of debt maturing next year, including $6.9 billion owned by banks, according to a recent report

by Goldman Sachs, which cites National Bank of Kazakhstan data. We should also stop for a

moment and think about the implications of assuming that oil and other commodity prices will

not rebound as we move through 2009. The implication here would be that global demand would

have dropped and stayed down. If we go for that scenario, this would seem to imply a

generalized recession in the developed economies of almost unprecedented depth (at least in post

WWII terms). While not doubting that some individual countries (Spain, for example) may be in

for a very rough ride indeed, I am not convinced that conditions will universally deteriorate to

this extent. We will have a recession in 2009, but hope fully it will not be so deep as to send

Kazakhstan off into Iceland-type bankruptcy.

So then, to return to my original question which was posed at the start of this post: should

we simply believe Karim Masimov when he tells that Kazakhstan won't be needing that IMF

help? Well no we shouldn't, since among other things he would be saying that, wouldn't he - and

if you don't believe me just look what the rest of East European walking wounded are saying as

they amble in. But we don't have to take Masimov's word for it in this case, since there are other,

more objective evaluations of the situation available. So why don't we close by taking a look at

what the IMF themselves have been saying, in this case in their September 28 Mission

Concluding Report. At this point in time their assessment and judgement is good enough for me,

especially since I think the principal arguments they advance make a lot of sense.

Kazakhstan has large financial resources to help it weather the current situation, and

medium-term economic prospects remain favorable. Official foreign currency assets, comprising

central bank (NBK) reserves and oil fund (NFRK) assets, reached $48 billion at end-September,

well above the mid-2007 level. The current account balance has strengthened significantly this

year, and oil production is set to increase substantially in the years ahead. As at the time of the

Article IV consultation discussions in April, we believe that in the short-term policies should

remain focused on managing risks to the outlook and setting the stage for the resumption of

strong and sustained growth. Since our last visit, the authorities have continued to skillfully

handle the difficulties the economy has faced, and we welcome the policy steps that are being

taken in the monetary, fiscal, and supervisory areas to strengthen the resilience of the

Kazakhstani economy. Nevertheless, considerable challenges remain, and these have been

heightened by the renewed bout of global financial market volatility. Kazakhstan's Government

Assumes Powers To Intervene In The Banking Sector. After Iceland, Kazakhstan still has the

highest risk of banks imploding, according to credit-default swap maintained by Bloomberg for

114 European and Asian banks. Kazakhstan's oil-led economy was also ranked as being the most

vulnerable, along with Latvia, in recent report from RBC Capital Markets. The RBC

classification was based on a study of bank reserves, current account deficits and private

borrowing. In part as a response to this situation Kazakhstan's government has now taken powers

to buy shares in ailing banks and remove their remove managers, halt dividend payments and

limit new deposits. If the state moves to bail out a bank, it has the right to buy authorized shares

equal to no less than 10 percent of traded shares including the stock acquired by the state

according to the law published today in government newspaper Kazakhstanskaya Pravda. The

purchases are aimed to protect creditors and to stabilize the financial system if government-

ordered corrective measures fail, the law says.

Kazakh banks posted a 61 percent drop in profit in the first nine months as lenders

increasingly put aside cash to cover bad loans. Total net income at the country's 36 banks

dropped to 71 billion tenge ($593 million) from a year earlier, when 33 banks reported income of

184.4 billion tenge, the Financial Supervision Agency said on Oct. 22. Kazakhstan's central bank

announced last week that the government may invest $5 billion of its energy windfall next year

in new bonds issued by commercial banks to ease a refinancing squeeze. The government may

also purchase bonds issued by the National Wellbeing Fund, bank Chairman Anvar Saidenov

was quoted as saying. According to the plan outlined in the law, regulators are to alert banks

when any of five key indicators reaches dangerous levels, including a drop in the ratio of

liquidity to liabilities, the share of deposits in total obligations, and an increase in loans that are

more than 90 days overdue. Banks must respond with an "early-reaction'' plan to address the

problems. If regulators are dissatisfied with the proposed plan, they can order the bank to cut

staff, fire managers, limit new deposits, halt dividend payments, increase capital and restructure

assets, among other measures. However, the quality of any such intervention in the banking

sector is open to questioning, and the effectiveness of one Kazakh state fund's investments has

recently been put in question by the funds own chairman. The value attributed to the JSC

Investment Fund of Kazakhstan has been effectively halved - the result of shoddy management

and accounting practices, according to the fund's chairman said. The fund allowed companies it

invested in from 2004 to 2007 to buy back the state's stake after two to three years by returning

the purchase price plus 9 percent annual interest, turning the fund into a ``source of cheap

uncollateralized credit,'' in the view of Maksat Kabashev. This arrangement led both companies

and some fund officials to treat taxpayers' money lightly, said Kabashev, who took over the fund

in January. While none of the companies the fund invested in ever made an effort to match the

state's cash injections, fund managers ``happily'' counted ``mobile telephones, used plumbing

fixtures, everyday items and even guard dogs'' as company contributions to their charter capital.

The fund, a unit of state development holding Kazyna, was formed in 2003 to help

Kazakhstan, holder of 3.2 percent of the world's oil, wean its economy off commodities exports.

Its investments, originally valued at 32.1 billion tenge ($267.4 million), are now worth half that

amount, Kabashev said. Ninety percent of the projects were financed between 2004 and 2006,

and about 3 billion tenge were due to be repaid to the fund by this year. Only 390 million tenge

has been received, he said.

``Today, 9 percent annual interest is a negative real rate, and you don't have to be a great

macroeconomist to understand the consequences of a negative real rate on your return on

investments,'' Kabashev said. ``It means the death of the enterprise and loss of money'' because it

restricts the fund's profit from investments.

The fund's investments include a company that produces caps for beer bottles that is ``on the

verge of bankruptcy,'' according to Kabashev. To recoup its losses, the fund may have to sell the

assets contributed by companies. The European Bank for Reconstruction and Development

declined to buy a stake in the fund "because of these reasons,'' Kabashev said.

Country Outlook

Kazakhstan, officially known as the Republic of Kazakhstan, lies in both Central Asia

and Europe. Ranked as the ninth largest country in the world by size, it is also the world's largest

landlocked country, with a territory of some 2,727,300 km² (greater than the whole of Western

Europe). It is bordered by Russia, Kyrgyzstan, Turkmenistan, Uzbekistan and China. On the

other hand, and despite its enormous size, Kazakhstan has a comparatively small population. No

one actually has an exact idea of the current size of the Kazakhstan population (not to mention

the thorny issue of just how many foreign migrants live and work there), but the US Census

Bureau International Database lists Kazakhstan’s population as 16.763 million. Whatever the

exact figure Kazakhstan’s population level, after falling substantially in the early 1990s as ethnic

Russians and the Volga Germans left, has now stabilized, and is virtually stationary. This

stagnant population is, in fact, a significant obstacle to the full development of the massive

resource base Kazakhstan has at its disposal – it is not much of an exaggeration to describe

Kazakhstan as a country which is sitting above some 95% of component items in the periodic

table of elements. The development of a comprehensive and inter-cultural approach to inward

migration is likely to be one of the major challenges to the Kazakh authorities moving forward.

Kazakhstan Central Asia’s largest energy producer and its $100 billion economy has

largely grown at the 10 percent a year rate since 2000 on the back of the revenue accruing from

these resources (see chart below). As the years past and the momentum developed this rapid

GDP growth sparked in its wake a substantial construction boom, and it was the bursting of this

boom in the autumn of 2007 - on the back of the seize-up in global wholesale money markets

which followed August's financial turmoil in the USA - which lies at the heart of Kazakhstan's

current growth slowdown. In fact the pace of Kazakhstan's economic expansion dropped back to

a 5.3 percent rate in the first quarter of 2008 - only half what was achieved in the same period a

year earlier, following a dramatic curtailment in bank lending. If Kazakhstan is able, despite all

the problems, to maintain some sort of growth momentum at the present time then this is

undoubtedly the result its ability to leverage oil and other commodity resources, and indeed the

country increased crude production by an annual 6.3 percent in the first four months of the year,

according to recent government data.

Kazakhstan's industrial output growth has, however, steadily lost momentum in 2008 as

the slowdown in the building industry lead to a slump in cement and other materials production.

Cement production was down 26 percent year on year in January, while copper and rolled iron

output declined an annual 13 percent, and output from refineries and manufacturers decreased an

annual 2.9 percent. Thus there is thus plenty of evidence for a very sharp shock having hit the

local economy in the last quarter of 2007. However some sort of slight recovery is already

underway and industrial production rose 3.8 percent in the January-June period when compared

with a year earlier, according to the most recent data from Astana-based State Statistics Agency.

In addition, since the country is so rich in resources, and since the first half of 2008 saw a

very significant global commodities boom, there were other economic sectors for the country to

fall back on, and mining production was up 6 percent from a year earlier in the first quarter,

bolstered by an increase in natural gas and coal output, which climbed 15 percent and 11 percent

respectively. Apart from oil and gas Kazakhstan has a huge array of potential resource reserves

just waiting to be tapped. Among these there is copper. London-listed Kazakhmys accounts for

the bulk of Kazakh copper output - and this was down 17.5 percent year-on-year in January-

April. Industrial output in Karaganda region, home to Kazakhmys and Arcelor Mittal mines and

smelters, declined 5.5 percent year-on-year in January-April.

Kazakhmys said first-quarter output fell 9.9 percent on ``severe winter weather'' and

repairs at its Balkhash smelter. Production of finished copper plates, or cathodes, from the

company's ore fell to 75,500 metric tons, from 83,800 tons a year earlier. So these drops in

output are, in many cases not directly associated with the credit crunch, but may indicate a lack

of experience in adequately deploying the new technologies the inward investment is making

available (skilled labor scarcity?), and they do give some idea of the challenging environment in

which the mining and extraction industries work in Kazakhstan. Realistically speaking, however,

it seems quite likely that output in these sectors will return to more normal levels during the

second-half of 2008, and in any event rebounding significantly from the low point reached in the

first-quarter. Kazakhstan is primarily suffering from the effect of a construction slump following

the imposition of a credit crunch. Concern about the rate of expansion in domestic credit in the

country goes back to an IMF report in October 2006 which said the pace of credit growth and

external borrowing in Kazakhstan was making lenders more vulnerable to external shocks such

as a reduction in the availability of financing. But the crunch itself only came following the

forecast reduction in the availability of financing following the August 2007 financial turmoil

produced by the US sub-prime crisis. Some of the Central Asian nation's banks, struggling to

borrow from overseas financial institutions after the collapse of the U.S. supreme mortgage

market, almost completely ceased lending to homebuyers and builders in September 2007.

And when the stop came, it came abruptly. Kazakhstan bank sales of Eurobonds and syndicated

loans, which had totaled $8.63 billion during the first eight months of 2007, suddenly plummeted

to an estimated $300 million in the three months from October to December. Hence it is possible

to talk about Kazakhstan having experienced a "sudden stop". Essentially the local banks had

been financing lending by borrowing in the global wholesale money markets, and the doors to

these were pretty much shut in their faces (just like they were shut in the faces of the Spanish

banks, the only other global case of similar magnitude) in September 2007. This evolving

situation lead to an ongoing series of "reappraisals" of Kazakh bank creditworthiness on the part

of the credit ratings agencies, with Standard and Poor's downgrading the country's foreign

currency-denominated debt rating one level to BBB- in October and revising its outlook on

Kazakh banks to negative in December. Fitch Ratings also changed its outlook on Kazakhstan's

long-term issuer default ratings to negative in December. Even Kazakhstan’s sovereign rating

outlook was revised to negative by S&P in late April. Credit-default swaps shot up, and those on

Kazkommertsbank, for example, surged in June to 694 basis points from an earlier 225 basis

points, according to CMA Data Vision. CDS contracts, which are used to speculate on a

company or country's ability to repay debt, increase when perceptions of credit quality worsen.

Contracts on the country's debt cost148 basis points at the end of 2007, compared with 34 basis

points at the end of May. The current level is twice that of Russia's debt, which generally has

similar credit ratings. External indebtedness shot up, with Kazakhstan banks' foreign liabilities

rising 490 percent in dollar terms between 2004 and the start of 2008 - to $13.5 billion - as they

leveraged their investment-grade ratings to borrow abroad and lend to consumers and real-estate

developers. This debt has now become impossibly difficult to refinance because of investor

wariness about all but the highest-rated debt. Kazakhstan's central bank holds about $20 billion

of reserves and the country's oil fund has around a further $15 billion, so if push comes to shove

they should be able to ensure Kazakh banks have sufficient funds to meet their obligations.

As well as the banks, Kazakh homebuyers also found themselves suddenly left out in the cold by

the global credit shortage. In Almaty, Kazakhstan's biggest city, about 30 people were to be seen

on March 18 peering into a hole in the ground which was all that was to be found where they

expected to see their new apartments rising. Work had stopped on the project after builder AO

Corporation Kuat declared it was unable to get the additional funding it needed to continue.

About 29,000 people are estimated to have had prepaid for apartments which were uncompleted

when the September squeeze arrived. More than 140 housing projects were halted in Almaty

alone, forcing the government to say it was going to provide $4 billion of emergency funding to

get contractors working again. Kazakh construction companies had sold 280 billion tenge ($2.32

billion) of unfinished apartments by September, including 170 billion tenge financed by

mortgages, according to government statistics. Homebuyers have in fact been receiving some

help from the government, which in March 13 voted to provide $500 million to help banks

finance loans to builders in Almaty, although many are still vociferous in their protests the

money has not been arriving as promised to the actual building work on their flats. The

governments announced $4 billion emergency investment program also includes funds to

purchase 6,000 uncompleted apartments in Astana alone. Prices for residential property soared

by 30.2 percent in 2007, reaching a record average high of 161,300 tenge ($1,338) per square

meter, up from 123,900 tenge in 2006. The rate of increase of new property prices has been

declining steadily since last autumn (see chart above), and indeed prices in the large cities like

Almaty and Astana are now falling substantially.

Inflation and the central bank response

Kazakh inflation accelerated in July, reaching an annual rate of 20 percent, the highest

level since March 2000. Food prices, which as elsewhere are one of the key drivers of the

inflation, were up by a monthly 1.8 percent in June and by 8.1% since the end of December

2007. The recent surge in inflation is all the more significant since inflation had been kept pretty

tightly under control since the start of the recent growth spurt in 2000. Despite the weakening

internal demand, Kazakhstan's central bank left its benchmark interest rate unchanged at 11

percent until the July meeting, following a 2% rate increase in December. The authorities place a

high priority on reducing inflation, hence the absence of interest rate cuts, but they did recently

cut the reserve requirement on foreign liabilities (to 6 percent from 8 percent) to help bank

liquidity in the face of the crisis. The current policy stance is an attempt to balance a number of

policy goals—preserving financial stability, cushioning downside risks to growth, and ensuring

that inflation is on a firm downward path. The governments have introduced a ban on wheat and

vegetable oil exports until September and October, respectively, in an effort to contain food

prices and ensure sufficient reserves for domestic consumption (wheat exports to the Kyrgyz

Republic are exempt). The NBK take the view that weaker growth will likely help reduce

inflation pressures in the coming months, but emphasized that it will be closely monitoring

developments and is prepared to adjust its policy stance as needed. The NBK sees changes in its

policy interest rate as an increasingly effective monetary policy instrument, although they also

stress that exchange rate management remains a very important tool for influencing macro

performance, and the IMF in their latest Article IV Consultation by and large accepted this view.

The IMF take the view that a well-crafted response is needed mitigate the negative effect of

higher food prices on poorer sections of the population, while encouraging increased production

of food products in the future. Given the strong fiscal position, they feel there is scope to

introduce well-targeted government subsidies to low income households to help offset the higher

cost of food. This, in their view, would be a better response than measures that seek to influence

prices, including trade restrictions, as these reduce incentives for higher production. They are

also undoubtedly right in pointing out that efforts to boost agricultural production and improve

distribution systems would offer additional help to alleviate price pressures going forward.

Banks dominate Kazakhstan’s financial system, and account for 80 percent of total assets. These

banks are mostly locally and privately owned, although foreign participation has increased

recently. The system is highly concentrated, with the largest five banks accounting for 78 percent

of market share. Banks are very reliant on external financing, with external liabilities making up

about 45 percent of the aggregate balance sheet. Easy access to external funding fueled very

rapid domestic credit growth, which expanded at an annual average rate of 70 percent from end-

2004 to August 2007, bringing bank credit to around 75 percent of GDP by end-2007. Lending

was mainly to households, and to the trade and construction sectors (the oil sector is not reliant

on domestic banks for its financing). Then came the "sudden stop" and confidence in

Kazakhstan's banks plummeted, with the consequence that household deposits contracted sharply

during the August–October period and nonresidents sold about $4 billion worth of tenge assets

— mostly held in central bank notes — putting in the process significant downward pressure on

the value of the tenge. Kazakhstan has, however, large financial resources with which to confront

the current situation. Official foreign currency assets totaled $46 billion in early June,

comprising NBK reserves of $21 billion and oil fund (NFRK) assets of $25 billion. Commercial

banks also have foreign assets of which about $3.5 billion are thought to be liquid. Total foreign

assets broadly match foreign liabilities when the intracompany debt of the oil sector is excluded,

while liquid foreign currency assets comfortably cover potential short-term foreign currency

drains. The NBK has established a framework for liquidity support for “financial stability

purposes” and in addition to the NBK’s refinance window, banks that have signed a

“Memorandum of Cooperation and Interaction on Financial Stability” have access to exceptional

liquidity support from the NBK. The NBK has also expanded the list of collateral it accepts at its

refinance window, and has increased the capital of the deposit insurance fund, although it

acknowledges that the fund would only be sufficient to cover deposits in the event of small

banks failing. The limit on individual deposit insurance is currently T 700,000 ($5,800 or about

85 percent of per capita income), a level that covers about 90 percent of household depositors.

To help manage financial difficulties at a bank, changes in the banking law are also being

considered.

These changes would increase the authorities’ ability to react quickly to adverse

developments in a bank’s financial position, including through public capital injections (under

the current legislation, the government can only inject capital into a bank when its capital ratio is

below zero). NFRK assets consist of a stabilization portfolio of about $5 billion (invested in

short-term debt securities) and an investment portfolio (invested in longer-term debt and equity

securities). While the NFRK fulfils both a stabilization and savings role, at present the

government has no intention to use the Fund’s assets to help cushion the downturn. Indeed, the

government spent only 86 percent of the guaranteed transfer from the NFRK last year, and

expects the mandated transfer to be adequate to meet spending needs this year. Exchange rate

stability is a central policy objective of the NBK. At present, exchange rate stability is viewed as

essential for maintaining depositor confidence, limiting the risks from the large foreign currency

exposure of the corporate sector, and helping reduce inflation. After substantial nominal

appreciation of the tenge in the first half of 2006, the NBK stepped up intervention in the second

half and the exchange rate depreciated. On average, the tenge appreciated during 2006 by 7½

percent and 4 percent in real and nominal effective terms, respectively. The tenge resumed its

upward trend in 2007, appreciating by about 6 percent against the dollar during January– April.

Following the credit crunch in September and the massive outflow in deposits, the tenge came

under considerable pressure, but the NBK managed to put a stop to the bloodletting by October.

Downward pressures on the exchange rate has abated since the turn of the year, and foreign

currency reserves have been rising, in part due to the decision to delay the automatic conversion

of oil fund revenues into foreign currency assets. The country’s official foreign assets (NBK

reserves and NFRK assets) are now well above the level reached prior to the onset of market

volatility in August 2007. Intervention in the foreign exchange market has been substantially

scaled back (as a share of total transactions) in recent months, although the NBK stands ready to

intervene in the market if downward pressures on the exchange rate re-emerge. The authorities

continue to view the exchange rate regime as a “managed float with no predetermined path for

the exchange rate.”

Current Account Issues

Following deficits in 2006 and 2007 (2.4% and 6.6% GDP respectively) the current account is

projected to move into surplus in 2008 largely due due to higher oil and commodity prices and

much slower import growth. Total goods and commodity exports (including oil) are projected to

rise from 48.3 billion USD in 2007 to 71.5 billion dollars in 2008 (a 47.8% increase), while

imports will only grow from 33.2 billion USD in 2007 to 35.8 billion USD in 2008 (a 7.8%

increase), largely due to weakening domestic demand (imports were up 37.7% in 2007, IMF data

and estimates). This improvement in the trade surplus is one of the factors currently supporting

headline GDP growth. The income balance will continue to deteriorate, as will the capital and

financial account, largely due to a decline in FDI and a withdrawal of funds from equities. The

fiscal position in Kazakhstan is very strong, with a large budget surplus and low public debt. The

nonoil fiscal deficit this year is expected to remain below the level staff estimate to be consistent

with maintaining per capita oil wealth constant in real terms. The government therefore has room

to allow the automatic fiscal stabilizers to operate, rather than seeking to offset any shortfalls in

tax revenue that may occur as a result of the slowing economy. Indeed, measures to increase tax

rates or lower expenditures to meet previously set fiscal targets could aggravate the slowdown or

lead to an inefficient allocation of resources where export taxes keep domestic prices artificially

low.

Outlook on Key indicators of Kazakhstan

• During the years 2000-2007 the Kazakhstan economy enjoyed an extended period of very rapid

growth, with real GDP growth averaging 10 percent annually. The expansion was underpinned

by the development of the oil sector, prudent macroeconomic policies, structural reforms, and

increased access to global financial markets. As a result, real per capita incomes have doubled

since 2000 and social indicators have generally improved.

• The global financial turmoil that began last summer had a significant impact on the Kazakhstan

economy. Market perceptions of risk on Kazakhstan's assets rose sharply last September and

remain relatively elevated.

• Economic growth is expected to drop back significantly in the wake of the financial shock, but

is still likely to sustain significant growth. The IMF are forecasting GDP growth of 5 percent in

2008 and a modest recovery to 6.25 percent in 2009.

• Consumer price inflation is still running at very high levels (20% in both June and July) but the

month on month figures have begun to ease and it is realistic to expect a decline to single digit

rates by year-end.

• The current account is projected to move into surplus in 2008 following the large deficit last

year, due to higher oil and commodity prices and much slower import growth.

• Looking forward, growth is expected to remain relatively subdued. Assuming limited bank

access to external financing and only modest deposit growth, credit to the economy is likely to

decline in real terms. Nonoil GDP growth is forecast by the IMF at 4.7 percent this year, down

from 9.2 percent in 2007, with spillovers from the oil sector partly mitigating the impact of the

credit crunch. Oil output should support somewhat stronger overall growth of close to 5 percent

in 2008. A strengthening in growth to 6.25 percent is projected next year assuming global

financial conditions improve and pressures on bank balance sheets are reduced.

• With banks repaying debt, the external debt/GDP ratio is projected to fall sharply this year, and

appears to be on a sustainable path under a range of scenarios. After surging late last year, CPI

inflation has eased on a month-to-month basis this year, and in the absence of further oil or food

price shocks, is expected to fall below 10 percent by year-end, from the present 20 percent.

Despite a weakening in nonoil tax revenues, the overall budget surplus is projected to increase to

6.75 percent of GDP in 2008 due to strong oil revenue growth.

• Risks are on the downside and a significantly weaker growth outturn than in the baseline

forecast cannot be ruled out. A prolonged period of tight conditions in global financial markets, a

substantial drop in oil prices, and/or a domestic event that triggered a loss of confidence in the

banks would adversely affect the economy. In such cases, real credit would decline sharply,

growth would weaken further, NPLs would jump, and bank capita ratios would decline. NPLs

would increase more if the exchange rate depreciated given un hedged foreign currency exposure

in the nonoil corporate sector.

• The current economic climate is challenging, but Kazakhstan has considerable financial

resources to help it weather the situation, and medium-term growth prospects remain favorable.

The policy response of the authorities to the drying-up of external financing has so far been

broadly appropriate, and policies should continue to focus on managing risks to the outlook and

setting the stage for a resumption of strong and sustained growth.

• Delaying adjustment, for example by replacing maturing external borrowing with new higher-

cost, short-maturity funding, is likely to increase vulnerabilities in the future. Banks should have

in place plans to maintain liquidity, preserve asset quality, and continue to meet solvency

standards, including, if necessary, by raising additional capital.

• If downward pressures on the exchange rate were to resume, a number of steps could be taken

to support the tenge, including: continuing to delay conversion of the oil fund receipts into

dollars; encouraging commercial banks to use their own foreign currency assets to meet external

debt repayment obligations; and intervening in the foreign exchange market, although under a

clear operational rule that limits the amount of reserves committed to defend the exchange

rate.When conditions in financial markets improve, a return to a more flexible exchange rate

policy would be desirable.

Kazakh President Nursultan Nazarbayev called last week for the creation of a "stressed assets

fund" as assets provided to banks as collateral for loans lose value, threatening the country's

banking sector. The diminishing value of assets put up as collateral ``doesn't allow banks to

recoup their expenses,'' Nazarbayev told lawmakers in the capital Astana.

Kazakhstan's 36 banks increased their collective loan portfolio to 8.96 trillion tenge ($74.9

billion), an increase of 0.98 percent from the beginning of the year, the Agency for Financial

Supervision said on Aug. 20, adding that the portfolio quality ``deteriorated, as expected,'' as the

share of ``bad loans'' increased from 1.5 percent to 2.8 percent. Kazakh inflation accelerated to

20.1 percent in August, the fastest pace since March 2000, led by electricity prices. The inflation

rate rose from 20 percent a month earlier, according to the latest data from the Astana-based

State Statistics Agency. Consumer prices rose 0.8 percent in the month. Prices for communal

services rose 2.5 percent in August, led by a 7.6 percent jump in the cost of electricity. Service-

industry prices advanced a monthly 2.2 percent. Air transportation grew 1.4 percent, and the

price of railway services increased 0.5 percent. Food prices remained stable in August from a

month earlier. Rice rose 3.4 percent, sugar 2.1 percent and flour 1.1 percent, while fresh

vegetables dropped 4.7 percent and fruits 3.8 percent. Non-food prices rose 0.7 percent from

July, led by a 2.6 percent increase in gasoline. Diesel fuel prices advanced 2.1 percent.

In an additional measure to fight inflation Kazakhstan barred the export of rapeseed, rapeseed

oil and soybean oil as it seeks to stabilize prices. Exports were banned until April 1, according to

an order published today in the government's official newspaper Kazakhstanskaya Pravda.

Economy of Kazakhstan in Figures

1. Macroeconomic Indicators

1.1. Gross Domestic Product by Type of Activity (mln tenge)

2003 2004 2005 2006 2007

GDP 4,611,975.3 5,870,134.3 7,590,593.5 10,213,731.2 12,849,794.0

Production of goods 1,980,265.6 2,493,643.7 3,339,674.5 4,581,092.4 5,575,678.4

Agriculture, hunting, forestry, fishing 362,603.0 418,127.2 483,484.6 561,329.8 727,335.8

Industry 1,341,482.1 1,719,372.3 226,1203.7 3,018,544.0 363,5126.0

Construction 276,180.5 355,828.3 594,986.2 1,001,218.6 1,213,216.6

Tertiary industries 2,390,019.1 3,133,483.5 3,948,769.8 5,272,838.5 6,968,485.4

Trade, car repair and domestic

consumption good’s repair

536,939.8 731,600.2 897,919.4 1,164,740.4 1,587,736.3

Hotels and restaurants 39,025.7 51,649.9 68,053.9 84,160.7 114,474.2

Transport 496,170.9 589,964.1 741,912.1 95,1403.6 1,160,169.3

Communications 74,623.1 101,284.7 154,902.1 227,428.3 321,466.9

Financial activities 145,847.6 172,221.9 245,775.6 475,525.9 761,616.0

Real estate activities, lease and services

rendered to enterprises

662,586.6 901,210.5 1,142,799.2 1,515,722.2 1,896,241.5

Public management 86,409.6 127,624. 0 157,851.5 190,892.5 249,746.8

Education 159,750.7 218,906.5 263,460.9 321,669.4 418,932.8

Health care and social services 83,634.1 113,499.2 129,837.5 158,772.9 213,356.9

Other municipal, social and personal

services

98,712.8 116,139.3 135,877.7 171,104.0 231,148.1

Households hiring servants and

producing goods and services for their

own use

6,318.2 9,383.2 10,379.9 11,418.6 13,596.6

Total by sectors 4,370,284.7 5,626,811.3 7,288,444.3 9,853,930.9 12,544,163.8

Indirectly measured services of financial

activities

-71,332.1 -110,000.3 -165,700.7 -306.033.9 -613,954.8

Gross value added 4,298,952.6 5,516,811.0 7,122,743.6 9,547,897.0 11,930,209.0

Taxes on products (net) 316,651.6 358,192.2 474,580.9 674,739.3 929,628.3

Subsidies on products and import 3,628.9 4,868.9 6,731.0 8,905.1 10,043.3

Source: Statistics Agency of Kazakhstan

2. State Budget (mln tenge)

2003 2004 2005* 2006 2007

Income 10,222,256 1,305,124 - - -

Receipts 1,004,566 1,286,734 2,098,532 2,338,034 2,887,874

Tax revenue 947,251 1,186,137 1,998,314 2,209,102 2,356,040

Corporate tax 272,632 382,814 834,332 776,609 758,301

Individual tax 93,281 98,535 122,999 165,033 221,025

Social tax 157,676 167,995 197,300 236,569 295,733

Property tax - - 51,602 65,248 82,931

VAT 231,338 242,955 343,926 489,572 629,279

Excises 26,986 29,913 33,416 47,433 58,753

Other taxis - - 414,739 428,638 310,018

Non-tax revenue 44,813 81,500 66,036 54,764 181,102

Income from sale of capital asseets - - 34,182 74,166 92,686

Income from transfers - - - 2 258,046

Income from capital transactions including privatisation of state

property

12,502 19,096 34,182 74,166 -

Loan Repayment 17,690 18,390 - - -

Expenditure 1,068,439 1,323,821 - - -

Spending 1,026,992 1,287,938 1,946,146 2,150,560 2,678,280

General public services 65,287 83,587 103,786 124,546 164,744

Defence 47,483 58,011 78,664 99,992 166,646

Public order and safety правовая судебная

уголовноөисполнительная

91,593 118,564 152,904 179,872 240,993

Education 148,989 190,748 256,935 327,291 455,430

Health care 89,781 131,184 185,456 223,373 299,381

Social security and social aid 239,230 272,333 345,356 422,423 502,381

Housing and communal services 34,544 69,058 118,326 135,010 199,937

Culture, sport, tourism and mass media 33,788 43,949 57,076 81,164 122,210

Fuel and energy sector and subsurface use 8,486 25,319 24,839 35,786 52,269

Agriculture, watering, forestry, fishing and environmental

protection

47,206 72,033 64,578 77,025 100,955

Industry and construction 3,896 2,353 5,215 7,354 10,465

Transportation and communication 82,354 104,587 119,476 161,807 289,654

Other expenditure 86,421 71,933 33,932 48,812 39,166

Debt servicing 35,437 34,970 30,345 28,698 34,011

Official Transfers 12,497 9,310 369,258 197,407 38

Operating balance - - 152,386 187,474 209,594

Net budget loans - - 7,240 7,917 8,102

Budget loans - - 18,591 15,560 15,889

Repayment of budget loans - - 11,351 7,643 7,787

Balance on operations with financial assets

- - 98,481 97,937 416,787

Acquisition of financial assets

- - 110,977 113,302 419,440

Income from sale of the state financial assets

- - 12,496 15,265 2,653

Budget deficit (surplus) -46,183 -18,697 46,666 81,620 -215,295

*changes are due to new combined budget classification adopted from 1 January 2005

Source: National Bank of the Republic of Kazakhstan

3. Foreign Debt of Kazakhstan

Absolute and Relative Parameters

The index 2003 2004 2005 2006 2007

Absolute parameters ($ mln)

Gross foreign debt (end - year) 22,920.2 32,713.2 43,428.5 73,996.2 96,369.3

including intercompany debt 11,993.0 16,675.0 19,228.1 25,510.8 29,904.1

Gross foreign debt excluding intercompany debt (end - year) 10,937.2 16,038.2 24,200.5 48,485.5 66,465.3

Aggregate charged payments 5,258.6 8,185.3 11,053.8 11,738.1 25,427.1

excluding intercompany debt 2,626.4 3,519.5 5,495.1 5,715.1 18.190.3

Export of goods and non-factor services (EGS) 14,944.9 22,612.3 30,529.0 41,569.7 51,901.2

Relative parameters

Gross foreign debt per capita ($) excluding intercomany debt 731.4 1,063.9 1.590.3 3,149.5 4,269.6

Gross foreign debt as a percentage of GDP (%) 74.3 75.7 76.0 91.3 89.5

excluding intercompany debt 35.5 37.1 42.4 59.9 63.6

Gross foreign debt as a percentage of EGS (%) 153.4 144.7 142.3 178.0 185.7

excluding intercompany debt 73.2 70.9 79.3 116.6 128.1

Debt reimbursing and servicing costs as a percentage of EGS

(%)

35.2 36.2 36.2 28.2 49.0

excluding intercompany debt 17.6 15.6 18.0 13.7 35.0

Paid interest as a percentage of EGS (%) 4.8 4.2 5.6 6.5 10.3

International reserves to short-term foreign debt, % 176.4 235.3 86.7 151.9 148.1

International reserves to short-term foreign debt by

remaining maturity (Guidotti Rule), %

- - - 77.3 62.4

Source: National Bank of the Republic of Kazakhstan

4. Balance of Payments ($ mln)

2003 2004 2005 2006 2007

A. Current Account -270.11 335.4 -1,055.8 -1,914.5 -7,183.7

Trade balance 3,679.00 6,785.4 10,321.8 14,641.7 15,140.7

Export 13,232.63 20,603.1 28,300.6 38,762.1 48,349.1

Import -9,553.63 -13,817.7 -17,978.8 -24,120.4 -33,208.4

Balance of services -2,040.40 -3,098.7 -5,267.3 -5,912.0 -7,970.5

Export 1,712.29 2,009.2 2,228.4 2,807.6 3,552.1

Import -3,752.69 -5,107. 9 -7,495.7 -8,719.6 -11,522.6

Balance of income -1,744.04 -2,863.1 -5,696.9 -9,436.9 -12,144.4

Interest on loans and credits -274.65 -413.4 -817.9 -1,797.2 -3,485.2

Income of direct investors -1,446.48 -2,376.4 -4,795.5 -7,833.1 -10,253.9

Interest on reserves 123.65 140.2 228.2 443.8 745.7

and assets of National Fund 68.10 118.3 181.8 378.6 715.5

Other (net) -214.65 -331.8 -493.5 -629.0 133.6

Current transfers -164.67 -488.2 -413.5 -1,207.4 -2,209.6

B. Capital and Financial Account 2,756.14 4,679.5 916.2 16,093.1 7,384.4

Capital transfers -27.78 -21.3 14.0 32.7 -37.5

including migrants transfers -45.53 -25.8 9.5 28.9 -11.1

Financial account 2,783.91 4,700.7 898.0 16,060.4 7,421.9

Direct investment 2,209.77 5,436.2 2,117.1 6,611.0 7,098.8

Financing (net-adoption) 4,462.71 9,659.4 6,535.3 10,859.1 12,729.9

Amortization -2,252.94 -4,223.3 -4,418.2 -4,248.1 -5,631.1

Portfolio investment -1,890.96 -417.2 -3,952.7 -4,322.2 -4,601.5

out of which Government euronotes 54.30 21.2 -59.8 0.5 -6.9

derivative financial instrument (net) 15.85 -46.4 -112.6 -67.8 -358.9

Medium-term and long-term investments 2,196.50 1,976.5 2,203.0 14,491.9 11,295.6

Trade credits 36.55 16.5 87.8 -93.5 -352.0

Guaranty of Government RoK -0.82 91.0 -34.1 -37.0 -53.4

adoption 132.41 205.8 117.2 56.3 56.3

amortization -133.23 -114.8 -151.3 -93.3 -109.7

Other (net) 37.37 -74.5 121.9 130.6 -298.7

Loans 1,884.95 1,4960.0 2,116.0 14,612.4 11,647.6

Government RoK attracts 57.36 -65.7 -827.3 0.7 -60.1

adoption 204.21 199.7 109.5 104.1 101.1

amortization -146.85 -265.4 -936.8 -103.4 -161.2

Other (net) 1,827.60 2,025.7 2,943.3 14,611.7 11,707.7

Other 275.0 0.00 0.00 -214.0 0.0

Other short-term capital 252.75 -2,248.4 642.5 -473.4 -6,012.0

C. Errors and Omissions -952.48 -1,015.9 -1,800.0 -3,104.0 -3,251.8

D. Overall Balance 1,533.54 3,999.0 -1,943.8 11,074.6 -3,051.2

E. Financing -1,533.54 -3,999.0 1,943.8 -11,074.6 3,051.2

NBK reserve assets -1,533.54 -3,999.0 1,943.8 -11,074.6 3,051.2

IMF credit 0.00 0.00 0.00 0.00 0.0

Source: National Bank of the Republic of Kazakhstan

5.3. Major Trade Partners of Kazakhstan ($ mln)

2006 2007

Export Import Balance Export Import Balance

CIS countries 5,574.0 11,063.5 -5,489.5 7,965.3 14,599.3 -6,634.0

Belarus 71.0 284.3 213.4 129.3 396.0 -266.7

Kyrgyzstan 267.8 138.9 128.9 355.1 175.9 179.2

Russia 3,731.1 9,072.9 -5,341.8 4,659.1 11,626.9 -6,967.8

Turkmenistan 20.7 132.6 -111.9 77.9 142.7 -64.8

Ukraine 622.8 983.9 -361.1 1,113.1 1,528.5 -415.4

Europe 24,032.4 6,506.5 17,525.9 27,117.8 8,458.2 18,659.6

Great Britain 1,143.9 506.2 637.7 1,133.2 737.1 396.1

Germany 553.5 1,809.7 -1,256.2 392.3 2,587.3 -2,195.0

Italy 6,891.6 1,430.4 5,461.3 7,774.2 1,130.9 6,643.3

Netherlands 1,704.5 189.5 1,515.1 2,464.3 375.7 2,088.6

Switzerland 6,721.2 97.2 6,624.0 7,475.9 248.1 7,227.8

Asia 7,648.7 4,385.0 3,263.8 11,369.5 7,406.1 3,963.4

China 3,592.5 1,925.0 1,667.6 5,639.6 3,507.3 2,132.3

Turkey 348.2 558.4 -210.2 934.4 959.0 -24.6

South Korea 215.0 359.3 -144.3 217.4 625.9 -408.5

Japan 214.1 914.1 -700.0 382.6 1,369.7 -987.1

America 895.9 1,613.0 -171.1 951.1 2,114.6 -1,163.5

USA 462.2 1,105.1 -642.8 422.2 1,624.5 -1,202.3

Bermuda Islands - - - - - -

Virgin Islands 109.8 14.7 95.1 95.0 9.5 85.5

Source: Customs Control Committee of the Ministry of Finance of the Republic of Kazakhstan

5.4. Export and Import of Basic Goods

Measure unit 2003 2004 2005 2006 2007

Export, total, including $ mln 12,926.7 20,096.2 27,849.0 38,250.3 47,755.3

Oil and gas condensate mln tonnes 44.3 52.4 52.4 54.6 60.8

Wheat and meslin thous. tonnes 5,195.8 2,587.5 1,899.0 4,194.8 6,178.1

Barley thous. tonnes 574.6 248.5 98.9 378.9 647.3

Sugar white thous. tonnes 107.3 134.9 142.7 61.1 27.9

Coal thous. tonnes 26,889.5 24,338.6 24,138.0 28,101.6 26,035.0

Aluminium oxide thous. tonnes 1,414.0 1,472.6 1,492.1 1,515.9 1,490.0

Ferrochrome thous. tonnes 759.9 860.6 920.0 943.1 1,012.1

Ferrosilicon thous. tonnes 74.5 58.5 53.4 51.3 32.5

Untreated gold tonnes 15.8 20.4 20.6 38.7 13.6

Untreated silver tonnes 808.7 716.1 811.9 774.7 732.0

Rolled flat steel thous. tonnes 3,309.8 3,499.4 2,834.2 2,684.6 3,015.5

Refined copper thous. tonnes 384.9 398.9 407.8 371.6 363.6

Untreated zink thous. tonnes 231.1 275.5 294.2 322.1 307.2

Untreated lead thous. tonnes 108.4 125.7 106.6 101.9 107.8

Import, total, including $ mln 8,408.7 12,781.2 17,352.5 23,676.9 32,756.4

Tea thous. tonnes 21.7 27.4 23.4 27.0 81.8

Vegetable oil thous. tonnes 76.6 65.9 96.0 85.2 468.8

Sugar thous. tonnes 513.4 538.5 593.8 467.9 77.2

Bakery product and pastry thous. tonnes 39.3 48.6 55.4 65.3 352.2

Coal thous. tonnes 355.8 460.4 437.9 298.3 878.8

Coke thous. tonnes 958.9 1,008.8 985.8 831.3 7,748.7

Oil and gas condensate thous. tonnes 2,331.6 3,250.1 3,728.3 5,691.9 2,044.1

Petrochemicals thous. tonnes 1,157.1 1,900.3 1,608.6 1,646.3 7,180.9

Natural gas mln cu m 6, 415.6 11,651.7 11,228.9 11,066.4 3,665.8

Electric power mln kWt H 3,505.5 5,234.3 4,552.3 4,056.9 665.5

Ferrous seamless pipes thous. tonnes 362.9 435.4 700.1 611.3 135.6

Television receivers thous. units 37.3 84.1 110.4 148.4 391.3

Passenger cars thous. units 128.8 181.9 237.6 398.2 34.8

Lorries thous. units 9.9 12.7 16.6 23.6 26.4

Source: Statistics Agency of Kazakhstan

6. Financial Sector

6.1. Money (end - year, bln tenge)

2003 2004 2005 2006 2007

Money Agregate

Money Base 316.9 577.8 663.0 1,501.3 1,464.1

M 0 (cash money) 238.7 379.3 411.8 600.8 739.7

M 1 411.3 680.6 799.4 1,281.5 1,532.7

M 2 691.7 1,175.5 1,515.9 2,814.6 3,553.6

M 3 969.9 1,650.1 2,065.3 3,677.6 4,629.8

Source: National Bank of the Republic of Kazakhstan

6.2. Average Annual Exchange Rate (tenge)

2003 2004 2005 2006 2007

$ 149.58 136.04 132.88 126.09 122.55

EURO 168.79 169.04 165.42 158.27 167.75

RR 4.87 4.72 4.70 4.64 4.79

Source: National Bank of the Republic of Kazakhstan

6.3. Second-tier Banks (end - year)

2003 2004 2005 2006 2007

Number, including 35 36 34 33 35

representative offices of non-resident

banks

20 18 18 23 26

Total of deposits (bln tenge) 963.9 1,255.4 1,653.5 3,077 3890,1

Total of loans (bln tenge) 1,056.8 1,484.0 2,592.0 4,691 7258,4

Source: National Bank of the Republic of Kazakhstan, Financial Control Agency of the Republic of Kazakhstan

6.4. Insurance Companies (end - year)

2003 2004 2005 2006 3007

Number 32 36 37 39 41

Source: National Bank of the Republic of Kazakhstan, Financial Control Agency of the Republic of Kazakhstan

7. Basic Indicators of the Kazakhstani Labor Market

7.1. Working-age Population (thous. persons)

2003 2004 2005 2006 2007

Kazakhstan, total 7,657.3 7,840.6 7,901.7 8,028.9 8,228.3

Akmola 410.7 416.9 418.1 422.3 427.3

Aktobe 348.0 365.8 372.9 380.8 387.4

Almaty 789.7 798.7 804.1 816.1 834.1

Atyrau 213.6 226.3 230.5 235 245.8

East Kazakhstan 743.5 752.1 751.7 756.8 764.2

Zhambyl 519.5 492.9 496.7 510.7 548.6

West Kazakhstan 314.5 319.8 319.7 321.3 327.5

Karaganda 726.2 729.7 737.4 740.7 744.3

Kostanai 541.1 553.0 557.4 556.5 560.5

Kyzylorda 287.6 297.4 301.9 299.2 307.9

Mangistau 156.6 182.4 188.5 189.7 194.3

Pavlodar 410.7 407.4 402.2 408.9 419.0

North Kazakhstan 404.9 399.8 395.6 394,7 393.9

South Kazakhstan 952.3 1,005.7 1,013.1 1,050 1,081.5

City of Astana 261.0 290.7 293.0 302.8 314.7

City of Almaty 577.3 602.0 619.1 643.4 677.3

Source: Statistics Agency of Kazakhstan

7.2. Employed in the Economy (annual average, thous. persons)

2003 2004 2005 2006 2007

Kazakhstan, total 6, 985.2 7,181.8 7,261.0 7,403.5 7,631.1

Akmola 372.8 378.6 380.7 385.8 393.2

Aktobe 314.3 331.3 338.6 348.2 358.5

Almaty 721.7 736.4 745.1 758.3 778.2

Atyrau 193.2 205.3 209.5 215.2 227.5

East Kazakhstan 689.4 697.6 698.1 704.4 713.7

Zhambyl 462.1 442.4 447.9 463.9 506.2

West Kazakhstan 285.1 290.4 290.9 293.7 302.0

Karaganda 671.5 676.0 685.9 689.6 694.8

Kostanai 494.1 506.2 511.9 513.2 518.4

Kyzylorda 254.7 267.1 272.5 271.2 282.6

Mangistau 141.4 164.4 170.2 172.0 177.8

Pavlodar 376.8 375.8 371.7 378.7 390.0

North Kazakhstan 372.5 367.2 364.3 366.1 366.7

South Kazakhstan 870.8 927.0 937.6 974.3 1,006.5

City of Astana 239.0 266.6 269.0 278.5 290.8

City of Almaty 525.7 549.4 566.9 590.5 624.3

Source: Statistics Agency of Kazakhstan

7.3. Volume of Unemployment (annual average, thous. persons)

2003 2004 2005 2006 2007

Kazakhstan, total 672.1 658.8 640.7 625.4 597.2

Akmola 37.9 38.3 37.4 36.5 34.1

Aktobe 33.7 34.5 34.3 32.5 28.8

Almaty 68.0 62.3 59.0 57.7 55.9

Atyrau 20.4 21.0 21.0 19.8 18.3

East Kazakhstan 54.1 54.5 53.6 52.4 50.6

Zhambyl 57.4 50.4 48.7 46.9 42.4

West Kazakhstan 29.4 29.3 28.7 27.6 25.5

Karaganda 54.7 53.7 51.4 51.1 49.5

Kostanai 47.0 46.8 45.4 43.3 42.1

Kyzylorda 32.8 30.3 29.4 27.9 25.3

Mangistau 15.2 17.9 18.3 17.7 16.5

Pavlodar 33.9 31.6 30.5 30.2 29.0

North Kazakhstan 32.5 32.6 31.2 28.6 27.2

South Kazakhstan 81.5 78.7 75.5 75.8 75.0

City of Astana 22.0 24.1 24.0 24.3 23.9

City of Almaty 51.6 52.7 52.2 52.9 53.1

Source: Statistics Agency of Kazakhstan

7.4. Average Monthly Wage (tenge)

2003 2004 2005 2006 2007

Kazakhstan, total 23,128 28,329 34,060 40,790 52,479

Akmola 14,954 18,706 22,740 27,687 36,540

Aktobe 23,848 29,482 34,851 40,905 50,271

Almaty 15,933 20,180 24,436 29,779 39,483

Atyrau 48,338 53,472 65,195 74,682 94,373

East Kazakhstan 20,099 23,846 27,688 33,101 42,137

Zhambyl 14,779 19,131 22,542 26,750 33,996

West Kazakhstan 29,876 31,868 36,145 40,198 50,242

Karaganda 19,962 24,772 28,440 34,612 44,236

Kostanai 16,803 20,693 24,431 29,249 37,584

Kyzylorda 19,928 26,400 30,948 36,116 46,859

Mangistau 44,369 53,832 63,959 72,086 82,055

Pavlodar 21, 801 26,872 31,062 36,882 46,297

North Kazakhstan 15,245 19,166 23,011 27,182 34,522

South Kazakhstan 15,309 19,386 22,854 27,586 36,707

City of Astana 33,002 41,921 51,001 63,001 79,210

City of Almaty 32,622 39,614 49,201 59,240 78,021

Source: Statistics Agency of Kazakhstan

7.5. Consumer Price Index (in per cent of previous year)

2003 2004 2005 2006 2007

Kazakhstan 106.8 106.7 107.5 108.4 118.8

Akmola 108.7 107.1 107.2 108.1 116.1

Aktobe 106.2 106.9 106.4 107.0 114.5

Almaty 105.2 105.8 107.3 107.3 118.6

Atyrau 105.8 106.2 107.5 108.1 115.2

East Kazakhstan 106.2 107.3 107.8 108.0 116.1

Zhambyl 108.6 105.6 106.5 107.8 118.4

West Kazakhstan 104.7 105.7 106.4 107.8 116.4

Karaganda 106.4 107.3 107.7 107.3 114.2

Kostanai 105.9 106.1 106.7 108.3 117.0

Kyzylorda 108.1 106.2 107.7 106.8 116.8

Mangistau 107.3 105.9 107.2 106.4 121.2

Pavlodar 106.0 106.8 107.1 107.8 117.4

North Kazakhstan 106.5 106.4 107.2 108.1 118.7

South Kazakhstan 106.9 104.8 107.4 108.8 123.6

City of Astana 106.5 107.1 108.0 110.0 119.8

City of Almaty 108.5 108.7 109.6 112.0 127.1

Source: Statistics Agency of Kazakhstan

8. Industry

8.1. Production of Main Types of Goods

measure unit 2003 2004 2005 2006 2007

Mining

Gross production in current prices, total bln tenge 1,371.3 2,065.9 3,121.1 3,761.3 4,444.5

Crude oil mln tonnes 45.4 50.7 50.9 54.3 55.3

Natural gas bln cu m* 16.6 22.1 25.0 26.4 29.6

Coal thous. tonnes 80,601.2 82,929.9 82,118.8 91,575.4 94,013.8

Iron ore thous. tonnes 19,280.9 20,302.5 19,471.1 22,262.6 23,834.1

Copper ore thous. tonnes 34,886.8 30,382.8 34, 067.1 34,081.8 31,266.0

Chrome ore thous. tonnes 2,927.8 3,287.1 615.9 269.2 231.2

Chrome concentrate thous. tonnes - - 3,065.3 3,096.9 3,456.0

Manganese ore thous. tonnes 2,369.0 2,318.1 2,233.2 2,531.1 2,482.0

Lead-zinc ore thous. tonnes 6,368.3 6,326.9 6,619.8 7,829.2 8,570.2

Aluminum ore thous. tonnes 4,737.3 4,705.4 4,815.4 4,883.8 4,962.6

*including bradenhead gas

Manufacturing

Manufacture of food products, including beverages and tobacco

Gross production in current prices, total bln tenge 334.4 404.8 463.1 518.5 637.2

Meet and edible products of livestock breeding thous. tonnes 67.5 68.8 85.6 91.4 110.2

Cow butter thous. tonnes 10.6 13.0 19.7 18.6 19.7

Sausages thous. tonnes 22.7 23.1 25.1 30.8 38.2

Cheese and curd thous. tonnes 11.2 13.0 15.0 17.0 17.1

Vegetable oil thous. tonnes 140.9 159.2 167.5 211.6 236.1

non-refined thous. tonnes 68.4 74.4 70.3 92.1 109.7

refined thous. tonnes 72.5 84.2 96.7 119.8 126.4

Margarine and similar products thous. tonnes 22.7 25.2 26.9 25.8 29.0

Chocolate confectionery, pastry and confection thous. tonnes 48.3 51.9 69.8 74.7 77.6

Macaroni, noodles and other similar products thous. tonnes 72.0 79.2 85.1 104.1 124.8

Processed milk and cream thous. tonnes 148.0 154.4 179.7 225.8 258.7

Textile and sewing industry

Gross production in current prices, total bln tenge 3 7.8 38.6 39.8 39.6 28.5

Cotton fibre carded or combed thous. tonnes 132.6 140.1 156.3 145.0 110.5

Wool yarn carded or combed, not put up for retail sale tonnes 367 269 350 195 148

Jumpers, cardigans and other (similar machine-knitting or hand-

knitting goods)

thous. units 70.0 158.0 161.7 146.3 206.6

Carpets and carpets articles thous. square

meter

98.9 99.1 105.6 101.5 36.1

Fabrics thous. square

meter

22,592.9 20,301.9 35,530.2 56,459.6 43,325.3

Leather and foot-wear industry

Gross production in current prices, total bln tenge 2.7 3.1 1.8 2.1 2.6

Leather -shoe mln 206.1 210.1 367.1 314.4 508.4

Treatment of wood and manufacture of wood products

Gross production in current prices, total bln tenge 5.3 5.3 5.9 6.4 8.4

Wood, sawn or chipped lengthwise, sliced or peeled, 6 mm thick;

railway or tramway sleepers of wood, not impregnated

thous. cu m 205.3 134.2 137.3 149.2 110.9

Wood element of building construction tonnes 60 203 702 343 653

Pulp and paper industry

Gross production in current prices, total bln tenge 28.2 35.7 46.1 56.4 69.9

Corrugated paper and paperboard, perforated or non-perforated

in rolls or sheets

thous. tonnes 17.2 23.0 29.1 31.9 38.0

Wallpaper and tapestry mln square

meter

19.6 27.1 35.7 33.7 19.2

Production of coke, refinery of crude oil and processing of nuclear materials

Gross production in current prices, total bln tenge 125.2 134.4 165.9 180.0 193.1

refinery of crude oil including thous. tonnes 8,648.4 8,872.6 10,843.5 11,202.0 11,286.7

motor spirit, (including aviation gasoline) thous. tonnes 1,841.4 1,927.5 2,359.2 2,345.3 2,633.3

kerosene, including kerosene type jet fuel (refining temperature

of 150-300 degrees centigrade)

thous. tonnes 309.2 294.3 248.7 313.6 385.0

diesel fuel thous. tonnes 2,754.1 2,887.6 3,704.7 3,887.5 4,294.5

residual oil thous. tonnes 3,069.3 2,708.4 3,549.9 3,333.1 2,583.8

Chemical industry

Gross production in current prices, total bln tenge 38.5 43.2 53.9 54.1 72.3

Nitrogenous fertilizers, mineral or chemical except fertilizers in

pills, similar forms or packages, with weight less than 10 kg

thous. tonnes 27.8 95.1 22.8 54.1 22.2

Phosphoric fertilizers mineral or chemical except fertilizers in

pills, similar forms or packages, with weight less than 10 kg

thous. tonnes 112.5 85.0 81.2 51.9 38.6

Ferrous metallurgy

Gross production in current prices, total bln tenge 224.0 280.1 275.9 280.6 441.7

Pig foundry iron or spiegeleisen in pigs, blocks or other primary

forms; ferrous products obtained by direct reduction of iron ore;

other spongy ferrous products

thous. tonnes 4,138. 1 4,283.1 3,582.2 3,369.4 3,795.4

steel thous. tonnes 5,069.4 5,371.7 4,476.6 4,244.5 4,784.1

ferroalloy thous. tonnes 1,401.1 1,447.3 1,530.1 1,614.3 1,702.8

Non- ferrous metallurgy

Gross production in current prices, total bln tenge 228.9 307.4 396.9 708.1 717.1

Untreated lead thous. tonnes 133.2 157.0 135.4 116.0 117.6

Affined silver tonnes 804.9 707.4 812.1 796.2 3,795.4

Affined gold tonnes 9.9 9.6 9.8 9.0 4,784.1

Untreated zinc thous. tonnes 294.6 316.7 357.1 364.8 1,702.8

Refined copper in intermediates, other than goods sintered,

rolled, extruded, forged

thous. tonnes 432.5 445.3 418.4 427.7 3,795.4

Crude aluminum thous. tonnes 1,419.8 1,468.0 1,505.4 1,514.7 4,784.1

Untreated cadmium tonnes 930 2,358 1,624 1,369 1,702.8

Machinery-producing industry

Gross production in current prices, total bln tenge 92.2 128.0 179.5 228.7 281.2

Field engine units 153 16 26 51 118.0

TV set thous. units 503.3 553.6 346.0 410.2 322.6

Video record thous. units 135.3 93.5 1.2 - -

Tape-recorder thous. units 77.3 60.6 55.6 46.1 11.2

Production and distribution of electrical energy, gas and water

Gross production in current prices, total bln tenge 247.6 265.3 280.4 342.1 414.6

Electrical energy bln kWt. H 63.9 66.9 67.9 71.7 76.5

Heat energy mln Gcal 85.7 87.3 90.8 83.2 93.2

Natural water mln cu m 2,221.1 2,387.8 2,349.6 2,463.8 2,672.7

Source: Statistics Agency of Kazakhstan

8.2. Industrial Gross Output (mln tenge)

2003 2004 2005 2006 2007

Total 28,360.02 38,678.57 52,530.00 65,098.96 78,158.65

Source: Statistics Agency of Kazakhstan

City of Almaty 117.8 112.4 120.2 111.2 117.5 103.3 105.4 105.7 106.3 111.7

Source: Statistics Agency of Kazakhstan

9. Agriculture

9.1. Gross Agricultural Output (in current prices, mln tenge)

2003 2004 2005 2006 2007

Kazakhstan, total 615,368.5 698,832.9 763,843.4 853,312.9 1,121,773.6

Akmola 69,900.2 79,347.2 82,008.8 90,032.0 131,005.2

Aktobe 24,493.1 27,001.8 27,362.5 29,388.8 40,700.6

Almaty 80,608.9 95,632.8 105,434.8 118,954.7 145,982.1

Atyrau 6,963.7 7,967.5 9,445.3 10,888.8 13,312.9

East Kazakhstan 58,173.2 70,020.1 75,118.5 80,290.4 98,504.3

Zhambyl 36,455.0 42,465.7 45,737.4 45,832.3 60,331.9

West Kazakhstan 24,168.2 25,335.5 22,917.2 27,049.8 34,729.4

Karaganda 29,715.1 36,722.7 35,533.3 43,095.3 54,822.2

Kostanai 84,643.7 92,181.0 108,742.9 130,255.4 188,866.3

Kyzylorda 13,296.5 16,107.5 16,848.7 18,376.1 24,146.1

Mangistau 1, 348.6 1,627.9 2,385.0 2,633.5 2,870.3

Pavlodar 25,649.4 33,497.0 36,268.7 39,037.5 50,187.6

North Kazakhstan 69,891.9 85,135.6 93,979.0 108,947.7 147,471.5

South Kazakhstan 86,182.7 80,421.9 95,218.9 100,858.1 118,669.4

City of Astana 2,356.3 3,413.9 4,762.5 5,441.9 7,077.0

City of Almaty 1,522.0 1,954.8 2,080.9 2,230.9 3,096.8

Source: Statistics Agency of Kazakhstan

9.3. Cattle Population* (end - year, thous. head)

2003 2004 2005 2006 2007

Kazakhstan, total 4,871.0 5,203.9 5,457.4 5,660.4 5,840.9

Akmola 388.6 397.4 394.1 389.3 396.4

Aktobe 350.9 372.3 397.9 421.2 435.5

Almaty 567.0 608.4 667.4 722.2 757.6

Atyrau 123.1 135.6 144.6 153.5 165.4

East Kazakhstan 661.9 706.0 734.8 754.9 764.1

Zhambyl 244.7 279.8 293.0 307.9 317.2

West Kazakhstan 386.0 410.3 416.7 422.9 433.7

Karaganda 362.6 381.7 389.7 400.2 406.5

Kostanai 448.4 477.9 501.9 516.6 537.0

Kyzylorda 178.6 199.5 216.2 230.8 240.1

Mangistau 6.4 7.2 8.8 8.5 9.6

Pavlodar 306.6 333.6 346.4 346.9 353.3

North Kazakhstan 319.1 324.8 332.0 338.5 344.4

South Kazakhstan 515.1 560.2 607.8 642.3 676.4

City of Astana 5.6 3.6 1.9 1.3 1.3

City of Almaty 6.4 5.6 4.2 3.4 2.4

*in all category

Source: Statistics Agency of Kazakhstan

9.4. Production of Key Livestock Products by Type of Producer (thous. tonnes)

2003 2004 2005 2006 2007

Cattle and poultry for slaughter –

total

1,243.0 1,317.3 1,375.0 1,447.3 1,504.7

Agricultural enterprises 74.9 81.8 89.0 113.2 119.1

The general public 1,093.8 1,149.0 1,183.8 1,218.4 1,252.5

Farmers 74.3 86.5 102.2 115.7 133.1

Gross milk yield 4,316.7 4,556.8 4,749.2 4,926.0 5,073.2

Cows’ milk – total 4,278.4 4,518.2 4,712.7 4,891.9 -

Agricultural enterprises 187.3 176.2 176.3 182.7 177.6

The general public 3,895.5 4,116.7 4,281.8 4,432.4 4,586.5

Farmers 195.6 225.3 254.6 276.8 309.1

Source: Statistics Agency of Kazakhstan

Financial Crisis. Risks and Opportunities

The second international conference “Risk Management in Developing Economies” was

held in Almaty in late October. Forum participants – professional risk managers from

Kazakhstan, Russia, CIS and other countries – tried to analyze external and internal risks posed

to the domestic economy amid the global financial crisis and its organisational shortcomings,

and discover possible ways of correcting them.

Experts believe that the world has faced the problem of the global undervaluation of risks in the

financial sphere in recent years. As a result of a rapid growth in savings and the weakening of

coordination of developed countries’ monetary policies, ratings agencies and regulators started

adopting more liberal approaches, losing control over investment and financial companies.

According to Citibank’s latest report, the assets of the world’s top 50 players have more than

doubled to $50,000bn in the past six years. However, their capital adequacy has fallen from

4.09% to 3.36%. This means that the capitalisation of banks grew inadequately. Citibank

analysts calculated that at least two or three years had to be spent on bringing this coefficient to

the 2002 level and either their assets should be reduced to $10,000bn or capital should be

increased to $420bn. Had regulators uncovered this imbalance on time, they would have had a

better understanding of the risks piled in the financial system. However, this did not happen. In

the situation of having excess cheap money, banks started offering new, increasingly

complicated financial instruments at the expense of their reliability. The results of this approach

are well known to us now. The bubble that had grown in the US sub-prime mortgage market

turned into a confidence crisis and the liquidity squeeze. It has finally led to the global financial

crisis, accompanied by bankruptcies and the nationalization of the backbones of the global

financial system, the stock market crash, and economic recession. The chair of the board of

directors of Halyk Bank Kyrgyzstan, Zhanat Kurmanov, noted in his report that market economy

developed cyclically, which is why there was nothing unusual in the regular outbreak of crises.

Moreover, they help correct imbalances in the economy. Many countries experienced crises in

the past and they made, as a rule, the very same mistakes and adopted the same measures to

overcome them. This chain is quite simple: aiming to ensure economic development, central

banks pursue cheap money policies, which bubble markets of certain assets if there is a lack of

regulation. In response, central banks tighten monetary policy and the bubbles explode. In order

to eliminate consequences, the cheap money policy is pursued again and this starts another

bubble. The price that has to be paid for this sort of regular “self-correction” can be really high.

For example, government spending on overcoming crisis accounted for 47% of GDP in China in

the 1990s, 18% in Mexico (1994-97), 30% in Turkey (2000-2003) and 175% in Spain (1977-85).

It is not hard to calculate that the public funds that Kazakhstan has allocated or promised for

overcoming the ongoing crisis have already reached 20% of GDP. In any event, crises have

emerged and will emerge, while risk management has to reduce their frequency and scale. For

this purpose, financial stability should be considered an important component of financial

development and they should interact through a proper system of risk management, whose

methods and approaches should concern not only the very system but also its regulation. The

latest crisis events and their negative impact on Kazakhstan’s economy have shown that in order

to ensure sustainable development, new approaches to solving strategic tasks are needed. The

growing level of integration into the global financial system has forced our country to feel all the

disadvantages of globalisation. Moreover, it has turned out that the smaller the economy the

more sensitive it is to external effects. Professional risk managers note that in order to

understand the current situation, one should consider the existing types of financial crisis, the

risks that characterize each of them, and to which of them Kazakhstan is more susceptible.

The crisis of the national currency. The main risk variables here are the actual exchange rate, the

current account balance (positive/negative), the degree of the dollarization of the economy,

foreign factors, and the ratio of foreign debt to GDP. Specialists estimate that the risk of such a

crisis emerging in Kazakhstan is generally small. Thanks to the National Bank’s policy, the

tenge’s exchange rate is stable, the level of dollarisation has fallen from 80% in the 1990s to the

current 50% and the balance of payments is positive. The only significant risk to our country in

this category is foreign factors, since major foreign players can hypothetically destabilize the

exchange rate quite easily, because of the small size of the country’s economy.

The banking crisis. It was the banks that first felt the negative impact of global financial

problems in Kazakhstan. The small size of the domestic base of funding is the most significant

risk that has already hit the domestic banking system. Up until mid-2007 when the global

liquidity crisis broke out, our commercial banks had been aggressively obtaining foreign loans,

but today, when access to these resources has been closed, the main problem of Kazakh banks is

the repayment of their sizeable foreign loans. The managing director of Kazkommertsbank,

Magzhan Auezov, says that the past year has shown that banks are managing to cope so far. At

least, “no bank has so far gone bust” and our commercial banks have passed the first test. They

have improved their strategies, realigning towards domestic sources of funds, sharply cutting

their spending and building up additional reserves and provisions. The relative strengths of our

system are the quality of regulation and the level of competition, one of the highest levels of the

capitalisation of commercial banks in the CIS, the well-developed market infrastructure

(financiers’ association, a credit bureau and a deposit security fund), as well as the adoption of

corporate management systems and international financial reporting standards. However, the

director of the Kazakh branch of the Professional Risk Managers’ International Association

(PRMIA), Eldar Isatayev, believes that the financial sector has not yet solved all of its problems.

According to his calculations, Kazakh banks will have to pay up to $2bn in foreign loans in the

fourth quarter of 2008 alone. Since they can obtain new foreign loans nowhere this means that

they will have to rely only on their own resources. It should be remembered that the share of the

banking sector in Kazakhstan’s total foreign debt has fallen insignificantly and is still around 40-

50%.The primary risks are now the quality of loan portfolios and the transparency and

availability of information. Mr. Kurmanov says that if – as a result of distorting data on the

quality of assets – at least one bank goes bust, this will undermine confidence in the whole

banking system.

The crisis of sovereign debt. Experts believe there are no particular risks of this in Kazakhstan.

Even though the country’s sovereign ratings in the national and foreign currency have been

downgraded, they still remain relatively high. The country has not faced defaults since its

independence and it has local institutional investors. We have a low budget deficit and the ratio

of public debt to GDP is only 3.5%. However, this is a quite disputable indicator because not

only the direct, but also the indirect, liabilities of a country should be taken into account while

assessing risks, since, as the practice shows, the government will have to offer support to core

banks and national companies if they start facing problems. Incidentally, conference participants

were most concerned about risks related to a possible crisis of corporate obligations and the

population’s insolvency. A sharp decrease in loans issued by banks has not yet uncovered the

weaknesses of the Kazakh economy. Risks of this category that have already been faced are the

lack of alternative sources of funding for companies and, as a result, the scaling down of the

activity of small and medium-sized businesses and high inflation. Although the necessity of

boosting competition and diversification has been raised at high government levels for several

years, our economy is still highly concentrated and export-oriented. Now when world prices of

oil, grain and metals have fallen these risks may strongly hit both businesses and the population

of Kazakhstan. Low incomes, savings, and investments of the Kazakh people and their low

purchasing power, do not offer any optimism either. Mr. Kurmanov thinks that the risk of

funding should be singled out from all the mentioned risks. The Kazakh economy is continuing

to grow, major projects have been launched or are about to be commissioned, and these projects

may demand between $200bn and $300bn. At the same time, the assets of domestic banks,

pension schemes, insurers and investment funds do not reach even $120bn. This means that in

order to keep going, the country’s domestic funds are not enough, so hopes are pinned on the

stock market. However, it has also, unfortunately, developed poorly. Its capitalisation started to

grow in Kazakhstan in 2005 when it reached 75% of GDP, whereas now this indicator has fallen

below 60%. Generally, this is comparable to levels in countries, such as Thailand (68%), Brazil

(67%), the Philippines (58%) and Poland (44%). The main problem is the low liquidity of the

stock market. This indicator stands at 0.02% in our country, which is 20 times smaller than in

Poland. This is because the Kazakh stock market is highly concentrated: the share of the top 10

issuers of the KASE is over 85% of total capitalisation. Three of them are raw material

companies and the others are banks. As experts believe, one of the main reasons for the poor

development of the stock market in a pre-crisis period was the unrealistic interest rate. In the

conditions when our banks attracted foreign loans at low interest rates set by foreign central

banks, funds of national institutional investors devalued, whereas their yields were lower than

inflation. Therefore, the government, namely the Ministry of Finance, now can and must set a

benchmark for the corporate sector through issuing government securities. As a result, a realistic

curve of yield will be drawn. Another long-term problem is to increase the share of foreign funds

on the stock market. For this purpose, Kazakhstan needs above all to adopt a law on protecting

the rights of portfolio investors and create a fund for securing deals. At the same time, an opinion

was floated at the conference that it was precisely the underdevelopment of the stock market and

its weak role in the real sector of the economy in the crisis that benefited Kazakhstan. This is

partly true, but if our country still intends to build an open economy and integrate into the global

financial system, it is impossible to avoid the development of the stock market and the risks that

accompany it.

For the first time since its independence, Kazakhstan faced a financial crisis, and judging

by existing preconditions, this crisis has all chances to spill well beyond the banking sector.

Understandably, amid the constant economic growth in recent years, risk management received

the least possible attention. Thanks to requirements set by regulators, commercial banks created

risk management systems a long time ago, while private businesses have only now realized that

they should reconsider their corporate management standards. The crisis will demand that all the

existing shortcomings be corrected both at an individual level and on the macroeconomic scale.

The government has already adopted a set of measures to stabilise the situation and it has

pledged to draft a large-scale anti-crisis program. Time will show how efficient this program will

be. Kazakhstan is now passing its first real test of creditworthiness. Depending on how we cope

with this challenge, the international community will judge whether we are ready to rise to a

higher level of economic cooperation.

KAZAKHSTAN CHALLENGED BY THE WORLD FINANCIAL CRISIS

In summer 2007, the American subprime crisis had an impact on the Kazakhstani real

estate market, and then, in 2008, on its entire banking sector, which after Russia’s is the most

developed in the CIS. This sector is facing major difficulties owing to its massive lending sprees

in international financial markets and its overexposure to the real estate sector. For the first time

since the Russian crash in summer 1998, Kazakhstani authorities are faced with managing a

major shock, compelling them to test, in real time, not only the solidity of the country’s most

dynamic economic sectors, but also the effectiveness of the state intervention mechanisms.

Astana ultimately seems to have demonstrated its overall financial solidity, but the long-term

social and regional costs remain unclear.

BACKGROUND: Boosted by great petrol reserves and looking for quick ways to make a profit,

Kazakhstani banks borrowed significant sums of money from U.S. banks involved in hedge

funds. Today, they are paying the price for their success and face two principal problems. First,

the weighty role played by the construction sector in their development (which, for example,

constitutes 45% of the Alliance Bank’s loan portfolio), and, second, their massive foreign

borrowings, which amount to more than 50% of their total borrowings, as compared, for

example, with the 18% borrowed by Russian banks. During 2006 alone, Kazakhstani banks

obtained more than US$18 billion in international credits. Today, the servicing of Kazakhstan’s

foreign debt that will have to be repaid by 2009, has reached a level equivalent to 42% of its

exports. In 2007, the country had a bill of US$4 billion to pay, tripling brutally to 12 billion as a

result of the crisis. Kazakhstani banks, for their part, hold US$40 billion worth of foreign loans,

a significant share of which now has to be refinanced at very high rates.

Nevertheless, the Kazakhstani authorities quickly stepped in to regulate and stabilize the

situation. In spring 2007, Kazakhstan’s Central Bank set up an aid fund for small banks with

insolvency problems. When Standard & Poor’s and Moody’s Investors Services downgraded the

credit ratings of Kazakhstani banks, the state decided to invest US$11 billion of emergency

money (nearly a quarter of the Central Bank’s reserves) in order to halt foreign borrowings and

avoid a credit ratings collapse. Astana also set up a Stabilization Fund of US$4 billion to ensure

liquidity, but this did not suffice to reassure foreign investors, especially when the Renaissance

Capital’s Rencasia Index for Central Asia, which is dominated by Kazakh equities, collapsed in

September 2008 after Lehman Brothers’ announced its bankruptcy. In October, Astana

announced it would give US$5 billion in aid to the major national banks for about a quarter of

their shares (the state already directly or indirectly controls a third of corporate deposits). Thus,

the BTA Bank, the largest in the country, is expecting a state injection of more than US$2

billion, while Kazkommertsbank, the country’s second largest, is awaiting a boost of US$300

million, and the Halyk and Alliance Banks US$500 million each. BTA was the most affected

because of its high-level involvement in the construction sector, but it was the collapse of the

Alliance Bank that caused the most ink to be spilled. After becoming the leading retail lender

and the fastest growing banking institution in Kazakhstan in only a few years, the Alliance Bank

spectacularly collapsed; in the first semester of 2008, its net income fell by almost half. In the

short term, this situation is going to facilitate foreign banks to establish themselves in the

Kazakhstani market, as their share had previously been a modest 15 percent. Now, for example,

Italian UniCredit, South Korean Kookmin, Israeli Hapoalim, Abu Dhabi-based private equity

fund Alnair Capital, and the London-based HSBC, all have their sights set on snapping up

sections of Kazakhstani banks. Moreover, Raiffeisen International and the Bank of Tokyo

Mitsubishi are planning to open offices in Almaty in the first half of 2009, the second to

facilitate Japanese firms’ entry into the Kazakhstani raw materials market.

The banking crisis continues to lean heavily on the Kazakhstani real estate market,

estimated at US$30 billion. The banks have massively increased their credit rates, making it

difficult to obtain a loan with annual interest repayments of less than 20 percent. As a result, the

construction market has collapsed in all the major cities and especially in the two capitals,

Almaty and Astana, which have reportedly plummeted by 40 percent in a few months. The

building on many construction sites has been blocked, and in Astana itself, financing shortages

have halted construction on nearly every second site. The decrease of the price per square meter

is making itself felt, especially since the real estate prices had literally shot through the roof,

increasing by 900 percent in four years. Tens of thousands of people have been unable to obtain

their recently bought apartments, whose construction has been halted. In order to forestall a total

market collapse, the government has set up a US$500 million aid program for construction

companies unable to get credit terms and has bought thousands of apartments in Astana.

Kazakhstani companies that previously invested in national real estate today are now purchasing

in foreign markets, while others have decided to stop selling housing altogether and wait for

prices to go up again.

IMPLICATIONS: This crisis has multiple implications. It caused major liquidities shortages for

the country. Attaining record levels of 18 percent in 2007, inflation has continued to climb in

2008 to around 20 percent, and the tenge’s stability remains fragile. Concerning domestic

political stability, the crisis is not in President Nursultan Nazarbaev’s favor. In fact, the

President’s popularity has been staked on the country’s economic success, on his twin resolve to

have it gain entry into the exclusive club of the world’s ten largest exporters of crude oil, and to

catch up to the living standards of Central European countries. Disappointed social expectations

could turn into political discontent. On the other hand, in the “Family’s” somewhat concealed

war against the technocrats and certain oligarchs, the crisis paradoxically plays into Nazarbaev’s

hands. Since the start of this decade, the Presidential clan has sought to re-establish “vertical

power” in the domain of resource management. This goal has been partially accomplished

through the Samruk holding, which has reinforced the preponderant role of the state in the

management of the country’s large companies (e.g. KazMunayGas, and Kazakhstan’s telecom,

postal, railway, and electricity companies). As a result, the oligarchs have concentrated their

oppositional forces in the world of finance and banking, as well as in the metallurgy industry,

which both are still privately held. The tycoons, including figures such as Nurlan Subkhanberdin,

who is often presented as the “Kazakh Khodorkovsky”, Alexander Mashkevich (Eurasian

Group), and Vladimir Kim (Kazakhmys), all make appeals for the diversity of economic actors

to be preserved. The sudden weakening of these milieus, in particular of the banking circles,

facilitates a recentralizing of the Kazakhstani economy around the state. In the short term, this

development raises questions about access to resources for private actors, and, in the long term,

questions about the stability of property at the time of the next Presidential succession. On the

societal level, the crisis not only affects the population of Kazakhstan, but that of the entirety of

Central Asia. Over recent years, Kazakhstan has become the economic motor of the whole

region. It is particularly important for Kyrgyzstan, since, with trade levels reaching nearly 450

million dollars in 2007, it rivals Russia and China as the country’s largest trading partner.

Moreover, Kazakhstan is establishing itself more firmly in Tajikistan, continues to be one of

Tashkent’s most important partners (for example, in cereals), and Kazakhstani-Turkmen

cooperation in the domains of hydrocarbons and uranium extraction is certain to develop in

coming years. Any collapse of Kazakhstani investments in the region, especially via bilateral

Investment Funds (Kazakh-Kyrgyz and Kazakh-Tajik), would be detrimental to the whole

region, even more so at the present moment when Bishkek and Dushanbe both face huge energy

shortages and the latter significant deficits of foodstuffs. In addition, Kazakhstan has an indirect

influence on its neighboring economies, since, after Russia, it is the second most favored

destination for Kyrgyz and Uzbek migrants. Since the beginning of winter 2008, construction

sector workers, mainly Central Asian immigrants, have not received any or only substantially

reduced proportions of their salaries. As a result, they can either no longer send remittances

home or are compelled to return to their countries without the hoped-for money, which has all of

a sudden deprived hundreds of thousands of families of revenue at the onset of winter.

CONCLUSIONS: In the end, this crisis may come to have positive consequences. It will

streamline the Kazakhstan banking sector by getting rid of those companies that placed all their

bets on speculation. It will also act as a corrective to the over-evaluation of real estate and

encourage investment in more productive sectors. The crisis has demonstrated that the country’s

overall financial basis is solid enough to enable Astana to contain a market collapse.

Kazakhstan’s central bank still has about US$20 billion in reserves and the country’s oil fund

stands at about USS$15 billion. Nevertheless, the long-term social impact remains unclear, and

were the “Kazakhstani model” to fail as a result of this crisis, it would have a detrimental impact

on the rest of Central Asia.

The macroeconomic overview after during financial crises

Economic Growth

Kazakhstan’s industrial sector remains under increasing pressure from anemic domestic

consumer and investment demand as well as the weakening global economy. In February, retail

sales fell for the second month in a row, shrinking by 4.5%, while fixed capital investments

declined by 5.6% . Apparently, both consumers and businesses continue to slash expenditures on

fears of an extended period of economic slowdown. According to the Consumer Opinion

Surveys conducted by the ASRK, the consumer confidence index fell by 9 percentage points in

January-February, pushing it into negative territory for the first time in two years. This means

that a growing number of households intend to delay spending on durable goods. This does not

bode well for retail trade, as the share of non-food products in retail sales has grown to nearly

70% over the last several years on the back of past shopping sprees for cars, furniture,

electronics and other durable items. Essentially, a retrenchment in private consumption is

gathering ground as consumers, who are already over extended by stagnating real wages and

tight bank lending, continue to downgrade their expectations. Several factors may explain this

accelerated erosion of consumer confidence. First, an abrupt decline in world crude oil prices

during the last quarter of 2008 came as a large unanticipated negative shock to Kazakh economy.

Second, weaknesses in the banking sector intensified, prompting the government to take a

controlling stake in the largest commercial bank. This implies that consumers can hardly expect

a loosening of credit conditions in the near term. Lastly, a large one-off currency devaluation at

the beginning of February considerably dented the financial position of households that

borrowed in foreign currencies, and may have rekindled inflationary expectations due to higher

prices of imports. Add to this falling real estate prices, which eat into the households’ wealth,

and the likely result will be a continued weakening of consumer demand.

Finally, the risk is that the recovery of domestic demand may be longer and weaker because

businesses have reduced investment spending as well. In January-February, fixed capital

investments declined 9.7% as fixed capital investments into industry and real estate, renting and

business activities (economic sectors that account for over 75% of all fixed capital investment)

fell by 25.4% and 14.9%, respectively. Weak investment spending may be associated with two

key factors. First, falling crude oil prices reduced the profit margins of oil producing companies,

which depressed capital outlays in the mining industry and investments into geological

exploration. Second, tight credit conditions continue to block the flow of funds to the

construction sector. As a result, in January-February 2009, less than 10% of all fixed capital

investment was financed with borrowed funds compared to more than 25% a year ago. On the

positive side, the share of foreign investors in capital spending doubled to 41% from 20.6% in

January-February 2008. After all, foreign oil producing companies continue to expand their

production capacities in Kazakhstan as the global economic slowdown and low oil prices may

help bring the cost of this expansion down. Indeed, Cambridge Energy Research Associates,

which tracks capital expenditure in the oil industry, sees a strong downward pressure on

upstream capital costs, which peaked in the third quarter of 2008. This means that oil companies

operating in Kazakhstan are likely to benefit from lower costs of equipment, materials and labor.

In particular, Royal Dutch Shell PLC plans to invest $900 million in Kazakhstan in 2009,

primarily into the Kashagan offshore oil field. Meanwhile, Tengizchevroil may expand the

production capacity of its Tengiz oil field to 0.75-1 million barrels per day.

In February, industry lost 4.7, following a downtrend that stretches back to November. As a

result, in January-February 2009, industrial production declined by 3.2% compared to 3.4%

growth a year ago (see chart 2). The manufacturing sector continued posting double digit

production declines, shrinking by 11.4% in January-February. On a positive note, in February

output in key manufacturing sectors (with the exception of fuel processing, which is facing a

reduction of demand from construction and trade) fell at a slower rate than the month before.

However, a comparison of industrial performance during the first two months of 2008 and 2009

shows that output contraction decelerated only in sectors producing construction materials

(primarily due to the sharp downward adjustment of output in that sector in 2008). Meanwhile,

performance of other manufacturing sectors visibly weakened. This means that manufacturing

output will continue to slide until global and domestic demand stabilizes. In particular, fuel

processing (where output fell by 6.7% in January-February 2009) may see its pace of decline

stepping up as demand for gasoline and other fossil fuels falls on the back of the anemic

transportation industry. Indeed, in January-February 2009, the volume of freight transportation

declined by 4.1% (up by 3.1% a year ago), while the volume of passenger transportation inched

up by only 0.5% (up by 4.9% a year ago).

Finally, it appears that economic weakness is spreading beyond the manufacturing industry into

the extracting sector. In particular, in February, output in the mining industry stalled for the first

time in more than a year, marginally shrinking by 0.3. Although oil and gas extraction grew by

4.7%, a sharp reduction in coal production (down by 21.4%) and falling extraction of metal ore

(down by 5.4) offset positive growth in other mining industries. However, if lower output of

metal ore may be associated with falling global demand for steel, falling coal production may be

rooted in decreasing output of utilities (down by 7.8% ). Indeed, in January-February, electricity

generation shrank by 9.6%, which may have caused a reduction of demand for coal since about

80% of electricity is produced by fossil fuel-fired plants, while more than a third of all locally

produced coal is consumed by the utilities sector.

Fiscal Policy. The government of Kazakhstan has revised its macroeconomic projections for

2009-2011 as a response to currency devaluation and intensified global economic slowdown. In

particular, assumptions on crude oil prices were lowered to $40 per barrel in 2009 and to $50 per

barrel in 2010. As a result, real GDP growth in 2009 is forecast to advance by only 1% – down

from the previous estimate of 2.7%, while consumer prices are anticipated to grow by 11% in

2009. The republican budget revenues were reduced by KZT 23.4 billion ($155 million) to KZT

2,837 billion ($18.9 billion), while budget expenditures were cut by KZT 21.2 billion to KZT

3,411 billion ($22.7 billion). This means that the deficit of the republican budget will stay at

KZT 573.6 billion ($3.8 billion) or about 3.4% of GDP. During the first two months of 2009, the

state budget registered a surplus of KZT 92 billion or 0.55% of projected full year GDP (see

chart 3). State budget revenues fell by 9.2% as tax revenues decreased by 10.7%. A decline in

tax revenues is most likely driven by lower VAT revenues on the back of decelerating retail

trade and imports. In January-February, state budget expenditures inched up by 1.2% as the

government cut spending on transportation, the energy sector and public housing. Meanwhile,

expenditures on agriculture, social security, education and healthcare continued to grow.

Obviously, this trend illustrates a shift in budget priorities, as tighter financial constraints induce

the government to cut or delay some investment projects while maintaining vital public services

and supporting social protection. Indeed, in January-February 2009, the portion of fixed capital

investment funded by the state budget narrowed to 3.7% compared to 6.1% the year before.

Monetary Policy. In February, the consumer price index (CPI) increased by 0.8% compared to

the month before (mom). Essentially, prices of non-food products (up by 1.8% mom compared to

a drop of 0.4% mom in January) were driven by the 22% currency devaluation in February,

which inflated prices of imports. As a result, prices of non-food products grew by 6%, offsetting

a deceleration of the growth of service tariffs and prices of foods. All told, in February, the CPI

grew by 8.7%. However, the exchange rate pass-through to higher prices of imports is likely to

continue pushing up domestic inflation in the near term. Indeed, the core CPI (which excludes

prices of foods and fuels) appears to exhibit a strong correlation with lagged exchange rate.

On a positive note, prices of Kazakh imports have been falling since September,

following global deflationary trends. Furthermore, weak consumer demand will almost certainly

limit the power of local retailers to pass on the full impact of the weaker Tenge to consumer

prices. Indeed, according to the Customs Control Committee, retail margins over the prices of

imported foods, fruits and vegetables tended to shrink in February. At the same time, retail

margins for non-food household products slightly increased. This may imply that the exchange

rate pass-through to consumer prices is likely to be more visible in sectors with limited capacity

for import substitution (for example, consumer electronics and household products) compared to

sectors where local competition is stronger such as food processing and agriculture.

In February, currency devaluation brought in a 25% nominal increase in forex-

denominated liabilities of banks’ borrowers. However, the total stock of forex denominated

credit inched up by only 1% mom to $27.6 billion as new forex loans in the amount of $1.7

billion were offset with $1.4 billion of repayments of outstanding loans, including $1.1 billion

and $0.3 billion paid back by companies and households, respectively (see chart 6). Meanwhile,

the stock of KZT denominated loans dwindled by 2.2% mom in February (or by 3.3%) as during

the first two months of 2009, the volume of newly issued KZT denominated credit fell short of

the amount repaid by both households and the corporate sector.

As a result, in February, the stock of domestic credit inched up by only 1.7% to $54

billion and was primarily driven by corporate borrowing in foreign currencies. Slower growth of

domestic credit and currency depreciation looks certain to elevate credit risks in the banking

system. First, slower expansion of credit portfolios deprive banks of future interest income,

which may lower profit margins and erode banks’ capital. Second, both households and

companies remain exposed to currency risks, as about 40% and 50% of all loans issued to

households and the corporate sector, respectively, are denominated in foreign currencies. This

means that borrowers who earn income in Tenge and repay loans in foreign currencies may be

forced to delay debt service payments or even default. As a result, more forex-denominated loans

will turn sour as households face higher unemployment and lower wages and corporate profits

dwindle (see chart 7). On an optimistic note, the impact of the recently launched bank bailout

program should become visible during the next several months. If this program helps to unfreeze

the banking sector and revive bank lending, the ratio of bad loans kept on banks’ balance sheets

may stabilize. However, it is likely that further efforts will be required to help the banks clean up

their books by encouraging private investors to purchase troubled assets.

International Trade and Capital. Falling global commodity prices continue to exact a toll on

Kazakhstan’s export revenues. In particular, in January, exports fell by 50.5% to $2.7 billion –

the lowest monthly volume since February 2006. This contraction was triggered by the 52% and

42% declines of prices of crude oil and ferroalloys, respectively. Meanwhile, imports fell in both

value and volume across virtually all commodity groups to $1.8 billion, decreasing by 21.4% .

As a result, in January the foreign trade surplus amounted to $0.75 billion or nearly 4 times

lower than a year ago (see chart 9). This means that the current account deficit may exceed $0.5

billion in the first quarter of 2009. However, the weaker Tenge, falling domestic demand and a

possible stabilization of crude oil prices in the second half of this year may help contain the

widening of the current account gap beyond 4% of GDP in 2009.

According to the National Bank of Kazakhstan, in 2008 the gross external debt grew by

11.2% (compared to 31% in 2007) to $107.8 billion. Meanwhile, faster growth of nominal GDP

helped to narrow the ratio of foreign debt to GDP to 82% from 92% at the end of 2007.

Essentially, last year the dynamics of foreign external debt was shaped by two main factors.

First, Kazakh banks reduced their external debt by 15% to $39 billion (see chart 10) on the back

of the sizable repayments of external loans and tight global credit markets. Second, other sectors

of the economy accumulated an additional $17.7 billion in foreign debt (or up by 37% to $67

billion). Lastly, the volume of intercomany lending jumped by 23% to $37 billion or over one

third of all external debt. At the same time, the allocation of foreign debt across sectors reveals a

strong bias toward the oil industry. Indeed, more than 55% of all foreign debt outside of the

banking sector is concentrated in the mining industry and geological exploration. Furthermore,

nearly 90% of this debt came in the form of intercompany lending (about 86% of all

intercompany lending). On top of that, more than 60% of all foreign debt that flows into

manufacturing is absorbed by metallurgy. All of this implies that foreign capital inflows (both as

foreign direct investments and debt flows) into the non-banking sector of Kazakhstan remain

skewed toward resource based industries.

World Financial Crisis “Freezing” Kazakh Economy and Might Lead to Recession in 2009

Oil and metal prices remaining high in recent years which make up about 90% of all Kazakh

export, entail high dependence of Kazakhstan on the world market conjuncture.

The situation became more aggravated for Astana because of total high level of foreign debt (as

of 1 January 2008) – 103,9 billion USD: national obligations of RK make up over 8 billion USD,

the debts of banks and enterprises of Kazakhstan exceed 95 billion USD, that make up almost

100% of the GNP of the country for the same period.

Given this, the gold and currency reserves of Kazakhstan, including general reserves of the

National Bank and resources accumulated at so called National Fund, was 38 billion and 438

mln. USD, out of which 21 billion USD belong to National Fund, as of 1 January 2008.

Experts say that according to results of 2007, despite high oil and metal prices, the deficit of

current payment balance of Kazakhstan was 7,2 billion USD. According to forecasts, in 2009

this data will be 4,9 billion USD.

The construction sector is also regarded as one of most affected by the crisis, where problems

started to emerge from summer 2007. It must be noted that such a situation was caused by rapid

development of construction in recent years at the account of massive crediting by second-level

Kazakh banks, which in their turn actively attracted foreign loans.

Lack of financing brought to “freezing” of more than 70% of construction sector of Kazakhstan

today. This was particularly evident in Astana and Almaty, where one could witness

demonstrations of protest of those shareholders who suffered from unfinished construction.

In these circumstances, in December 2007 the government announced about allocation of 4

billion USD to “fund the completion of construction of living houses in Astana, support small

and medium businesses, as well as refinance industrial facilities and infrastructure”, out of them

85% - from budget and 15% - private capital. Almost all of construction sites in both Kazakh

capitals are “foreseen”, no lending.

The allocation of government funds to finance the completion of construction is not able to

completely solve the problem, because the funds are obviously not sufficient. Only in Astana the

total cost of construction projects, as per estimates of builders, exceed 6 billion USD and

throughout Kazakhstan cost is bigger for several times.

Given this, experts are pointing to presence of corruption in the decision of the government on

financing some projects, among which 74 projects, which belong to either relatives or entourage

of N.Nazarbaev.

The crisis in Kazakhstan rather negatively affected the banking and financial sector, which was

rated by western rating and PR agencies as “best in CIS”. From 1 July to 10 October 2008 the

market price of companies, traded at KASE (Kazakh Commodities Exchange) dropped to more

than 61% - 1048.99 (as of 15 September 1709.72), thus decreasing in cost terms from $81.07 to

$31.62 billion. At the same time the volume of trades also soared. Within 8 months of 2008 the

volume of shares transactions (buy-sell) at KASE and at special trade platform of regional

financial center of Almaty was 2,6 billion USD, that is 2.1- fold lower than the same period of

the previous year.

The most capitalized companies at Kazakh commodities exchange such as ENRC, RD

KazMunaiGaz, and Bank TuranAlem have lost 65-70% in price during the same period. The

price of 1 share of Alliance-bank, which in June 2007 was $14 at London Exchange, today is

traded at $1.14. As a result the future of the bank itself is under question.

Kazcommertsbank became significantly cheaper as well: if in 2007 its assets were $5.3 billion,

today they are less than $2 billion. Khalyk bank, Temirbank and TsentrCredit bank suffered the

same.

At the same time the quality of their credit portfolios is lowering. Growing insolvency of

creditors and the urgent need to get back foreign credits are forcing Kazakh banks to hold trades

on pledged property throughout the country.

By selling pledged flats, cars, office equipment, furniture and other long-life goods, the banks

are trying to accumulate funds to return more than $12 billion, which must be paid out by the end

of this year.

With further decrease of credit rates of Kazakh banks given by international agencies, experts are

forecasting possible serious problems in the whole financial system of Kazakhstan.

In this situation the government of RK in October announced creation of so-called “fund of

stress assets” to support financial system of the country. Its volume is not known yet and will be

defined only when results of the budget for 9 months of 2008 are available. It’s not excluded that

the government may revise the current budget to lower some expenditures and direct them to

create a “stress fund”.

According to some estimates, the size of the fund can be $6 billion, out of which less than $1

billion are direct financing by the republican budget.

The situation taking shape at world financial markets pushed investors to leave the Kazakh

market. Outflow of finances from funds, investing in obligations and shares from so-called

“developing markets”, to which Kazakhstan belong as well, brought already to massive outflow

of shares from these countries, instability of their national currencies and sharp drop at

commodities exchanges.

The banking sector of RK constitutes a large portion of the commodities market of the country –

20%. Consequently, its problems are mirrored at the market as a whole. Another large niche is

occupied by raw materials sector (50%), which is experiencing hard times as well. According to

experts, it’s quite natural that the Kazakh market started to drop sharply and with all of its

components”.

The discussion of new Tax Code of Kazakhstan, which is to be introduced on 1 January 2009,

does not add any optimism. The intention of the government to lower the tax pressure on the real

sector of economy at the account of significant increase of load on the raw materials companies

cause serious concerns among investors, causing a “downward gamble”. In particular, Kazakh

government, based on the Russian experience, is intended to introduce from 1 January 2009

export duties for oil, oil products and some metals.

But the situation is getting more serious for the financial system of Kazakhstan as prices for the

main export articles - energy and metals fall down. If last July oil prices went up to a record level

of $147 for a barrel, in early October it was under $90. At the end of November, price of oil fell

to less than 50 dollars per barrel. This already led the Kazakh government to cut budget

expenditures by almost 20% for budgets of 2009, 2010 and 2011.

One can witness as well the fall of prices for articles of mining industry and metallurgy. Thus,

the owner of Karaganda Metallurgy Plant – Arcellor-Mittal, the largest in RK, had to send 30%

of the personnel or 4200 people on leave for 3 months. Other major companies and planning to

shed up to 25-35% of existing workforce.

Significant growth of inflation and decline of industry are taking place. This caused slowing of

GDP growth, decline of business, “freezing” or full stop of already launched investment projects.

Consumer demand is also dropping, which makes practically impossible the growth of Kazakh

economy at the account of inner reserves.

These trends have already negatively affected the rates of development of Kazakh economy.

According to IMF, growth of GDP of Kazakhstan as of the results of the current year dropped

from 5% to 4.5%, and in 2009 it will drop from 6% to 5,3%. But expert predict than real growth

of Kazakh GDP be almost 0%, since fall of demand and world prices for all major Kazakh

export commodities, among which commanding positions occupied by oil and metals (make-up

up to 92% of total export).

But the possibility of further aggravation of the world financial crisis can bring to a bigger

decline of GDP because of full “freezing” of funding by foreign investors of their projects in RK

and refusal of foreign banks to allocate credits for Kazakh enterprises.

Small and Medium-Sized Businesses:

the Two Remain, Bankers Drop Out

Small and medium-sized businesses (SMB) are the basis of stability in civil society, and the

Kazakh population's well being depends on their development. SMB do not only play a big

social role, supporting the economic activity of the majority, but also provide significant tax

revenues. In today’s difficult situation, small and medium-sized businesses can act as a stabiliser

– this is why they have the right to rely on appropriate social and government support.

The international experience shows that if a state wants to develop dynamically and stably then

its socioeconomic program must include measures aimed at stimulating small and medium-sized

businesses. Today, SMB account for from 40% to 90% of the gross domestic product (GDP) in

developed countries. Therefore, it is quite natural that the governments in those countries attach

a priority importance to the support of this sector. In principle, Kazakh SMB are following

global trends, but their contribution to economy drastically differs from global indicators.

According to official statistic reports, the SMB’s contribution to the Kazakh GDP stood at 30.9%

in 2007. Industry and Trade Minister Vladimir Shkolnik said that the production output in this

sector grew in 2007 from 350 billion tenge in the first quarter to 689 billion tenge in the fourth

quarter. In addition, this year’s indicators are much less – the output at constant prices (that is

after allowing for inflation) demonstrates a decrease in the development. Specifically, the

production growth stood at only 3% in the first half of this year and 2.5% following eight

months. Mr Shkolnik said that this happened as a result of a decrease in the crediting of the SMB

that started in the third quarter of 2007, causing a proportional fall in production after two-three

months.

In September 2008, the country numbered 666,098 active small enterprises (up by 1.4% on

January). Because of their population density, the cities of Almaty and Astana and Atyrau and

Mangistau Oblasts have the majority of enterprises. There are more agricultural farms in South

Kazakhstan and Almaty Oblasts. Over 1.9 million people are employed in SMB.

However, according to estimates by the Independent Association of Entrepreneurs (IAE) the

crisis, which has also shocked the SMB, has already led to a cut in the number of functioning

enterprises. Their number reduced by 25-50% in the past several months, depending on sectors

of the economy, while companies’ turnover decreased by 25-35%. This is quite explainable as

small businesses are first to experience all of the adverse effects. They are sensitive to any

changes in economy and ready to grow or shrink, reflecting the state of market.

Experts believe that the number of functioning SMB may further reduce by another 25% until

the end of 2008. They may reduce by 50% in certain sectors. Of course, these figures are much

lower in other regions because economically active people are spread unevenly across various

regions.

A swift growth in investment in construction in Almaty and Astana prior to the crisis, implied

the development of service sectors as well. At the same time, the consumer demand also grew –

with the help of consumer loans. The trade and service sector, which received a bigger amount of

loans, also gained its dividends. It is not surprising that a fall in the construction sector caused a

domino effect. Those regions where construction boomed less suffered fewer economic

consequences.

Following the economic locomotive’s derailment, private funds and loans invested in

commercial construction fell out of turnover as construction sites closed down. Under uncertain

circumstances, it is unlikely that invested funds can be recovered even in their initial volume.

The government’s measures like fund allocations for finishing buildings will not save the

situation. It is no secret that the lion’s share of houses were bought for mortgage loans, hence it

is no wonder that there is an increasing number of refusals to buy cheapening square metres at

exorbitant prices. Despite the creation of the Stressed Asset Fund, which was expected to

stabilise the situation, no one undertakes to forecast real estate prices.

For SMB, this kind of development of the situation will appear in the weakness of business

activities. The process of mutual non-payments has begun. Specifically, according to experts

from the IAE, defaults on bank payments have already reached 15-20% and may grow to 50% at

the end of the year. There is also a fall in the population’s purchasing capacity. Goods turnover

has also started to decrease, in some sectors by up to 70%. All of these are leading to an increase

in the term of capital turnover.

With the absence of second-tier banks’ opportunity to attract foreign loans, the problem with

funding SMB has worsened. The actual volume of last year's bank loans amounted to 1.461

billion tenge. Considering the trends in recent years, one can suppose that only in 2007 SMB

received more than 300 billion tenge, or $2.5bn, less.

Was the lifebuoy thrown far enough?

Official statistics also confirm the negative trends. According to reports by the National Bank, if

loans issued to SMB amounted to 232 billion tenge in June 2007, they fell to 85 billion tenge in

June of this year. This is even lower than the level in the same period of 2006, when 93 billion

tenge was loaned. In this situation, the state shifted to the policy of urgent assistance to SMB in

order to fill in the shortage of bank loans. In late 2007, the Kazyna Sustainable Development

Fund allocated 122 billion tenge to maintain a stable development of Kazakhstan’s economy.

Out of this sum, 48.8 billion tenge was earmarked through the Damu Small Entrepreneurship

Development Fund in seven second-tier banks in order to fund projects of SMB. At the same

time, areas of crediting were not limited and the interest rate should not exceed 12.5%.

During the programme implementation, these funds were used fully for 2,548 projects. The

deputy chairman of board of Damu, Marat Imankulov, told the international conference called

“The Future of SMB in Kazakhstan” that “the majority of the loans issued as part of the

programme, about 60%, was issued to fund the trade sector, and only 2% for agricultural

projects. At the same time, only 33% of the received loans were used for investment projects and

the majority was drawn to replenish circulating assets.”

Among positive results of the programme, Mr Imankulov noted timely financial aid to SMB

under the aggravating liquidity crisis in second-tier banks and the prevention of a decrease in the

crediting of SMB. At the same time, negative results included uneven allocation of funds across

the regions. The city of Almaty, where 10.5 billion tenge was spent on 311 projects, and

Karaganda and East Kazakhstan Oblasts drew on the maximum of credit funds. Almaty,

Zhambyl and Atyrau Oblasts drew on the least. In addition, despite the specified upper limit, the

effective crediting rate of 20.1% proved to be very high for final borrowers. Another problem is

the disbalance in sectoral distribution. According to experts, the trade and service sector drew

about 80% of the funds.

It was expected that these shortcomings would be resolved by dividing the state support of SMB

into three programmes: 50/50, Damu-Regions and Damu-Koldau (Development-Support), the

approval of which was announced in August this year.

The first of them, the 50/50 Programme, provides for the Damu Fund’s earmarking of state funds

worth 50 billion tenge through operating banks, and it is in fact the second tranche within the

stabilisation programme, which was launched last year. According to co-financing conditions

under the fifty-fifty plan, partner banks are obliged to provide additional 50 billion tenge of their

own funds. In total, SMB must receive 100 billion tenge. The interest rate for final borrowers

must not exceed 12.5% p.a., and at least 50% of the loan is to be used to buy fixed assets. The

programme was launched in August 2008 and planned for six months.

The Damu-Regions Programme was expected to resolve shortcomings in regional distribution of

the state aid. The programme provides for the allocation of 56 billion tenge for crediting SMB

under the conditions of equal co-financing: the government earmarks 28 billion tenge from the

national budget through the Damu Fund, and the regional administrations allocate the remaining

28 billion tenge from local budgets. In line with the 28/28 programme, the interest rate must not

be over 13.6% p.a. Each regional administration independently specifies the terms of funding in

line with regional priority programmes.

Finally, Damu-Koldau is expected to resolve the domestic economy’s disbalances between

sectors. This programme envisages the annual allocation of 10 billion tenge from the fund’s

private resources as a direct support of profitable productions in the processing industry,

transportation and communication. The programme’s objective is to support diversification by

cutting the costs of credit resources allocated for the expansion and the modernisation of fixed

assets, and the technological re-equipment of actively functioning enterprises in sectors that are

prioritised in the strategy of industrial and innovative development.

It seems that the lifebuoy has been thrown and banks have received the state funds fully.

Nevertheless, intermediate results are far from being unequivocal. The 50/50 Programme yielded

quite deplorable results in the first three months of its implementation. Virtually, participating

banks issued only 12.4 billion tenge for 402 SMB projects, or 12.4% of the planned funds, in this

period. Average weighed rate stood at 12.5% and the effective rate at 14.4%. The leading regions

included the city of Almaty (20.2%, or 2.5 billion tenge), West Kazakhstan Oblast (10.4%, or 1.5

billion tenge, 29 projects), and Almaty Oblast (9.2%, or 1.2 billion tenge, 25 projects).

Mangistau, Kostanai and Zhambyl Oblasts were outsiders.

The main reason behind the slow application of the funds, in the opinion of Damu, are long bank

procedures, which take two weeks to consider and approve a project and another two weeks to

register securities. For their part, bankers said that application procedures were delayed because

the implementation of the first programme revealed significant risks posed by borrowers’

improper use of funds. It is clear that the state will make banks responsible for this, and this is

why the latter have to play safe in selecting projects. Another problem that was revealed during

the programme implementation is a limit of bank loans that are issued to maintain the working

capital and refinancing. At the same time, most of entrepreneurs have quit thinking about new

projects, as they need to secure the current liquidity, facing problems of servicing their debts. In

this situation, the circle of potential borrowers among small enterprises has shrunk a lot, and it is

impossible to expand it by including bigger companies because of the limit of bank loans.

In order to speed up the loan issue procedures, the decision to renew agreements with second-tier

banks was reached, cutting the term of application of funds from six to four months. At the same

time, restrictive measures like the ban on the refinancing of earlier loans and bank loans for

replenishing the working capital were lifted. In addition, the upper limit on assets of production

companies was raised from $3m to $5m. It did not take long for results to appear. According to

the president of Kazyna, Kairat Kelimbetov, it was reported that as of 20 November 2008,

second-tier banks had applied 39 billion tenge (735 projects), or almost 40% of the total sum.

However, considering that the bans were lifted only in the middle of November, one can assume

that bankers have begun to hurry up under the government's pressure. It is likely that the threat of

funds redistribution within the programme did its job. Mr Kelimbetov said that, considering the

change in the terms, the plan was to use all of the 102 billion tenge until the end of 2008.

The Damu-Regions Programme is plodding along with even more difficulty. If the 50/50

Programme involved eight partner banks, the regional programme included only two in the

beginning. This figure grew to five later. Major players like Halyk Bank, Nurbank, ATFBank,

Kazkommertsbank, Tsesnabank and Kaspi Bank are not involved in the programme at all. They

have the same reasons – strict conditions, i.e. the bans on financing trade and intermediary

operations, refinancing earlier issued loans and bank loans for medium-sized businesses.

However, in this case, the situation is aggravated by the fact that regional administrations

suggest projects that have social importance for regions but do not meet bank requirements at the

same time. Many of them are poorly elaborated start-up projects, which will be implemented in

rural areas. Under these circumstances, banks simply refuse to undertake risks. In light of this, it

was suggested that second-tier banks be removed from the programme and projects be

implemented directly through the Damu Fund, as it was done earlier. In this case, the state fund

will undertake all risks. This may reduce interest rates, cut the term of project consideration and

increase the number of participants.

On the other hand, Mr Kelimbetov said that the analysis showed that not all of the regional

budgets could find an additional 2 billion tenge. As a result, in late November, the government

began cutting funds that had been allocated earlier. Funds that were earmarked for Pavlodar,

Mangistau and Almaty Oblasts are under consideration for reduction.

In all, 11.9 billion tenge out of 26 billion tenge of the government funds was allocated in five

participating banks as part of the implementation of the 28/28 Programme until the end of

November. At the same time, 6.2 billion tenge, or 50% of the amount transferred to the banks,

was spent on 295 projects. The amount of loan applications from entrepreneurs under this

programme reached 21 billion tenge, which shows the great unmet needs of SMB in regions.

In order to speed up the investment of state funds, the Samruk-Kazyna National Welfare Fund

has suggested that special project selection commissions, which were created under regional

administrations, be removed from the decision-making process. However, SMB representatives

fear that this measure will instead worsen the situation and decrease the number of potential

programme members. They said that, as executive bodies, regional administrations know what

projects, companies and sectors to fund in order to develop their regions and support

entrepreneurs.

Another problem of the Damu-Regions Programme is the lending rates that are higher than in the

50/50 Programme. You recall that, in this programme, regional administrations’ margin range

between 6.72% and 8.64% (the rate of return on government securities serve as a reference for

fixing the rate), the Damu Fund’s rate up to 1.5%, and second-tier banks another 5%. As a result,

the interest rate for final borrowers reaches 14%. In this connection, Mr Kelimbetov told a

government meeting on 10 November that the final rate should be fixed at 12.5% p.a. so that

there was no competition between the state programmes. The plan is to achieve this by cutting

the rate of regional administrations. They will provide their resources from Samruk-Kazyna

under the rate of 3% p.a. Experts from the fund said that all of the state funds earmarked for the

28/28 Programme would be used until 1 March 2009.

Are there options?

So, having accepted the programme, the government is creating institutions and allocating funds.

The main stumbling block is the implementation of these programmes, during which all

problems have been revealed. In addition to high interest rates, other obstacles include

bureaucracy, borrowers’ lack of securities, the underdevelopment of the financial infrastructure,

and corruption. Recent opinion polls among people working in SMB show that over 90% of

them find it necessary to increase state support, excluding intermediary links, for instance, banks,

from the so called the ’state-SMB‘ chain.

However, this suggestion gives rise to certain doubts. An illustrative example is the Damu-

Koldau Programme that is not working in practice because of continuous internal agreements.

The fund’s requirements, which are imposed on borrowers with regard to risks, financial

stability, organisational consistency and elaboration of projects, do not differ much from those of

banks.

At present, from 50% to 70% of entrepreneurs are receiving bank loans. Very few, a little over

10%, use services of microcredit organisations, whose interest rates are higher.

Kazakhstan has other sources of funding that are alternative to crediting. However, they still

remain a theoretical possibility for SMB. Attracting business partners or investment funds is one

of the methods. Considering our realities, entrepreneurs used to dash aside from these options

until recently. Today’s problems make them change their positions. Another option is the stock

market. Everyone is continuing to talk about the need for its development. Terms of entering this

market have been liberalised significantly, especially for small and new companies. The key

term is transparency, for which entrepreneurs themselves are not ready yet. Another option is

venture capital financing but, despite its long history and existing infrastructure, this sector does

not yield high results. SMB could renew their key assets through leasing; especially now that the

government rejected draft changes to the laws on abolition of benefits for leasing companies.

However, the development of this market has also halted against the background of a fall in the

production sector.

To be continued…

Meanwhile, at the conference in government in Astana on 24 November, the chairman of the

board of Samruk-Kazyna announced that the fund would earmark additional one billion tenge of

loans for SMB in the following year under the president’s assignment. Seventy percent of these

funds will be used to refinance current projects in order to decrease the general rate for small

businesses and 30% to implement new projects. Mr Kelimbetov said that the state funds must be

offered to SMB at a final rate of not more than 14%. It is noteworthy that the implementation

schema will not change considerably: the plan is to distribute funds of Samruk-Kazyna through

the Damu Fund and commercial banks, whose participation conditions and margins have not

been specified yet. Hopefully, the programme’s final implementation mechanism will be

developed through a dialogue between government bodies, development institutions and

businesspeople and the coordination of their efforts. Otherwise, they may step on the same rake

again and again.

By Roman Yakutkin

KAZAKHSTAN International Business Magazine №5/6, 2008

The Bankers are in Trouble

The nationalization of BTA Bank and Alliance Bank, 25% devaluation of tenge and another

downgrade of international ratings of Kazakhstan second-level banks are the major events in the

financial market that will make the first quarter of 2009 remembered.

Under governmental protection

Kazkommertsbank and Halyk Bank, receiving one billion US dollars each from the government,

put "their signatures with blood before the President", the Prime Minister said. BTA Bank and

Alliance Bank had to "sacrifice" 78.14% and 76% of their stock, respectively, in favour of the

government.

While "the samurais" from the Alliance Bank "got nothing" back for issued bank shares (100

tenge for entire stake), the situation with BTA shareholders developed the other way: the

government washed out the stake of previous owners and made a decision to organize additional

issue of bank stock unilaterally.

The official representatives reasoned their historic decision of February 2 by the fact that due to

the dramatic change in the quality of BTA assets, it urgently required huge help from the

government. New Board of Directors Chairman of JSC BTA Bank, Arman Dunayev, noted that

"the main reason why the government acquired a share in BTA capital is the violation of

liquidity coefficient and capital adequacy ratio, allowed by the bank".

According to Deputy Head of the Financial Regulation Agency (FRA), Kuat Kozhakhmetov, the

government exercised its right set out in the new amendments to banking legislation. "In

accordance with the latest amendments, if the bank violates the capital adequacy ratio, the

government is entitled to make a decision to purchase at least 10% of additionally issued stock

that will help bank improve the situation and meet all the standards. Therefore, the decision on

additional capitalization was produced. It was defined at the level of 251.3 billion tenge. This

will allow ensuring the government’s participation in the bank at 78.14%". At the same time, Mr

Kozhakhmetov believes that government’s actions in relation to the BTA Bank are not a

nationalization attempt: "The participation of the government is a temporary action and it is

limited by one year. If current shareholders or potential investors do not have enough resources,

the state will continue participating in the bank as a shareholder".

Nonetheless, it was officially declared earlier that state support will be limited "only and

exclusively" by a 25% state participation in the capital of four backbone banks – BTA Bank,

Alliance Bank, Kazkommertsbank and Halyk Bank. The government promised to offer the

preemptive right to current shareholders on the purchase of additional issue stocks, based on the

previous version of the law On joint stock companies, but not the new amendments. The latest

changes in the banking legislation introduced the norm, according to which if the bank is not

able to maintain a capital adequacy ratio, the government can take unilateral action on

conducting the additional issue of stock.

Born in the devaluation

Soon straightaway after the public digested the information about the transfer of BTA and

Alliance under state control, suddenly, in the following two days, the "old-new" Chairman of

National Bank, Grigoryi Marchenko, announced a 25% devaluation of Tenge on February 4.

In the first days after making the decision to devaluate the Tenge, many foreign and domestic

analysts supported this measure. Later on, however, a number of critical comments arose.

Specifically, Standard & Poor’s and Fitch Ratings reported that the rapid devaluation of the

Tenge would produce further deterioration of the banking assets quality due to the significant

volume of loans, issued in foreign currencies (and this is over 50% of the principal receivable in

the banking sector) and issued to non-hedged corporate clients and individuals that receive their

income in Tenge.

In the opinion of S&P experts, another risk, associated with devaluation, "is in the possibility of

losing confidence in the stabilization of the monetary system and, therefore, further loss of

confidence in the banking sector, as a result of which the exchange rate of the national currency

can drop even lower. This, in its turn, is likely to become the reason for a new outflow of

deposits from banking system". Moreover, the rating agencies note that business conditions for

"not large banks" (second group) are getting worse and the level of associated risks also

increased.

The domestic experts also give critical comments on the actions of the National Bank. For

instance, the head of the Group for Macroeconomic Studies, Olzhas Khudaibergenov, explained

why the demand for foreign currency will remain at the high level, even if the exchange rate

drops to 200 tenge per US dollar: "First of all, the borrowers need to service foreign loans to the

total volume of $105 billion. Secondly, they need to repay foreign currency loans, issued in the

country". This year, only the first group mentioned above has to repay $12-13 billion while the

second group has to repay another $6 billion. As a way out, Mr Khudaybergenov suggests

"abandoning the financial ideology that supplied foreign currency loans to the economy and

population at least in those sectors and operations, where foreign currency is not highly needed".

He suggests to transfer all foreign currency loans, issued to legal entities and individuals before

February 4 of this year, into Tenge loans, based on the old exchange rate, and to remove all the

fixations to the exchange rate fluctuations from the Tenge-issued loans. At least, it is expected to

apply such mechanism in the banks with state participation in order to "zero out unnecessary

demand inside the country".

In his turn, in an interview with the Respublika weekly edition the director of Kazakhstan

Development Institute, Magbat Spanov, noted "Our managers, economists try to follow the same

aggressive way of Mr Marchenko. He applied the same strict measures that we experienced

twice. They took place in the beginning of 1990s and in the beginning of 1999. I believe these

were not the right steps".

According to the expert, today, the situation in the economy is totally different; therefore, "the

correct action had to be to launch a floating rate of the Tenge and its gradual devaluation", since

"the population owes money to the banks and state – overall, the entire country sinks in

mortgage and consumer loans". Now, up to 60-70% of the economy is likely to go illegal that

will, therefore, produce the radicalization of political life.

Ex-Head of BTA Bank, Mukhtar Ablyazov, gave the most critical comments on devaluation. In

his interview to Azattyk radio the banker says that this time the devaluation was organized in a

"very rude and cynical” manner while "the state has many optional instruments". Mr Ablyazov

also informed that in January of this year during his meeting with the President of Kazakhstan he

"proposed his own plan of devaluation and warned that this step requires very serious

preparation". Moreover, Mr Ablyazov affirms that the preparation to devaluation in April of

1999 was initiated six months prior to its launch.

To change, but not to leave

In taking care of banks and running this shocking devaluation, the government had to see the

results of its efforts. At first, Standard & Poor’s agency lowered long term counterparty credit

ratings of Kazkommertsbank, Halyk Bank, Alliance Bank, BTA bank and its two subsidiaries –

Temirbank and BTA Mortgage. At the same time, the rating forecasts for Kazkommertsbank and

Halyk Bank remained "negative" while the rating of other banks "was under re-consideration".

Later on, Standard & Poor’s disseminated another message. This time it mentioned the second

group banks representatives – Eurasian Bank, KazInvestBank, Lariba Bank, Nurbank and

Tsesnabank. Unlike the largest banks, which received governmental support, these five banks

were analyzed by the agency that confirmed their long term counterparty credit ratings with a

"negative" forecast, although, prior to that, Lariba Bank and Tsesnabank had been awarded a

"stable" forecast. The agency reasoned its conclusion by the fact that "despite deterioration of

assets quality and pressure on liquidity, the funding opportunity for many small and medium size

banks looks better than for some large credit organizations in Kazakhstan, because they have less

needs in refinancing of external debt". Another advantage, highlighted by analysts, is the

different crediting base, since "the second group banks are mostly oriented at the Kazakhstan

market and it also received a deposits inflow from larger second-level banks. Although

devaluation also negatively impacted the quality of assets of these banks, their level of foreign

currency loans is significantly lower across the banking sector.

Unlike S&P, on February 19 Fitch Ratings reported more a pessimistic conclusion in relation to

Kazakhstan. First of all, it moved the sovereign ratings of the republic into the “Negative" list –

long term issuer’s default rating (IDR) in foreign ("BBB-") and national ("BBB") currency, short

term foreign currency IDR ("F3") as well as country ceiling rating ("BBB"). The agency states

that the reason for this decision is higher pressure on the banking sector that "can potentially

weaken state finance". According to Fitch, very soon the government will have to offer a new

financial assistance package to second-level banks that will be, first and foremost, used by

nationalized banks to perform their liabilities.

The Fitch Ratings analysts report that since September of last year foreign state-owned assets

have diminished by 7.2%. Considering the fact that $14 billion must be repaid on external debt

in 2009 the pressure on foreign finance of Kazakhstan will inevitably get intensified. However, it

seems that so far our country is not yet in trouble since total state debt of Kazakhstan is equal to

7% of GDP while the position of the government as foreign net-creditor equals to 28% of GDP.

And this is considering the fact that average indicators for countries with "BBB" rating category

reach 28% and 8%, respectively. However, if the foreign creditors demand massively early

repayment of external debt from banks and national companies, the situation is likely to get

complicated rapidly.

Fitch also turned out to be stricter than S&P, in relation to leading of second-level banks of the

country. The long-term issuer’s default rating for BTA Bank and Alliance Bank were lowered by

two grades – to "B+" and "B", respectively. Six other banks saw their IDR, lowered by one grade

to "BB-" for Kazkommertsbank and Halyk Bank, "B+" for BankCenterCredit, "B+" for

Temirbank, "B" for КASPI BANK, and even "CCC" to Tsesnabank. The agency also awarded

low rating to capital-based Astana-Finance, controlled by Samruk-Kazyna NWF, and its

subsidiary – same-name leasing company, whose rating had been lowered to "B+".

Regarding the rating forecast, Fitch lowered the ratings of КASPI BANK, Tsesnabank and

Eurasian bank from "Stable" to "Negative". The rating of all other banks, including ATFBank,

Kazakhstan Development Bank and KazAgroFinance state company, were moved to the

"Negative" list under monitoring.

However, some of our bankers were not surprised with the downgrade of the ratings. According

to КASPI BANK CEO, Mikhail Lomtadze, today the world financial system is revising its

working mechanisms. The ratings are also reconsidered under the influence of world recession.

"The agency reports are influenced by the world dynamics and these are predictable steps". Mr.

Lomtadze believes that nothing has changed for Kazakhstan banks, especially for those that do

not have as much in foreign loans. "To be honest, today, the ratings do not play so much of an

important role for decision-making in general. I am affirmed that we will witness the downgrade

of ratings throughout the world and Kazakhstan is not an exception. The investors throughout the

world lost a great amount of funds. The value of many companies dropped to 10 year old figures.

The ratings are under high pressure of the world economic crisis, and this is the reason for

lowering the ratings of countries, companies and banks. We can expect higher ratings only after

improvement of the global economic situation in general and, unfortunately, their upgrade does

not depend on individual efforts of certain companies".

This happened in February. In the following month, during March 23-30, for the worse, the

international rating agencies published another bunch of negative information in relation to

nationalized Kazakhstan banks.

The first statement, oriented at state-owned banking institutions of Kazakhstan, was made by

Fitch Ratings that had lowered the long term foreign currency issuer default rating (IDR) of BTA

Bank and its subsidiary Temirbank from "B+" to "CC". Moreover, the ratings were moved to the

Rating Watch list under monitoring with negative forecast. Fitch analysts say that downgrade of

ratings "is reasoned by possible default, at least for some financial liabilities of banks and that

became the answer to BTA Bank statement made on March 17, 2009". It mentions the

consideration "of possible debt structure change of BTA group" and notes that "in case of

accelerated repayments of certain financial liabilities of BTA group prior to their repayment

deadlines, Samruk-Kazyna may be no longer capable to provide financial support". Fitch notes

that in accordance with the methodology of forced exchange in liabilities, this exchange is

considered to be valid in the following cases. First of all, if "the terms of organization’s financial

liabilities are changed dramatically, resulted in overall aggravation of the situation for creditors

with regard to their initial contractual obligations". Secondly, if such changes take place "due to

forced or de facto necessary exchange, even if, from technical point of view, the exchange is

processed voluntarily". The analysts note that the organization of forced exchange of debts leads

to downgrade of issuer’s rating to "D" level (default) or "RD" (limited default).

Fitch was less critical in relation to Alliance Bank. The agency lowered its IDR from "B" to

"CCC", moving its rating under monitoring to Rating Watch list with negative forecast. The

agency analysts report that the downgrade of rating reflects the presence of uncertainty about the

level of support, to be provided to the bank by the government of Kazakhstan, as well as high

risk of possibility that the bank will restructure part of its financial liabilities. At the same time,

Fitch made it clear that forced exchange of debts will influence the downgrade of Alliance bank

rating to "D" or "RD". Nonetheless, the agency increased the rating of Alliance bank by one

grade, unlike the case with BTA Bank and its subsidiary Temirbank. Fitch motivates its decision

by three factors. First of all, Alliance Bank had not been acquired by that time by the government

of Kazakhstan "and, therefore, certain norms on change of control in the documentation on

bank’s debts had been launched with less lower probability". In their words, this means that "the

current scale of possible acceleration of debt is possibly much smaller while the need in

restructuring the bank’s liability in short term may become less serious". Secondly, the

substantially smaller size of the bank, comparing to BTA, means that the size of governmental

support, which Alliance bank may need, will also possibly be less. Third, bank "has not made

official statements on potential restructuring of its debt".

In its turn, Standard & Poor’s lowered the ratings of BTA Bank and its subsidiaries, Temirbank

and BTA Mortgage, twice, on March 24 and 26. At first, S&P downgraded their ratings to

"CCC+/C" and then to "CC/C". Alliance Bank was not missed out: S&P lowered its ratings from

"B/B" to "CC/C" on March 26. At the same time, the ratings of Alliance, BTA and its

subsidiaries also remain included in CreditWatch with a negative forecast that increases the

probability of their further downgrade to "D" level or issuer’s default rating. According to Annet

Ess, on the one hand, the decision of lowering the ratings is reasoned by "very high probability

of debt restructuring by BTA and Alliance Bank". On the other hand, there is "less probability"

for these financial institutions to receive state funding for the debt repayment. Moreover, S&P

rating reports were also influenced by problems with funding, liquidity and deposit base

instability in the banks, as well as pressure on their creditability "also due to substantial

deterioration of assets quality". S&P warns that it will lower the ratings of BTA and Alliance to

"D" level, if there is absolute necessity of debt restructuring or their failure to repay debts on

time.

Moody’s agency also mentioned nationalized banks, lowering the ratings of BTA Bank and its

subsidiary, Temirbank. The foreign and local currency deposit rating of BTA fell from "B1" to

"Caa3". The rating of senior unsecured foreign currency debt dropped from "B1" to "Ca". The

Bank financial strength rating was lowered from "E+" to "E". Speaking of Temirbank, Moody’s

lowered its foreign and local currency ratings from "B3" to "Caa3" whereas the financial strength

rating dropped to "E". Herewith, the agency analysts report that banks’ financial strength ratings

have stable forecast while their deposit ratings and senior unsecured debt ratings remain in the

reconsideration list with possible downgrade. As well as Fitch and S&P, Moody’s highlights that

the downgrade of ratings reflects the higher probability of default and debt restructuring of BTA

and Temirbank in connection with continuous weakening of financial strength of these banks as

well as lower probability of state support for covering their foreign liabilities.

After a while, the agency made the same conclusions in relation to Alliance Bank, lowering its

local and foreign currency deposit ratings from "B2" to "Caa3". The foreign currency senior

unsecured debt rating dropped to from "B2" to "Ca". At the same time, all ratings of Alliance

remain in the reconsideration list with the possibility of further downgrade.

Editorial

5 November 2007

Subscribe to press release email alerts

Related links

Kazakhstan homepage

Small business homepage

Kaspi Bank SME/MSE Loan [Project Summary Document]

ЕБРР оказывает поддержку развитию малого бизнеса в Казахстане

[Press Release]

EBRD supports small businesses in Kazakhstan

$59 million loan to Bank Caspian to benefit small enterprises

The EBRD is providing a 5-year loan to Bank Caspian to support the expansion and further

development of micro, small and medium-sized enterprises (MSMEs) in Kazakhstan.

The $59 million credit will be on-lent to local companies outside the major cities of Almaty and

Astana. Access to finance in the remote regions of Kazakhstan remains difficult.

The MSME sector is an important provider of employment and is increasingly critical for the

wider Kazakh economy. It is estimated that about 20 per cent of Kazakhstan’s economic output

can be attributed to the sector. The government sees the growth of small businesses as key to

sustainable development of an economy which is otherwise dominated by natural resources. The

demand from local micro and small businesses for loans has increased strongly and local banks

are increasingly solicited to provide longer term funding to the sector.

The EBRD loan will consist of two equal portions. The first portion will be for loans below

$200,000, focused on the smallest businesses with an average loan size expected to be $10,000.

The second portion will be used to finance loans worth the equivalent of $200,000 to $500,000,

aimed at small and medium-sized enterprises. Thus Bank Caspian will be able to accompany the

growth of its smallest clients as well as to provide finance to larger more established borrowers.

The loan is supported by a $150,000 Technical Cooperation grant provided by the government of

Japan under the Japan Kazakhstan Small Business Programme (J-KSBP) to improve the

efficiency of the MSE lending. This programme will support three financial institutions in

Kazakhstan including Bank Caspian.

Bank Caspian and the EBRD have been partners since 2004 when Bank Caspian joined the

EBRD’s Trade Facilitation and Warehouse Receipts Programmes. Today, Bank Caspian is a

universal mid-size bank focused on servicing micro, small and medium sized enterprises as well

as private individuals. It is the eighth largest bank in Kazakhstan in terms of assets and the third

largest in terms of branch and point of sale network.

Andre Kuusvek, EBRD Director for Kazakhstan, emphasised that the loan to Bank Caspian will

have a special focus on the distribution of funds to micro, small and medium-sized enterprises in

Kazakhstan’s regions. With this loan the EBRD is assisting Bank Caspian to further diversify its

funding base and supporting the bank’s growth, he added.

Mikhail Lomtadze, Chairman of the Management Board of Bank Caspian, expressed his

“enthusiasm at EBRD’s decision to support Bank Caspian’s growth. This is an important

milestone in the development of Bank Caspian funding opportunities. Our strategy is to build the

most transparent and true retail bank. EBRD financing is one most important justification of our

efforts and strategy. SME and micro financing is one of key business for our bank. And this

financing, will enable us to further continue developing this business line and continue building

our market position.”

To-date, the EBRD has invested about $2.5 billion through selected projects that support

economic diversification, entrepreneurial activities and job creation in Kazakhstan.

Press contact:

Axel Reiserer, Tel: +44 20 7338 7753; E-mail: reiserea@ebrd.com

Financial Crisis Coming to Kazakhstan?

February 26th, 2008 Elena Suhir Posted in Eurasia |

(10 votes, average: 4.6 out of 5)

While many in Kazakhstan and abroad are wondering whether a large financial crisis is in store

for this oil-rich giant, others are hoping that this could be a window of opportunity to bring about

reform that embodies transparency, inclusiveness, rule of law and accountability, all key

elements in ensuring long-term stability and prosperity. Some have praised Kazakhstan as a rock

of stability and a regional leader in economic growth, however its current troubling

developments point to the danger of the contrary.

Recent political and economic trends in Kazakhstan have disappointed many well-wishing

international observers, who view the country as having significantly drifted away from

openness and transparency and embraced strong-armed tactics in the political arena as well as

the economy. These trends are disturbing not only because they stifle channels of civic

participation in the policymaking process, essential for democratic progress, but also because

they discourage investment and undermine the sustainability of Kazakhstan’s hailed economic

boom. If a crisis can lead to reform, then one can hope that this situation presents such an

opportunity.

Today, business laws in Kazakhstan typically favor the top-heavy Government and its loyal

financial groups, which emerged as a result of the opaque privatization of the 1990s. State

interests, including state-owned businesses, have a high stake in ensuring that the ruling party

stays as strong as possible: August 2007 Parliamentary elections, which by most accounts were

flawed, cemented the ruling party’s hold on the nation. In the last six months, Kazakhstan’s

policy has shifted harshly toward increasing government intrusion into business activity in the

energy sector, enacting laws that substantially boost the position of domestic government-loyal

business groups’ stake in the energy sector and granting the government power to unilaterally

cancel any contract with a foreign company that it deems to endanger the nation’s interest.

Due to the closed nature of government, one is left to believe that the decision of

“endangerment” will be left to the arbitrariness of high officials to be made behind closed doors.

These types of policies with short-term gains that benefit a handful of individuals, have widely

been proven to be harmful to nations’ long-term sustainable development by thwarting

investment, jeopardizing stability, undermining predictability, halting growth, threatening

progress and reflecting negatively on the country’s image abroad. In addition, the closed

policymaking process currently in place in Kazakhstan contributes to these problems by

weakening the government’s support among the population and undercutting the possibility of

adopting reform-oriented measures to design and implement sound investment policy.

Many indeed believe that Kazakhstan is experiencing the beginning of a financial crisis.

President Nazarbaev vaguely and uncommittedly alluded to this in his address to the nation on

February 6, 2008. Independent observers, however, are more pessimistic. Reports from the

region unilaterally point to symptoms of an economic slowdown and a rising predicament that

has not and cannot be solved by large reserves of energy resources. Local economists and

business leaders offer the following evidence of trouble on the horizon and a crisis in the

making:

The construction boom has slowed drastically. Anyone who has visited Almaty in the last few

years could not help but notice the omnipresent construction sites (and resulting traffic jams that

at times paralyzed the city). Today, cranes have stood motionless for months in Almaty and a

number of large construction companies face bankruptcy, dramatically cutting staff. Cost of

housing in Almaty fell by 30% and in Astana by 20% according to some estimates. This is

particularly significant as construction has highly contributed to GDP growth.

Lack of mortgage loans has led to a drastic fall in demand for housing.

Changes in the construction and mortgage sectors have led to deep decreases in personnel in

other industries, cutting upward of 30% of staff in some large companies.

Banks have been unable to provide credit to businesses, leading to shortages in working capital

for businesses and difficulty in turnaround. Although the government has pumped large amounts

of cash into the banking system through the Central Bank, this has led to a slight decrease, but

not eradication of this problem. There are rumors that many banks will have to substantially alter

the compositions of their Boards and management. The Central Bank is currently unable to

mitigate the banking sector problems.

Interest rates charged by banks do not cover the inflation rate.

Locals estimate that the unemployment rate has reached 20%.

Fortunately, to-date there has not been a massive movement to withdraw deposits from banks.

This is primarily due to two reasons: (1) The President and his Government command a

relatively high degree of trust on behalf of the population and more disturbingly, (2) the

population lacks the knowledge on the fundamentals of financial issues and the ramifications

such problems can have. The fact that massive withdrawals have not yet occurred, does not mean

that it cannot happen in the near or even not-so-distant future.

To his credit, the President has undertaken some laudable means to avert disaster. On February

14, the President of Kazakhstan issued a moratorium on all inspections of small- and medium-

sized businesses. This decision was based directly on the advocacy efforts of CIPE partners, the

Almaty Association of Entrepreneurs (AAE) and the Kazakhstan Forum of Entrepreneurs (KFE),

specifically on the recommendations that they provided to the Government on January 15, 2008.

The Government also began to organize courses for shareholders and the general population on

investment opportunities. People are seeking out new ways to invest with domestic crediting

sources. However, this is clearly not enough.

To truly avert crisis and ensure sustainable long-term growth, Kazakhstan must not go the way

of other energy-rich nations that have embraced authoritarian top-down political and economic

structures, eschewing reform and discarding alternate policy strategies to promote good

governance and long-term prosperity. Kazakhstan must undertake a series of reforms to

strengthen democratic institutions, establish an inclusive policymaking process, reinforce rule of

law and advance the principles of economic and political openness. As Kazakhstan prepares to

take the helm of the OSCE in 2009, it is even more imperative that its leadership does not waste

this opportunity to undertake substantial measures to lead its nation and the region toward sound

policy reform.

Economy of Kazakhstan cannot avoid recession

[15:03] 24.04.2009, Kazakhstan Today

The economy of Kazakhstan cannot avoid recession. Independent Director of JSC Company

National-Analytical Centre at the government and National Bank of Kazakhstan, Arystan

Esentugelov, stated at the conference organized by People's Democratic Party Nur Otan, the

"Kazakhstan Today" agency reports.

"The economy of Kazakhstan is not able, despite any measures, avoid recession because it does

not depend on internal factors," A. Esentugelov said.

According to the expert, the economies of the USA, Europe and Russia are in recession now.

According to A. Esentugelov, Kazakhstan, following the results of the first quarter, has come

into the recession zone. "If GDP falls down two quarters in a raw, it is a recession sign," he

explained.

Kazakhstan seeks economic stability, growth amid

financial crisis

www.chinaview.cn 2009-04-10 17:46:23 Print

Special Report: Global Financial Crisis

ALMATY, April 10 (Xinhua) -- Kazakhstan, the leading economy in Central Asia and the

third largest among the Commonwealth of Independent States, has employed round all efforts to

seek social and economic development in the current global financial crisis.

Kazakhstan Prime Minister Karim Masimov said that most of government's allocation for

economic stability should go to the agricultural sector as grain prices on the world market have

witnessed a slump since last September. Masimov announced in November last year that

Kazakhstan would spend 1 billion U.S. dollars on agricultural development in the next three

years.

Although the country's industrial production has kept increasing since 2000, it suffers from a

structural imbalance. The government implemented a series of measures to readjust the structure

and this has proved effective. The food processing, computer software and printing industries

have seen rapid growth.

Kazakhstan's trade volume was 109.1 billion U.S. dollars in 2008, a 35.5 percent growth year

on year and the sixth consecutive year of growth. However, currently Kazakhstan's economic

growth still relies on the oil and gas industry. The government has scrapped the export tax on all

oil companies registered in the country in a bid to boost exports and drive the economy.

Since the first trading day of this year, Kazakhstan's stock exchanges have continued to drop,

in which the financial sector has been the most seriously hit. With a timely injection 9.9 billion

U.S. dollars into the financial market, the Kazakhstan government has avoided bankruptcy risks

to the state-owned commercial banks due to the great slump in their stock prices. Furthermore,

the stock market has been stabilized, and investors' confidence re-established.

The government has also taken several measures to secure socialst ability and the people's

livelihood. Grigory Marchenko, governor of the National Bank of Kazakhstan, the country's

central bank, announced in February a 25-percent devaluation of the Tenge, the country's

currency. The benchmark exchange rate of the Tenge against U.S. dollar has been readjusted

from 120:1 to 150:1.

At the same time, Masimov ordered that prices of products, such as food and pharmaceuticals,

should not be raised on the pretext of the currency's devaluation.

Kazakhstan's housing sector has also suffered from a slump since the third quarter of last year.

The government has implemented a basket of measures, including national loans, encouraging

institutions to buy houses, and building more tenement houses.

The financial crisis has also hit the country's auto industry. Since the second half of 2008,

production and sales have greatly decreased.

However, huge potential still exists. Based on the economic situation and the people's living

standards, a lot of major auto producers hold an optimistic view of Kazakhstan's auto market.

They believe it will revive quickly once the financial crisis eases.

Shigeo Katsu, vice president of the World Bank for European and central Asian issues, said

that Kazakhstan through the implementation of various measures will be able to survive the

shock of the global financial crisis.

Kazakhstan shakes up banking sector

Published: 09 February, 2009

Print this article Email

In a week of dramatic change for Kazakhstan’s banking sector, the Kazakh government has

taken the country’s largest bank by assets, BTA, into state ownership, via sovereign wealth fund

Samruk-Kazyna.

The fund purchased $2.07bn in BTA equity, giving it a 78% stake.

This happened just one week after BTA’s existing shareholders had voted to increase the bank’s

share capital by more than 50%. Arman Dunayev, the Deputy Chairman of Samruk-Kazyna, was

appointed to the board of BTA. Central bank governor Anwar Saidenov was made an advisor to

BTA chairman Roman Solodchenko.

Mr Saidenov’s replacement at the central bank is also his predecessor in the role, Grigory

Marchenko, who had in the meantime been the CEO of another commercial bank, Halyk, in

which Samruk-Kazyna recently took a minority $1bn stake. The fund also acquired a 76% stake

in the smaller Alliance Bank, and invested $980m in the country’s second-largest bank,

Kazkommertsbank.

Mr Marchenko immediately announced a devaluation of the Kazakh currency. This is intended

as part of the country’s measures to stem the outflow of foreign exchange reserves, but will

increase the cost of foreign currency debt servicing payments for Kazakh banks, which had

borrowed heavily overseas.

At the time of BTA’s earlier share increase, the bank had announced that a separate deal would

be signed with Samruk-Kazyna to provide liquidity for project finance lending to the Kazakh

economy. However, it appears that the Kazakh government decided to seek direct ownership of

the bank instead.

The bank was the country’s largest lender to the non-oil sector, including heavy exposure to real

estate assets that were estimated to have fallen by 60% in the year to July 2008 alone, as well as

to construction companies that are suffering from the property downturn. BTA had also invested

heavily in Russia, where equity valuations and credit conditions deteriorated sharply in 2008.

The Kazakh government is reported to be considering selling BTA’s Russian operations to

Russia’s largest lender, Sberbank.

BTA had originally indicated as late as December 2008 that it had sufficient resources to repay

US$1.7 billion and US$1.9 billion in foreign currency debts maturing in 2009 and 2010,

respectively. But Max Wolman, emerging markets debt portfolio manager at Aberdeen Asset

Management, had warned at a meeting of the Emerging Markets Trade Association in late

January 2009 that BTA’s methods for classifying non-performing or doubtful loans were opaque

BUSINESS & ECONOMICS

KAZAKHSTAN: ASTANA ACTS

AGGRESSIVELY TO CONTAIN

FINANCIAL CRISIS

Joanna Lillis 10/21/08

Print this article Email this article

Kazakhstan is making a massive cash injection into its economy in an effort to soften the impact

of the global credit crunch.

The government will pump $15 billion into the economy by the end of the year, Prime Minister

Karim Masimov announced during an October 20 cabinet session. The cash injection includes $5

billion directly from the National Fund, $5 billion from a holding company that manages state

assets, and $5 billion to support banking liquidity. "These are huge funds that will allow us to

make a huge breakthrough at this stage and level out the consequences of the crisis from the

foreign market," Masimov said during the session.

The National Fund figures prominently in the government’s economic stabilization plan.

Established in 2000, and capitalized with proceeds from the sale of oil and gas, the fund now has

assets totaling almost $27.6 billion. In effect, the government will be using $10 billion of the

fund’s reserves, as it had previously been announced that $5 billion would be transferred from

the fund to a new body created through the merger of two separate entities, the Samruk holding

company and Kazyna fund. Samruk-Kazyna, which has an initial capitalization of $40 billion, is

now the holding company that manages the state’s assets, including those produced by the state

oil-and-gas company, KazMunayGaz, the state nuclear agency, Kazatomprom, and the telecoms

company, Kazakhtelekom.

Kayrat Kelimbetov, a former minister of the economy, was moved from his position as head of

the presidential administration to run the newly-merged structure, chiefly because of his prior

experience managing the Kazyna fund. Nazarbayev’s son-in-law, Timur Kulibayev, became one

of the fund’s deputy chairmen, marking his return to a high-profile position just over a year after

he was removed from the post of deputy head of Samruk. [For background see the Eurasia

Insight archive].

Masimov’s announcement about the cash injection came just four days after Nazarbayev gave an

hour-long TV interview aimed at allaying public concern about the effects of the financial crisis,

which has hit Kazakhstan hard because of its reliance on foreign borrowing. In the interview,

broadcast on all major television channels October 16, Nazarbayev dwelled at length on

explanations for the causes of the global financial crisis. He also attempted to assure citizens that

Kazakhstan would weather it. "Despite the crisis that has taken place and which has affected our

country, the economy continues to work in a normal mode," he said, adding that Kazakhstan’s

gold and currency reserves and National Fund stand at a combined total of over $51 billion.

He went on to outline some of the measures being taken to combat the credit crunch. Some $4.5

billion was allocated in 2007 and 2008 to assist the ailing construction sector. Problems in the

sector have resulted in thousands of people being left without homes for which they had already

paid. A total of 8,000 people will receive their apartments this year and the remainder will get

theirs by the end of 2009, Nazarbayev pledged. "People should understand that this is huge

assistance and support from the government," Nazarbayev added, pointing out that the

government would also guarantee bank deposits of up to 5 million tenge (approximately

$40,000).

Nazarbayev additionally reiterated promises to increase pensions and public-sector salaries by 25

percent in 2009, and by a further 25 percent in 2010. He also said the state would build more

schools and hospitals. "There are still enough problems, but look at the rate at which the state is

dealing with these issues," he said.

Given the state’s abundant energy resources, many people in Kazakhstan had become

accustomed to double-digit economic growth. Now, they will have to adjust expectations.

Nazarbayev’s interview came amid rising concern among ordinary Kazakhstanis as the financial

crisis continues to bite. Growth slowed last year to 8.5 percent, down from 10.7 percent in 2006.

On October 21 the government lowered its forecast for GDP growth this year by 0.3 percent to 5

percent, a figure some analysts suggest may be extremely optimistic. Inflation officially ran at

18.8 percent in 2007, and many analysts doubt that the government will manage to meet its

target of keeping it below 10 percent this year. The latest official forecast on October 21 puts

annual inflation within the range of 7.9-9.9 percent.

The government’s aggressive action is designed to keep Kazakhstan on target to achieve

Nazarbayev’s cherished goal of joining the ranks of the world’s 50 most competitive countries.

But some experts wonder whether the moves will be enough to maintain Kazakhstan’s present

ranking. The World Economic Forum’s Global Competitiveness Report 2008-2009 saw

Kazakhstan drop five places on the previous year to rank 66th.

The Asian Development Bank singled out both inflation and the banking sector as areas of

concern in its Fact Sheet on Kazakhstan for 2008: "Strong prices for oil, gas, and minerals; the

rapid growth of domestic consumption; and a rebound in investment continued to propel

Kazakhstan’s economy in 2007. However, these strengths also bring challenges, including the

immediate need to control rising inflation and to improve the performance of the country’s banks

in a challenging environment."

Public protest is rare in Kazakhstan, but there have been small, sporadic demonstrations in

Almaty and Astana over living standards, the construction-sector crisis and home repossessions.

In a sign that he is aware of the potentially destabilizing nature of the economic climate,

Nazarbayev had some tough words for the government in mid October. "Everyone who wants to

use the current situation for their narrow and also political aims, spreading various provocative

rumors, should expect a harsh punishment," he told the cabinet on October 13. "Let them not say

later that I did not warn them."

While he seeks to bolster public confidence, Nazarbayev has made it clear that it will be the

responsibility of Masimov’s cabinet to develop policies that allow Kazakhstan to navigate the

crisis. "It is time you banged your fist on the table and started working normally," he told

Masimov at the October 13 cabinet session, adding that the government has "carte blanche to

carry out a program to stabilize the economy and financial system, and wide powers to make

non-standard decisions."

Editor's Note: Joanna Lillis is a freelance writer who specializes in Central Asia.

Posted October 21, 2008 © Eurasianet

http://www.eurasianet.org

Kazakhstan's Construction Collapse

The global financial crisis has hammered the building business in

Central Asia's largest country. Recovery will depend on the oil market

Shouts of "Give houses to the people!" rang out when casualties of Kazakhstan's collapsing

construction industry gathered in an Almaty square earlier this month. Many in the crowd said

they were homeless after taking out mortgages on apartments that were never built. Once the

symbol of boom times in Kazakhstan, today the construction sector reflects the economic

slowdown and the country's vulnerability to the global financial crisis.

Many heavily indebted construction companies, big and small, have stopped work, although they

may not have declared bankruptcy. Over the past months, the sight of abandoned concrete

apartment blocks and cranes standing idle has become common in Kazakhstan's cities.

Such scenes are a personal matter for Igor. Like many other protesters on the square in the

country's commercial capital, he took out a bank mortgage. His house was supposed to be

finished in December, but it's far from being completed, he said.

Igor, 35, sells used cars and he spends almost all his income on monthly payments to the bank.

"I wanted my bank to freeze the mortgage payments until the construction is resumed. However,

they refused," he said. "I'm going to sue the construction company and demand that it pays the

bank all my mortgage debt."

Igor understands that he will most likely lose. If that happens, he said he'll simply stop paying

the bank.

An additional problem is that Igor's mother is the guarantor of his mortgage. So Igor said he will

sell her house and his car so the bank won't be able to seize them for unpaid debt.

Igor has already paid $70,000 on his mortgage. "But I can't keep paying for something that does

not exist," he said.

A BOOM BUILT ON DEBT

Other homebuyers who did not want to take out a mortgage are in a no less difficult situation. "I

sold my apartment in Astana, sold my car, borrowed money from my friends to buy a flat in

Almaty in one of the construction projects," Roman Malikov, 34, said. "And now I don't have

my old flat or my new one. I'm homeless."

Construction companies were among the first to feel the swelling global liquidity squeeze in

Kazakhstan a year ago. These companies were heavily dependent on bank credit to buy land and

building materials, so when Kazakh banks, themselves heavily in debt, stopped giving loans and

instead put pressure on builders to pay back their loans, many collapsed. Builders also raised

cash outside the banking system by selling not-yet built apartments to fund current building

projects, but many of those projects now also have ground to a halt.

According to the National Bank of Kazakhstan, the country's foreign debt stood at $100.6 billion

as of 30 June, $45 billion of it owed by banks. Numbers like these pushed foreign financial

institutions to stop lending to Kazakh banks once the early signs of the crisis started surfacing.

"From the second half of 2007, Kazakh banks were no longer able to raise cheap funds as they

did before," said Gairat Salimov, an analyst in Almaty with the Renaissance Capital investment

bank.

"Thus [banks] started cutting down lending, reducing their portfolios, and repaying their debts.

This had a serious impact on the Kazakh economy, which was significantly driven by credit

expansion," Salimov said.

Many companies in construction and other parts of the economy could not survive without bank

credit. Small and medium-size businesses were particularly hit. Consumption dropped, and GDP

growth is expected to decline from the average of 10 percent that was recorded for the past few

years to 5 percent in 2008. Compounding the misery, the annual inflation rate reached 20.1

percent in August.

Astana is concerned that people's anger from their losses may turn against the government.

During a speech to legislators in October, President Nursultan Nazarbaev said that people's

difficulties were "caused by the global financial crisis that came from outside and not because

there were mistakes made domestically." Members of the opposition, particularly the Azat party,

criticized the government, saying that it was responsible for the recent economic hardships, and

in November called on the cabinet to resign.

Kazakhstan's neighbors Kyrgyzstan, Tajikistan, and Uzbekistan are also getting nervous. Their

economies are heavily dependent on remittances from people working abroad. In Tajikistan

alone, money sent by labor migrants in 2007 made up 36 percent of country's GDP, according to

the World Bank. Many migrants do construction work in Russia and Kazakhstan; job cuts have

already begun, with immediate effects in their impoverished homelands.

The poorer states of the region may be hard hit by the crisis, but through indirect routes that they

can do little to control. In Kazakhstan, far more closely integrated into the global financial

system, the government decided in October to intervene and, like a number of other countries,

try to bail out the economy. Fifteen billion dollars in total will be released: $10 billion will be

drawn from the National Oil Fund, and the central bank will provide major banks another $5

billion to increase their liquidity.

One analyst believes that the money the government is spending is not enough to rescue the

economy. Aitolkyn Kurmanova of the Central Asian Institute of Economic Strategies said the

main purpose behind the $15 billion bailout is to display strength and calm the population – an

effort that may not succeed given that banks owe three times that much to foreign creditors.

The four largest banks – BTA, Kazkommerzbank, Halyk, and Alliance – are to be partially

nationalized. The state will use $5 billion from the oil fund to buy up 25 percent of newly issued

stocks to inject the necessary cash to deal with their bad debts and free up credit to business. This

will be overseen by a fund newly created through the merger of two major state holdings,

Samruk and Kazyna.

The fund itself will be capitalized with the other $5 billion of oil fund money, which will then be

used to finance state projects.

BANKING ON OIL

Petroleum resources and rising oil prices helped the state accumulate almost $28 billion in the oil

fund, money that will form the keystone of the rescue package. The 2009 state budget forecasts

oil prices at $60 per barrel. If prices go lower than that for any length of time – oil is currently at

about $54 a barrel, compared with over $140 at the peak last summer – Kazakhstan's economy

will be in trouble, experts say.

"If prices stay low for a long time, the Kazakh government would have to spend more of its

savings to stabilize the economy," Salimov said. "This would lead to the reduction of [currency]

reserves and the reduction of the national oil fund, which in fact reduces the stability of the

system."

However, the impact of low prices on the economy could be eased by other factors. Kazakhstan

could increase the volume of oil for export to keep revenues up despite lower prices. More

importantly, the government is counting on a continued high level of investments by foreign

energy companies into its oil fields.

Led by Eni of Italy, a consortium that also includes Exxon Mobil, Total, and Shell has invested

more than $12 billion into preliminary work at the Kashagan oil field, Reuters reported. The

consortium plans to invest tens of billions more in the coming years. With so much riding on the

exploitation of its petroleum resources, Kazakhstan's economy would suffer severely if the

biggest foreign investors' interest cools. This is seen as highly unlikely, though, given the

continued demand for oil and the potential for profits from the vast Kashagan field, once the

challenges of extracting the oil from under the Caspian seabed are overcome.

"Committed FDIs into a single project – the Kashagan oil field – are estimated at $140 billion,

which exceeds Kazakhstan's current GDP," Salimov said. "And this country, which could see

[the equivalent of more than one year's GDP] injected through FDIs over the next five years, has

a chance to come out of the crisis earlier than many others."

Provided by Transitions Online—Intelligent Eastern Europ

Kazakhstan’s construction companies have been forced to

search for new sources of capital. As local analysts suggest, now is the time for the builders to

switch from relying on bank loans as a sole source of financing to partnering with strategic

investors. This may result in increased mergers and acquisitions activity in local real estate and

construction sector.

The mid- and long-term outlook of purchasing power among the Kazakh population will likely

be lowered - not only as a result of the liquidity crisis, but also because of the of the deteriorating

health of the entire economy. Accordingly, builders need to search for alternative sources of

funds, and reexamine their strategies and financial models. “Today’s lack of liquidity affects big

builders with excellent reputation just as much as small construction companies. The absence of

acceptable bank financing shapes no longer only the market for real estate, but the whole

consumer sector of the economy as well”, says Bakhytbek Katen, director of NAI Kazakhstan

Aristan, a consultancy.

“Recent freeze of construction shook the reputation of the entire real estate market”, says Oleg

Alferov, the vice president of National Association of Realtors. “As a consequence, buyers’

activity in the fourth quarter of 2007 was at its lowest level in the last three years.”

Present situation is favorable for those interested in entering the Kazakh real estate and

construction sectors. The barriers to entry are low compared to the last few years, and interested

parties may be able to acquire shares in new and unfinished projects relatively cheaply.

Alexander Kalinin, the chairman of Kazakhstan Estimators Association agrees: “The banks were

focused excessively on the construction sector. Mortgage banking, construction and other real

estate loans and similar financing deals accounted for 56-70 percent of the banks’ credit

portfolios.” Under the current conditions, the sector is ripe for consolidation. According to

Kalinin, the market will soon be dominated by large corporations characterized by high quality

of their property portfolios, balanced price policies and additional sources of financing besides

Kazakh banks. “One such institution could be, for example, corporation ‘Basis A’. I have no

doubts that it is backed by serious shareholders with strong interest in Kazakhstan’s economy.”

Other business models will have difficulties surviving in the new conditions, suggests Kalinin.

According to him, other construction companies like Vek, MAK or TS Engineering will state

afloat as well. But the days of the most high-profile construction company in Kazakhstan, KUAT

Corporation, are likely numbered. “Obscure policy and opaque management, and especially its

murky dealings with land acquisition have apparently led to significant problems at KUAT.”

According to observers, the construction companies will need to share their risks and assets.

“There are different ways to finance real estate development — starting with bank financing and

ending with selling a stake in the project to a strategic investor. Today, construction companies

are looking for any possible way to secure financing to ensure the completion of already started

projects. Bank loans to construction companies look increasingly precarious and the builders

cannot be confident that they will be able to finance their deals solely with bank credit, as was

the case until the summer”, emphasizes Katen.

This is a situation when investors other than real estate developers can jump onto the market.

Nowadays, only few existing construction companies have the financial capabilities to take over

the unfinished objects of their competitors. Moreover, as a result of the stagnation of the market

for residential real estate, this segment lost its recent attractiveness. “Commercial real estate

developers with effective marketing methods are currently in a much more advantageous market

position”, says Mr. Katen.

Alferov believes that foreign investors will become major providers of financing to struggling,

yet potentially lucrative projects. “Notwithstanding the events of the second half of last year,

European, American and Israeli investors are still expressing strong interest in our markets.

Another potential source of emergency funds for halted projects are domestic development

institutions”, he says. According to Alferov, European developers are interested in the projects of

Kazakhstan’s biggest builder KUAT Corporation. SilkWay Construction, another major

construction company, is likely to sell some of its projects to a new investor. “Projects like

Tristar and Verniy.kz in Almaty are most likely to be taken over,” says Alferov.

There are two possible scenarios: the arrival of large development companies as co-investors in

objects lacking financing, and 100-percent buyouts of the incomplete projects. “The question is

only in how attractive will the troubled domestic companies make the proposal to new investors.

But there will likely be abundance of tempting offers from construction companies that

experience difficulties”, thinks Alferov. Most likely, he assumes, new investors will not acquire

the construction companies themselves but rather individual projects, be it in the form of land,

unfinished properties, designs, and building permits.

“For the current holders of these assets, these scenarios would mean that they could recover

funds, at least partially, sunk in the projects. The cost should be sufficiently low and attractive,

but only in the intermediate- and long-term outlook. Therefore, this absorption of construction

sites will be profitable only to important strategic investors, not looking for quick profits”, thinks

Alferov.

In Almaty, there are more than 900 licensed construction companies registered, but only 8-10

major ones, estimates Kalinin. “It is likely that within a year or two, 70 percent of the small- and

medium-sized will not survive or will be taken over by larger ones.” Those emerging

successfully from the real estate crisis will be those companies that have access to external

financing and developing untypical projects like the Apple Town housing estate in Almaty, and

the land owners who sold their land to construction companies at the height of the housing boom.

Meanwhile, the government has already allocated capital to aid construction companies, but thus

far only in Astana, the capital city. In 2007, a state commission affirmed a list of 112 objects in

Astana that would receive priority in state support for their completion. For this purpose, the

government put aside $400 million from the budget that was channeled through the state

development fund Kazyna. On the commission of Prime Minister Karim Masimov, the

government has created two working groups to effectively take control over the construction

projects and also to allocate funds from the state budget to support the ailing construction

industry. The two working groups, headed by the Minister of Industry and Trade Galym

Orazbakov and the akim (governor) of Astana Askar Mamin, include representatives of Kazyna

and Kazakhstan’s banks.

Meanwhile another working group, headed by the akim of Almaty, has together with the banks

and construction companies made a list of projects in Almaty that will require state support.

There, 314 billion tenge ($2.6 billion) would be required to assure the completion of unfinished

objects, and 167.2 billion tenge ($1.4 billion) will be necessary to finish projects with a high

degree of progress, calculated akim Imangali Tasmagambetov. According to his data, there are

93 construction companies working in Almaty right now constructing 143 residential complexes.

The total living area of those is 5.1 million. sq. m. This is more than 36 thousand apartments, and

12 thousand of those are paid for by would-be owners.

“Why would the state subsidize the building of 24 thousand apartments, not paid for by

anyone?” - asks Meruert Makhmutova, director of the Public Policy Research Center. Moreover,

she believes that the government should no longer allot budgetary money to construction

companies. “In each specific case, it is necessary to investigate how the builders used the funds

collected by owners who paid in advance. It is known that many construction companies worked

as financial pyramids”, noted Makhmutova.

Does the Financial Crisis Mean a Credit Crisis for Small Businesses?

While high-growth capital freezes, small community banks continue to

lend

By Matthew Bandyk

Posted October 3, 2008

While a lack of liquidity in the commercial paper market is making a mess of funding for some

Fortune 500 companies, it's a whole different ballgame when you scale down to the world of

small business. According to a National Federation of Independent Business survey of a random

sample of its half-million members in August, only 2 percent of respondents saw their financial

situations as their biggest problem. On the other hand, 10 percent did say they found loans harder

to come by—the highest figure in more than five years. But NFIB chief economist William

Dunkelberg notes that that number pales in comparison with previous economic downturns. In

the early 1980s, some 30 percent called access to credit their No. 1 headache.

Credit is tightening, and it's not completely clear how the increased turmoil in the credit markets

since August has changed the equation. But there's at least some reason for cautious optimism.

Even though most banks have essentially stopped lending to each other, that does not mean that

they are not lending to businesses. Dunkelberg says that small, community banks—he is

chairman of one in Cherry Hill, N.J.—are "not particularly affected" by the broader financial

problems when it comes to making commercial loans. "Credit is not really a problem on Main

Street," Dunkelberg says. Jim Blasingame, a small-business advocate and radio host, notes that

"if you're an established small business, you can get the money."

But even if there's no sectorwide credit crunch for small businesses yet, that doesn't mean many

firms, especially the bigger ones, aren't being squeezed. George Gendron, director of the

Innovation and Entrepreneurship Program at Clark University, says that right now "there is no

growth capital" for high-growth small companies with millions in sales—firms that tend not to

deal with small banks. "I have never seen this population more concerned than they are today,"

Gendron says. Things might be getting worse, too. Rich D'Amaro, CEO of Tatum LLC, an

executive services firm, says that his clients—small and midsize businesses with $50 million to

$500 million in annual revenue—are mostly finding growth capital "frozen," with the past 60

days especially bad.

Take the case of Steven Rothschild. He runs bulbs.com, a venture-capital-backed online light

bulb distributor in Worcester, Mass., and has been seeking credit to finance a small acquisition.

A month ago, he was turned down by a large bank. The situation has forced Rothschild to

consider hard choices: "Do you hoard cash, do you cut back on inventory—how insular do you

become?" Rothschild is hoping he'll find a solution by shopping around to other banks. He's

talking to three banks right now—including a small, local bank.

Will those efforts pay off? Many entrepreneurs are finding that it takes more hard work to get

credit but that it is still out there if you try. Paula Camara of Clark University's Small Business

Development Center advises small-business owners on how to get their businesses off the

ground and growing. She says that as the economy has slowed over the past year, the climate for

credit has not seen a day-and-night change from what it was when the economy was stronger.

Small-business owners have always needed to work hard for credit—they might just need to

work a bit harder now. "You really want to work with a small-business adviser to make sure

you're dotting your I's and crossing your T's before you present yourself to a bank," Camara says.

Related News