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Reference ID Created Released Classification Origin
07ASTANA1512 2007-06-03 11:04 2011-08-30 01:44 CONFIDENTIAL Embassy Astana

DE RUEHTA #1512/01 1541104
P 031104Z JUN 07

C O N F I D E N T I A L SECTION 01 OF 04 ASTANA 001512 
E.O. 12958: DECL: 06/04/2017 
REF: A. ASTANA 1243 
     B. ASTANA 1240 
     C. ASTANA 1122 
     D. ASTANA 1234 
Classified By: Pol-Econ Chief Deborah Mennuti; reasons 1.4 (b) and (d). 
1. (SBU) Summary:  In spite of the failure of a regional bank 
and the International Monetary Fund's recent characterization 
of Kazakhstani private sector external borrowing as an 
emerging "global market risk," the mood among Kazakhstani 
financiers remains upbeat.  With no end to petrodollars in 
sight, they see major opportunities for growth in financial 
services, particularly insurance and asset management. 
Still, the IMF's focus on the size of Kazakhstani banks' 
external borrowings has helped highlight the Kazakhstani 
economy's vulnerability to higher global interest rates as 
another risk to the country's financial system.  Most 
well-informed observers are already concerned by the apparent 
real estate bubbles in Astana and Almaty.  Even more, when 
speaking frankly, acknowledge that the twin deficits of 
proper corporate governance and the rule of law remain major 
obstacles to the development of Kazakhstani business in 
general and the financial sector in particular.  End summary. 
Driven by Oil and Intent to Keep Going 
2. (SBU) However they may assess the principal economic 
risks, decision-makers in the Kazakhstani financial sector 
agree that oil will, for the foreseeable future, continue to 
fuel the Kazakhstani economy and, concomitantly, the 
financial services industry.  Roman Solodchenko, CEO of Bank 
Turan Alem (BTA), told a visiting Treasury official and 
econoff on April 16 that the outlook for the Kazakhstani 
economy remains rosy, as oil prices are not expected to 
plunge.  Even if oil does fall, Solodchenko noted, it will 
still support economic growth, because oil contracts are 
structured in such a way that the actors are interested in 
increasing production "no matter what the oil price does." 
Furthermore, Solodchenko implied, the Kazakhstani 
Government's (GOK's) ongoing sterilization of its oil 
revenues through the National Fund has limited the government 
budget's dependence on the oil sector, thus cushioning the 
economy against any dramatic falls in the price of oil. 
3. (C) Notably, Kazakhstan's National Bank (NBK) Deputy 
Chairman Gulbanu Aimanbetova does not see oil's classic side 
effect, "Dutch disease," as a significant problem for the 
Kazakhstani economy.  She explained during an April 17 
meeting that Kazakhstani firms rely heavily on imports for 
their inputs, citing the example of Rakhat Candy, which 
imports 70-80% of its inputs.  Tenge appreciation, therefore, 
does not necessarily have an adverse effect on the global 
competitiveness of Kazakhstani producers, since it helps 
lower their costs, according to Aimanbetova.  (Note: 
Aimanbetova may have merely been restating the GOK's official 
position, which another NBK official described as "Kazakhstan 
does not have Dutch disease, just the symptoms."  Whatever 
the GOK's principal decision-makers think of the threat of 
Dutch disease, however, they are currently embarking on a new 
major effort to diversify the economy away from the 
extractive sector.  Ref A, B, and C.  End note.) 
Kazakhstan: Attracting Capital (and Notoriety) 
--------------------------------------------- - 
4. (SBU) While oil-funded economic optimism is the spirit of 
the day, views appear to be significantly more diverse in 
regard to the Kazakhstani private sector's current borrowing 
binge abroad.  The already much-discussed phenomenon was 
featured in the IMF's April 2007 Global Financial Stability 
Report.  The IMF report specifically highlighted the combined 
external borrowing by Russia's and Kazakhstan's private 
sectors as "an emerging market risk."  The report makes 
particular note of the external borrowing by Kazakhstani 
banks.  In 2006, according to IMF figures, Kazakhstan's 
financial institutions borrowed $8.4 billion abroad; in just 
the first 44 days of 2007 (Jan. 1 through Feb. 13), they 
borrowed $6.3 billion.  The report sees this as a factor in 
the context of "global risks," due to Kazakhstan's 
"relatively low capital adequacy" and "relatively high 
nonperforming loans ratio," particularly when the country's 
rapid credit growth is taken into account. 
5. (C) One prominent actor in Kazakhstan's financial sector 
ASTANA 00001512  002 OF 004 
privately called the IMF's decision to place Kazakhstan 
alongside the U.S. and Russia "flattering."  Some 
well-informed observers expressed to us the view that the 
causes of the Kazakhstani private sector's borrowing binge 
were rational and benign, rather than speculative and 
dangerous.  Kazakhstan's banks, they explained, are turning 
abroad to access long-term capital that they cannot obtain at 
home.  Magzhan Auezov, Ma
naging Director of KazKommertsBank 
(KKB), remarked, "it's just that borrowing abroad is 
cheaper," echoing the often-stated view that Kazakhstan's 
banking system, although widely described as the 
most-developed in the CIS, is not an adequate source of 
long-term capital.  Some bankers explained that while the 
public-at-large continues the gradual post-Soviet process of 
warming up to banking, deposits remain relatively small and 
"flighty."  As a result, the argument goes, the domestic 
market only provides banks with limited, short-term capital, 
forcing seekers of long-term capital to go abroad. 
6. (C) NBK's Aimanbetova, however, stated unequivocally her 
concern with the extent of the banks' external borrowing. 
Kazakhstan's external debt - now at $73 billion - has, she 
said, greatly expanded in the past two years due to private 
sector borrowing.  Banks are currently responsible for 45% of 
the country's external debt, she added.  Aimanbetova also 
said that banks are becoming overly aggressive as they drive 
up interest rates in competition for deposits.  Erlan 
Balgarin, CEO of Centras Securities, an Almaty-based 
investment company, was more blunt in an April 16 
conversation.  Credit expansion, he said, represents a 
serious risk to the Kazakhstani economy.  Banks enjoy a high 
ability to borrow but very limited investment opportunities, 
which leads them to provide loans to questionable projects. 
As a result, Balgarin concluded, the quality of the credit 
portfolio tends to be very low. 
7. (SBU) The Financial Supervision Agency (FSA) recently 
tried to limit banks' external borrowing by instituting 
stricter reserve requirements.  As these requirements take 
effect, some of the largest banks are turning to issuing 
equity abroad or seeking foreign investors as alternate ways 
of attracting foreign capital.  For now, however, the IMF 
figures appear to indicate that the external borrowing binge 
is continuing. 
Real Estate: How Big a Risk to the Economy? 
8. (C) There is consensus among observers that a lot of the 
capital borrowed abroad by Kazakhstani banks ends up flowing 
into domestic real estate.  There appears to be agreement 
among top Kazakhstani bankers that the real estate markets in 
Almaty and Astana pose risks.  However, the bankers differ in 
the levels of their concern and their approaches to mortgage 
lending.  The National Bank's Aimanbekova said that the real 
estate market is being driven by "speculative, not real, 
demand," and that "problems" are expected in 2008.  She 
blamed the excess demand on Kazakhstan's shadow economy, 
which produces large sums of money in need of laundering. 
(Note: for discussion of Kazakhstan's shadow economy, see Ref 
A.  End note.)  Balgarin of Centras seconded this view: 
compared to securities investments, he said, real estate 
investments enjoy a high level of non-transparency, making 
them an ideal vehicle for "parking" illicit capital.  Greater 
transparency of the oil sector, Balgarin added, would lessen 
pressure on the real estate market and "spread money around." 
9. (C) Grigoriy Marchenko, the CEO of Halyk Bank and former 
NBK Chairman, echoed Aimanbekova's comments, telling us on 
April 17 that real estate prices are "the biggest industry 
risk for the banking system" and that a correction could come 
in 2008.  Marchenko emphasized his bank's "contrarian" 
orientation in treading carefully in the real estate sector. 
Yet even he qualified his pessimism: while the real estate 
market, he said, is overpriced in Astana and Almaty, it 
remains "very segmented" and still has room to grow "in the 
10. (C) BTU's Solodchenko -- who described his bank as "not 
the most aggressive one" in the context of real estate (that 
title, he said, belongs to KKB) -- provided a mixed view.  He 
said that Kazakhstan -- with a living space per capita figure 
of 17 square meters -- still has some catching up to do with 
Eastern Europe's 34 square meters per capita.  Solodchenko 
added, however, that his bank has now pulled out of Astana's 
real estate market, which is approaching "saturation" at 
ASTANA 00001512  003 OF 004 
22-23 square meters per capita.   Still, he stated, the real 
increase in housing in Almaty is not as great as it may 
appear.  The first floors of many residential buildings, 
Solodchenko explained, have been converted to retail stores. 
The need to replace this "lost" residential space, combined 
with the continuing post-Soviet "decompression" of extended 
families crammed into single apartments, is often viewed as 
at least partly responsible for driving the demand. 
11. (C) Auezov of KKB, Kazakhstan's largest bank, readily 
acknowledged his bank's substantial involvement in the real 
estate sector.  However, he said, KKB's risk is "particularly 
structured."  Auezov explained that KKB focuses on financing 
construction, including construction of industrial and 
governmental buildings.  This preference for "construction 
risk," he implied, helps insulate KKB from the risks of the 
real estate market's fluctuations.  Mukhtar Bubeyev, 
Department Head at the Financial Supervision Agency (FSA), 
expressed a similar perspective, stating that Kazakhstan's 
banking sector is "quite diversified."  The real exposure to 
the real estate market, he said, is shouldered by mortgage 
companies, which also fall under FSA's purview. 
After Valut Transit Debacle: How Good is the Oversight? 
--------------------------------------------- ---------- 
12. (C) Most observers do not see the recent collapse of the 
Karaganda-based Valut Transit Bank (VTB) as an indication of 
systemic problems in Kazakhstan's banking system.  (Note: Ref 
D reports the legal proceedings surrounding VTB.  End note.) 
The consensus appears to be that the VTB's downfall was 
precipitated by unmistakably "criminal" factors.  Balgarin of 
Centras framed the saga in terms of corporate governance; the 
bank, he said, issued a lot of credit to finance its own 
stockholders' projects.  Other observers echoed this view but 
differed somewhat in their assessment of the regulator's 
(i.e. the FSA's) fault in the bank's downfall.  Bakhyt 
Mazhenova, General Director of the Deposit Insurance Fund, 
shared her personal  opinion with us that "politicization" 
and "weakness" of the FSA prevented it from spotting and 
bringing to light the VTB's troubles in a timely fashion. 
Other observers also thought that the FSA may have been 
excessively timid and slow to the scene, particularly in 
pulling the sinking bank's license. 
13. (C) Halyk's Marchenko, however, painted a picture of a 
largely blameless FSA, which was simply prevented from doing 
its job by a lack of power and a faulty legal system.  It was 
essentially impossible, Marchenko said, for the regulator to 
unravel the multi-layered loan sche
me at the center of the 
VTB's demise.  Any action the FSA takes, he explained, can be 
challenged in court.  Marchenko added that in the VTB case 
the FSA likely assumed that it would lose such a challenge, 
"even if (the bank) had not bribed the judge - a big if." 
FSA's Bubeyev, while sounding rather defensive about the VTB 
scandal, appeared to support Marchenko's thesis.  In the wake 
of the VTB's bankruptcy, Bubeyev said, legislative amendments 
have been enacted, expanding the FSA's powers.  The 
legislation, in part, dictates that the FSA's instructions 
must be followed even if they are being challenged in court. 
14. (C) Marchenko suggested that knowledgeable domestic 
investors, particularly large financial institutions 
(including Halyk), had pulled their investments out of VTB in 
time to avoid falling victim to the bank's collapse.  On the 
other hand, foreign institutions and domestic depositors, 
Marchenko added, could not see the trouble coming. 
15. (C) The ripple effects for Kazakhstan's financial sector 
of the collapse of the VTB are, according to a discernible 
consensus, rather limited.  Mazhenova of the Deposit 
Insurance Fund (DIF), "Kazakhstan's FDIC," however, stated 
that the impact on the banking system would have been "big," 
had the DIF not made payments to the VTB's depositors.  The 
DIF's actions, she said, prevented a major outflow of capital 
from the banking system following the VTB's collapse. 
Mazhenova said that the failed bank served 100,000 depositors 
and held 250,000 accounts.  Mazhenova described the VTB as a 
"large regional bank" and a key player in the economy of the 
industry-heavy Karaganda Oblast.  The DIF, she said, insures 
bank deposits up to the amount of KZT 700,000 (approx. 
$5,833); 52% of VTB's deposits were under that threshold. 
Mazhenova stated unequivocally that the VTB meltdown is 
taking a major financial toll on the DIF, resulting in 
obligations of approximately KZT 15 billion (approx. $125 
million).  She added that a decision has been made to grant 
ASTANA 00001512  004 OF 004 
to the DIF an inflow of capital, possibly to the tune of 5 
billion KZT (approx. $41.7 million), from the National Bank. 
New Horizons and Where the Buck Stops... 
16. (SBU) In spite of the clouds of the VTB debacle and 
excessive external borrowing by banks, Balgarin of Centras 
presented an optimistic vision of the Kazakhstani financial 
sector's foreseeable future.  The asset management and 
insurance industries, he said, lag behind the "very 
well-developed" banking sector but have great potential. 
Balgarin added that insurance companies may receive a major 
impetus if existing pension funds come under their 
management.  While the lack of "financial literacy" among the 
Kazakhstani public remains an obstacle, he said, "the public 
mind is evolving."  As evidence, he cited $20-22 billion now 
in deposits and $400 million under asset management, although 
only 15-20% of the latter is "active on the market." 
17. (C) Balgarin was decidedly gloomier when discussing 
issues of corporate governance.   He said that the lack of 
transparency is a problem, and that it is very difficult for 
a shareholder to influence a company.  "The problem," 
Balgarin stated, "is not legislation but the legal system and 
the culture.  When it comes to enforcing rights, the buck 
stops at the courthouse steps."  Balgarin's remark was a 
clear allusion to the notion that the fate of the Kazakhstani 
financial services industry is strongly tied to that of the 
domestic corporate sector, which remains plagued by poor 
corporate governance and the legal system's failures in 
enforcing contractual and property rights. 
18. (SBU) Whatever the extent of the risks that Kazakhstan's 
overindulgence in foreign debt brings to the global financial 
system, the phenomenon certainly exposes Kazakhstan's banking 
system to external risks, particularly higher interest rates. 
 Should global interest rates rise, Kazakhstani banks may 
find it difficult to refinance their maturing -- and 
mushrooming -- debt.  A possible switch in focus from debt to 
equity may alleviate this concern.  Concern will remain, 
however, over the quality of the banks' investments and 
loans, particularly in real estate. 
19. (SBU) The optimists' assessment that Kazakhstan's banking 
sector is relatively impervious to a possible bursting of the 
real estate bubble understates the wider socio-economic 
effects of a truly hard landing.  Astana and Almaty's 
construction boom relies on the cheap labor of untold numbers 
of Central Asian migrants, who will abruptly and collectively 
become unemployed if the real estate music stops. 
Furthermore, many middle-class Kazakhstanis in Astana and 
Almaty - many with mortgages - have invested large portions 
of their net worth in newly built apartments.  A wave of 
foreclosures would be a phenomenon both unprecedented and 
deeply worrying for an important layer of Kazakhstani 
society.  While well-informed observers increasingly mention 
2008 as the year when the real estate market is likely to 
peak, the behavior of market bubbles is notoriously difficult 
to predict.  End comment. 


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