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Reference ID Created Released Classification Origin
06ASTANA492 2006-11-07 10:30 2011-08-30 01:44 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Astana

DE RUEHTA #0492/01 3111030
P 071030Z NOV 06

E.O. 12958: N/A 
1. (SBU) Summary:  In July 2006, the government of Kazakhstan 
implemented a new mechanism governing contributions to the National 
Fund, altering the rules for state use of oil revenues.  Under the 
new mechanism, all oil-sector revenues are steered directly to the 
National Fund and invested abroad, with the budget receiving back a 
legislated amount earmarked for "development projects." 
Non-development expenditures, meanwhile, are to be funded 
exclusively via the "non-oil budget." The new mechanism reinforces 
the GOK's overall objective of stimulating diversification.  In 
implementing the new mechanism, the GOK followed World Bank 
recommendations closely, and appears to have taken another solid 
step in legislating prudent spending limits and responsible 
management of Kazakhstan's oil revenues.  End summary. 
2. (U) The GOK established the National Fund by presidential decree 
in August 2000.  The National Fund, invested entirely abroad, was 
designed both to save oil revenues for future generations and to 
reduce the national budget's dependence on world commodity prices 
and the economy's vulnerability to inflationary pressures caused by 
inflows of excess petrodollars.  As of September 2006, the National 
Fund had accumulated $11.8 billion, achieving an average annualized 
return of just over 5%. 
Old Mechanism: Oil in Economy's Veins 
3. (U) The "old system" functioned by accumulating in the National 
Fund all marginal state revenue generated from oil enterprises when 
oil prices exceeded $19/barrel.  Revenues from the first $19/barrel 
entered the national budget. Criticism of the "old" mechanism 
focused on three primary weaknesses: (a) the definition of "oil 
enterprise" was non-inclusive and frequently changed; (b) successful 
application of the formula - and hence budgetary planning - depended 
on a complicated estimation of anticipated oil revenues; and (c) the 
old concept allowed the government to simultaneously contribute to 
the NF and issue new debt, thus undermining the sense in which 
contributions to the NF represented "net savings."  (The 
presidential decree establishing the new mechanism emphasizes 
another flaw in the "old mechanism" - the fact that government oil 
revenue is dependent on the concept of taxable income, and thus on 
various accounting tactics which vary greatly from year-to-year.) 
4. (SBU) There is indirect empirical support for the notion that the 
old mechanism was a faulty safety valve for limiting the flow of NF 
money into the national budget.  Although the GOK does not currently 
provide budget data differentiating its oil revenues from non-oil 
revenues, there is evidence that the government's 2005 spending 
splurge in the run-up to the presidential election was largely 
fueled by oil revenue.  According to official statistics, the 
overall budget revenues (national and local) grew from 22.2% of the 
GDP in 2004 to 28.2% in 2005, a radical rise that can not be 
explained by increases in non-oil revenue.  The year offered plenty 
of other economic signs of more petrodollars finding their way into 
the economy: rapidly rising money supply (48% growth from January to 
September 2006), inflationary pressures (evident as inflation ticked 
up from 7.5% in December 2005 to 8.7% in August 2006), and the 
steeply appreciating tenge (rising 12.9% against the dollar and 8.3% 
against the euro in the year ending July 2006). 
The New Mechanism: Fiscal Discipline in the Air 
--------------------------------------------- -- 
5. (U) The new mechanism transfers all oil revenues directly to the 
National Fund.  A defined quantity, established by a formula with 
legislatively set variables, is then transferred back to the budget 
every year.  This amount is restricted to funding "development 
programs."  This implies that general government expenditures are 
financed solely by non-oil revenues.  This, according to the 
government's plan, is an important limitation on spending as well as 
an incentive for developing the non-oil sector, since general 
government expenditures can only be increased by boosting budgetary 
revenues from the non-oil sector.  The new NF mechanism thus 
reinforces the general GOK ambition to diversify the economy away 
from hydrocarbons. 
6. (U) The new mechanism contains features designed to address the 
criticisms levied against the "old" system.  For example, the 
definition of "oil revenues" is made broader and more explicit. 
(Comment: A logical next step in protecting the national budget from 
fluctuations in commodity prices might be to include in the National 
Fund government revenues from other important commodities such as 
copper.  End comment.)  Furthermore, the guaranteed transfer from 
the NF in any given year is subject to a ceiling of one-third of the 
National Fund's total assets.  Most importantly, perhaps, the new 
mechanism introduces a "budget deficit limitation," which sets the 
maximum level of government borrowing to fina
nce the overall budget 
deficit at 1% of the GDP (measured as the annual average value over 
ASTANA 00000492  002 OF 002 
a 5-year period); this is meant to prevent the government from 
engaging in a borrowing binge while ostensibly stashing oil revenues 
into the NF. 
7. (SBU) The new mechanism was designed with significant input from 
the World Bank, and, predictably, local World Bank representative 
Loup Brefort lauded the mechanism, telling Econoff that the GOK had 
essentially adopted the World Bank's recommendations.   However, 
Brefort downplayed the importance of limiting NF spending to 
"development programs."  The fungibility of money, he said, negated 
much of the distinction's efficacy. 
The Tenge Connection? 
8. (SBU) Some observers believe that the recent reversal in the 
long-standing trend of tenge appreciation is a result of the new 
mechanism, which serves to ease upward pressure on the domestic 
currency by investing more of the government's petrodollars abroad. 
(Note: after peaking against the dollar at 117.25/$1 on July 23 
2006, the tenge has retreated to 127.84/$1 as of November 1.  End 
note.)    However, another observer, claiming access to inside 
information, told post that the tenge reversal is a result of the 
National Bank's current dollar-buying campaign aimed to "flush out 
offshore speculators" betting on further tenge appreciation. 
9. (SBU) Comment:  The new mechanism represents a clear improvement 
over its predecessor, and the GOK deserves credit for 
institutionalizing limits to its own discretionary spending.  Having 
said that, it is difficult to dispute Brefort's caveat that the 
fungibility of money undercuts the limitation of the use of Fund 
monies only on "development programs."  Ultimately, the 
effectiveness of the mechanism will depend on the government's 
commitment to control the non-oil budget deficit and resist the 
political pressures to legislate parameters which greatly expand the 
size of the "guaranteed transfer." Given the GOK's ongoing grandiose 
plans to further develop Astana, create a "financial center" in 
Almaty, and spur economic diversification through 
government-financed projects, such pressures are likely.  End 


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