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Reference ID Created Released Classification Origin
07ASTANA372 2007-02-13 01:10 2011-08-30 01:44 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Astana

DE RUEHTA #0372/01 0440110
R 130110Z FEB 07

E.O. 12958: N/A 
REF: 06 ASTANA 492 
ASTANA 00000372  001.2 OF 003 
1. (SBU) Summary:  In a January 19 meeting, Medet Sartbayev, Deputy 
Chairman of Kazakhstan's Central Bank,  discussed with Charge 
d'Affaires the current state, the risks, and the outlook of the 
Kazakhstani economy.  Sartbayev expressed his concern with 
persistent inflationary pressures, the real estate bubble, the 
strength of the tenge, and risks arising from the remaining 
weaknesses in the country's financial institutions.  He emphasized, 
however, that the government is pursuing policies designed to 
address these problems.  End summary. 
2. (SBU) Sartbayev, one of four Deputy Chairmen of the National Bank 
of Kazakhstan (NBK), supervises the management of the National (Oil) 
Fund's assets and issues of international cooperation.  Speaking to 
the Charge, he readily acknowledged the inflationary pressures 
present in the Kazakhstani economy.  Inflation, he said, reached 
8.5% in 2006, and the NBK clearly recognized the real estate bubble 
as an issue.  He cited a number of contributing factors, including 
burgeoning oil revenues, rapidly expanding borrowing by the 
commercial banking sector (which, he noted, stood at about $20 
billion at the end of 2006), corporate borrowing (roughly $30 
billion at the end of 2006), and an expansionary fiscal policy, 
particularly a 30% increase in government salaries over the course 
of 2006. 
3. (SBU) Sartbayev concurred with the Charge's observation that wage 
growth was outpacing growth in productivity.  This, he suggested, 
relates to a difficult structural problem, with the service sector 
dominating growth and industrial production (outside extractive 
industries) weakening.  While industrial production rose 4.5% in 
2005 and is expected to increase 6% in 2006, its rate of growth 
remains well below that of wages. 
4. (SBU) Sartbayev emphasized that, given these pressures, the NBK 
will continue its policy of inflation targeting.  He also expressed 
the hope that the new government would be more proactive in managing 
the budget's contribution to inflationary pressures.  Sartbayev made 
it clear, however, that serious challenges remain.  A key risk 
factor for 2007, he said, is the strong growth of unhedged 
short-term tenge positions taken by a number of financial sector 
actors (banks, hedge funds, etc.).  He drew a parallel with the 
combined role of property and currency bubbles in Southeast Asia's 
financial meltdown of the late 1990's. 
5. (SBU) Sartbayev turned to the NBK's role in the currency market. 
(Note: the tenge's steady rise has posed a particular challenge to 
the NBK.  The domestic currency's strength presents a major obstacle 
to the cornerstone of President Nazarbayev's stated economic policy: 
diversification away from the extractive sector.  End note.)  He 
described the August-October 2006 events (when the tenge sharply 
reversed its steady climb and gave back some ground to the dollar, 
falling from its peak of about 118 KZT / $1  to around 128 KZT / $1, 
as a "learning curve."  Both the market and the NBK, he said, gained 
experience and understanding of the NBK role in managing the new 
mechanism for the National Fund (NF) (see reftel). 
6. (SBU) The new mechanism, Sartbayev explained, compels the NBK to 
be quite active in the foreign exchange markets as it 
re-intermediates tenge receipts back into dollars and other 
currencies for investment in the NF.  (Note:  According to another 
NBK official, all but three or four "oil majors" with special 
agreements with the GOK are required to pay their taxes and fees to 
the government in tenge.  End note.)  Sartbayev cited the current 
softening of oil prices as a factor putting downward pressure on the 
tenge in the coming months, although he foresaw no significant 
depreciation in the first half of 2007. 
7. (SBU) Note:  The sudden tenge reversal of August-October 2006 
attracted significant public attention in Kazakhstan.  In December 
2006, an NBK official cited to Econoff two causes behind the shift: 
the July 1, 2006 advent of the new NF mechanism (which "captures" 
and converts into foreign currency more of the GOK's oil revenues 
than the more leaky old mechanism did), and the NBK's open-market 
operations aimed at breaking the tenge's rise.  The latter 
explanation dovetails with another insider's assertion that the NBK 
has been trying to "flush out offshore speculators" who are betting 
on the tenge's appreciation.  Yet another well-informed observer 
told Econoff that the NBK was following the IMF's advice to "break 
the predictability" of the tenge's strengthening.  The observer saw 
this policy as futile: as the NBK takes increasingly drastic 
measures to counteract the growing oil revenues' upward pressure on 
the tenge, the currency's future rise "is more predictable than 
ASTANA 00000372  002.2 OF 003 
ever."  End note. 
8. (SBU) Sartbayev was frank in addressing the issue of the housing 
bubble and responding to the Charge's remark that spiraling costs 
make housing unaffordable to many.  (Note:  Based on one estimate, 
at the end of 2006, mortgages comprised one-third of Kazakhstani 
banking system's credit portfolio.  Prices for both residential and 
commercial property in Astana and Almaty now rival those in many 
Central European cities, in some cases approaching as much as $2,000 
per square meter. End note.)  He observed that in addition to the 
need to restrain liquidity, the government should review its 
subsidies and other policies stimulating the construction industry. 
He also noted that the Anti-Monopoly Agency could act more 
effectively against oligopolistic behavior in the construction 
9. (SBU) Note:  Sartbayev appeared to be implicitly underlining the 
linkage between construction, corruption, and the grey economy.  In 
fact, Post has seen ample evidence, albeit mostly anecdotal, of the 
role of real estate in the grey economy.  Astana and Almaty real 
estate is widely seen as a suitable safe haven for "parking" wealth 
away from the eye of the tax authorities.  The public - and the 
press - have noticed that, despite rising rents, a striking number 
of premium apartments in Astana stand unoccupied; apparently, some 
owners simply do not bother renting their "investments" out. 
According to a well-informed westerner, the highest-end apartments 
are appreciating the fastest, another sign of housing being used as 
a speculative investment vehicle.  End note. 
10. (SBU) Sartbayev emphasized the lack of alternative financial 
instruments as a key factor inflating the real estate market and 
noted that there had been gaps and weaknesses in regulation.  While 
reiterating the current risks to the financial sector, Sartbayev 
cited several factors that he expects will help mitigate these 
risks, particularly the initial phase of the realization of the 
"Almaty Financial Center," and the development of non-bank financial 
intermediaries.  The emergence of these institutions, he said, could 
broaden and deepen the types and volumes of financial instruments 
available for trading, helping to alleviate the real estate bubble. 
11. (SBU) Sartbayev also noted that the NBK was in early discussions 
to explore with the government - as well as key private sector 
financial actors - the possibilities for increasing the volume and 
lengthening the maturities of NBK and/or GOK paper in the market. 
He noted that having a suitable volume of government debt would make 
the exercise of monetary policy more efficient, but that in 
principle the NBK can and does plan to increase its issue in 2007. 
12. (SBU) Note:  The "Agency for the Regulation of the Almaty 
Financial Center" was established in 2006.  While it has ambitious 
goals to transform Almaty into a regional financial powerhouse, the 
agency remains rather vague about its plans.  In December 2006, it 
announced plans to build a trading platform alternative to the 
existing Kazakhstani Stock Exchange (KSE).  The KSE, its volume 
dominated by block trades and its liquidity painfully low (bid-ask 
spreads, according to an insider, often amount to one-third of a 
listed stock's price), is a stock exchange that never quite managed 
to take off.  By comparison, the Kazakhstani bond market, stimulated 
by government debt (always in high demand and low supply) and 
domestic companies' preference for issuing debt over equity, is 
significantly more developed.  End note. 
13. (SBU) Periodic (and limited) lapses in fiscal discipline aside, 
the GOK has traditionally pursued a very sound macroeconomic policy. 
 Still, political interference remains a persistent risk.  Great 
disparities in wealth distribution increasingly add to the pressure 
to raise government wages and pensions.  Furthermore, as the 
National Oil Fund grows dramatically (from $ 8 billion to $14 
billion in 2006), the idea of "investing" some of its assets within 
Kazakhstan is gaining prominence in the political discourse.  Such a 
shift would unquestionably make the NBK's task of controlling 
inflation and holding down the tenge more difficult. 
14. (SBU) As the Charge's discussion with Sartbayev  demonstrates, 
GOK policymakers are highly cognizant of these risks as well as of 
the Kazakhstani economy's overdependence on oil.  Indeed, the 
official policies (economic diversification, development of 
financial institutions, relative fiscal discipline) directly address 
these issues.  The principal question lies in the implementation, 
particularly the government's ability and resolve to safeguard its 
ASTANA 00000372  003.2 OF 003 
initiatives from the pressures of politics and patronage.  End 


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