Is Kazakhstan Taking Reform Seriously?

by Scott Horton

Partner, Patterson, Belknap, Webb & Tyler LLP

Adjunct Professor of Law, Columbia University

Keynote presentation delivered at the Columbia University School of International & Public Affairs Conference "Kazakhstan’s Economic Development After the Russian Crisis," New York, April 29. The views expressed are personal to the speaker and do not necessarily reflect the views of any institutions with which he is affiliated.

Today, an historic reassessment of the strategic significance of the Caspian/Central Asian region is underway. An area which was once hyped as a new "Persian Gulf" with hydrocarbon reserves put at a grossly inflated 200 billion barrels is now debunked as a third-tier production region with intractable transportation issues. As George Soros points out in his current book, our marketplace specializes in pendulum swings in which opportunities are almost always either portrayed too bright or too gloomy—the savvy investor knows to take advantage from these pendulum swings rather than be caught up in them. Two countries in particular are in the cross hairs in this reassessment: Kazakhstan and Azerbaijan. Today I will attempt a brief assessment of the situation in Kazakhstan from an investor’s perspective.

This republic of the Steppe was the "fair haired boy" of the American reform advisors for many years, although in the past four years criticism of Kazakhstan has gotten continually louder, and condemnation surrounding the recent reelection of President Nazarbayev was particularly harsh. But to attract investment, Kazakhstan does not need perfect scores on the reform agenda of foreign powers. It needs a competitive advantage over similarly situated emerging markets derived by weighing and balancing risk and opportunity. Put differently we might ask, what does Kazakhstan offer that Malaysia or Argentina does not?

In undertaking this tour d’horizon, I will adopt an investor’s perspective. My focal question is whether the country is taking its reforms seriously. But of course reforms are not an end in themselves; they are a means of creating conditions which promote economic growth and prosperity, developing a civil society and creating political institutions that win the support of the population and provide a basis for predictable and smooth transition of leadership. "Stability" is a funny word. Central Asian leaders like to use it a lot; in fact they like to use it to cover a multitude of sins. A senior advisor to one of the region’s presidents once treated me to a curious dinner-time diatribe. For fifteen minutes he described his government’s arrest and repression of various opposition groups, imprisonment and banishment of opposition political leaders who were a threat to the president and then he proceeded to the conclusion that a wonderful, stable business environment had been created. He plainly saw no contradiction between his two presentations. But as The New York Times points out in its now famous editorial on Central Asian stability, we must be cautious about stability which is wrought from repression and authoritarianism. Rarely does this constitute a favorable environment for lasting commercial investment. More often it is but the calm before the storm of civil insurrection and violence.

"Stability" has many faces, and I believe that in developing further the parameters of "stability" we can derive a new kind of political risk analysis. I will speak of four areas. First, political stability: strength of political institutions, the rule of law, public confidence in the executive. One question which leaps to mind is how the mantle of leadership will be passed from one leader to the next? Do we have assurance that this will be through a transparent process which gives deference to popular will? Conversely is there a risk of civil insurrection, intrigue, coup d’état? Second, economic stability: economic growth, unemployment, income distribution, budgetary policies, monetary and trade policy. There is a famous debate among political scientists and economists about whether political reform should precede economic reform. It is often suggested that an authoritarian regime which creates a basis for accumulation of popular wealth will be tolerated, but one which impoverishes its people is less likely to continue for long. No doubt there is a relationship between these factors, and no doubt it is difficult to quantify that relationship without importing many cultural or social variables. Third, what progress has been scored towards the establishment of a civil society? Throughout the post-Soviet space, it may be appropriate to start this inquiry with a darker issue, namely whether deteriorating interethnic r

elations present the potential for social unrest. Fourth, security issues broadly put. Does this country face some serious threat from abroad? Alternatively, do its own security structures present a threat to its society? There are of course many other factors we could sort through, but these four factors already constitute an advance beyond the traditional scope of inquiry on "stability," which for political scientists has focused on political institutions and for economists has focused on budgetary and monetary policy.

Political stability. There is a popular perception that Nursultan Nazarbayev is a strong leader with broad public support, and this perception is sustained by the pollsters. This is an important consideration surely, but an investor may be considering putting his money at long-term risk and therefore has to be concerned about the road far ahead. What happens when this leader is called to his maker? Have steps been taken to assure stability and continuity?

Viewed on paper, the constitution and legislation adopted by Kazakhstan since independence probably constitute the most comprehensive, consistent and progressive restructuring of any of the sovereigns of the former USSR—outside perhaps of the Baltics. This is an important accomplishment.

Unchecked Executive Power. However, the constitution adopts a model in which the judicial, legislative and executive structures are consciously not "balanced." Clearly the executive is paramount. Our Kazakh colleagues will quickly point out that this is also the case for France, which is not an "authoritarian" state. In Kazakhstan’s case, there is little question about the strength and health of the executive. But the judiciary and legislature are weak and underdeveloped institutions, and hardly in a position to check any abuse of power by the executive. France, as we know, frequently has "cohabitation" in which governmental power is shared by a prime minister and president of opposing parties. Moreover, France chooses both its legislative and executive branches through free and fair elections, vigorously contested by well-organized political parties.

Kazakhstani leaders appear unwilling to accept the risks that real democracy entails. They also appear unwilling to lay the groundwork for an independent, professional judiciary. As a senior judge appointed by President Nazarbayev recently told me on assurance of confidentiality, "President Nazarbayev has no compunction about intervening in matters that concern him or the state; and he has little interest in sharing power with any one."

Kazakhstan hardly stands out among the Central Asian states in this respect, of course. Indeed, Nazarbayev has been more tolerant of oppositional thought than any Central Asian ruler save his in-law Askar Akayev. Regretably, however, the trend in Kazakstan has most recently been against free expression and gains in many areas, such as press freedom, have recently been reversed.

An assessment of political stability must weigh the president’s undeniable talent as a leader against shortcomings in institution building. To borrow from my friend Michael Ochs, Nazarbayev is not a George Washington—who famously declined to be king and firmly set out to govern for two terms as president before returning like Cincinnatus to his farm. Nazarbayev is not even a Kravchuk, a Snegur, or a Brauzaskas—all CIS presidents who allowed a peaceful electoral transfer of power to the opposition. I say this in reliance on the OSCE’s reports, which remind us that conditions for free and fair elections were absent in Kazakhstan this past January. In a press conference, President Nazarbayev said that perhaps Kazakhstan had progressed 20% of the way towards free and fair elections; that might be a realistic assessment, but it is a damning one. Even if we like Nazarbayev, and most foreign investors clearly do like him, we must still be concerned about who comes after him. Clearly a political process that tolerates competing political parties, a loyal opposition, a tendency to use the crucible of politics to form consensus, is a desirable, indeed, a critical element of long term reform. Kazakhstan continues to score poorly in these categories.

We must therefore focus attention on Kazakhstan’s December 1999 parliamentary elections. Will the government allow meaningful participation in those elections by opposition parties like Akezhan Kazhegeldin’s Republican Party or Petr Svoik’s Azamat? The signs from Astana thus far are mixed on this issue. Kazhegeldin’s party has been registered, but with serious limitations and strings attached. And a campaign of harassment, intimidation and criminalization has targeted many oppositional figures, including Kazhegeldin and Svoik. Particularly in light of the reversals in press freedom, we must also be concerned about whether opposition figures have access to the media and an ability to present their views to the public.

Corruption. Public perceptions matter. True, polling gives Nazarbayev high marks. Polling also suggests a broad perception of gross and widespread corruption in his government, and we must be concerned that this perception will undermine confidence in his government. Indeed, Nazarbayev must share this concern. Otherwise his recent law on state secrecy would be incomprehensible. That law puts disclosure or publication of information about the president and his family and their economic interests or investments into the realm of state secrets punishable by severe sanctions. The law is clearly intended to thwart reporting on transactions involving the president which may have an aura of corruption about them. It screams vulnerability in a more thorough fashion than any newspaper exposé ever could.

Kazakhstan’s record on "political" issues is therefore strong on paper, but weak in implementation. It is a mixed and disappointing scorecard.

Economic Reform. Of the post-Soviet states, Kazakhstan may well have made the fastest transition towards a market economy—certainly if we leave the Baltics aside. It quickly privatized small and medium-scale enterprises and has also privatized many significant large-scale enterprises. Moreover, it demonstrated a lot of flexibility and ingenuity in the process. Kazakhstan has created a market economy, or at least something very close to one. Most impressively, the change has not merely been on paper. There has been a transformation of mentality among the Kazakh people—something which no visitor to Almaty these days can help but notice. Viewed in the context of its neighborhood, Kazakhstan’s performance in economic reform is extremely impressive. But there are some serious issues for Kazakhstan on the road ahead; many of them have been discussed by this morning’s speakers.

The Dutch Disease. I share the concerns of this morning’s panelists about the Dutch Disease. Kazakhstan’s economic policymakers have focused excessively on the natural resources sector and particularly on oil and gas. It is critical that Kazakhstan develop a more diversified economy with broad manufacturing capabilities. Yet many Kazakh policies point to movement in the opposite direction.

Trade. Take trade, a topic which merits much more attention and study than it gets these days. Last year Kazakhstan saw a 5% decrease in GDP, and it’s tempting to put this entirely at the doorstep of the Russian crisis. Russia accounts for some 40% of Kazakhstan’s exports, after all. Moreover, a collapse in value of the Kyrgyz som and the Uzbek soum led to Kazakhstan’s markets being flooded with inexpensive foodstuffs earlier this year. This in turn led Kazakhstan to impose "safeguards" in the form of 200% tariffs on select imports from the region. In taking these steps, Kazakhstan was no doubt responding to the pleas of domestic manufacturers who suffered from cheap imports. The decision was short-sighted and a serious mistake. It launched the CIS’s first real trade war, which continues to embroil Central Asia. The 200% safeguards were terminated with the decision to float the tenge, but they provide strong evidence of the absence of an affirmative trade policy. No one stands to loose more from this trade war than Kazakhstan—the nation which leads the CIS in securing per capita foreign investment and has the best potential to diversifying its manufacturing capabilities. Kazakhstan needs to promote free trade, especially with Russia and its principal Central Asia trading partners, Uzbekistan and Kyrgyzstan. Kazakhstan also needs to pursue WTO membership more aggressively, and its recent trade measures are sure to slow the process. Kazakhstan needs access to the WTO’s trade dispute resolution procedures. It also needs relief from anti-dumping measures pending against Kazakh metals producers in the U.S. and Europe, most of which would fall if Kazakhstan were to secure WTO membership. Kazakhstan’s steps on trade issues to date are the major factor leading analysts to question fidelity to reform economics or at least a consistent commitment.

Privatization. The strong progress in the arena of privatization I discussed is an historical fact. Today the process is stopped. As Grigory Marchenko said this morning, very accurately, the situation is "highly inadequate." The transition to the Balgimbaev administration was marked by a distinctive cooling of enthusiasm for privatization and many promises to stop this process in its tracks. For the last year, signals continue to be conflicting on this subject. However, Balgimbaev was able to implement his pet project, the creation of Kazakhoil, a state-owned petroleum company into which most of the as-yet unprivatized oil enterprises were collapsed. The jury’s still out on Kazakhoil as an entity, but so far its costs of production are staggering and it seems serious restructuring would be necessary to make Kazakhoil an entity capable of competition on the world stage. Investors in London and New York continue to focus attention on Kazakhoil because of its long-term potential as a target of direct investment or as an IPO, and also because it is a bellweather for privatization in general.

Kazakhstan needs to put its blue-chip privatization program back on track. This would be a critical lure to foreign investors, particularly in the middle market and manufacturing sectors where investment is most needed to spark growth and diversification.

Monetary Policy. Kazakhstan takes a lot of flak these days over the decision to float the tenge. In fact only a few days ago, a widely respected analyst of Kazakhstan delivered these remarks at a presentation in New York:

This analysis seems precipitous to me. Floating was the right thing to do. If criticism is warranted, then the Kazakhs should be criticized for having waited so long in reaching this decision. It was the obvious solution to Kazakhstan’s trading problems.

However, the devaluation was accompanied by some other measures designed to shore up hard currency reserves and stabilize banks and some of these are dubious. In particular, depositors who withdraw no more than 30% of their holdings in the next six months are offered a dollar exchange guarantee pegged to the pre-devaluation rate of 88.3 tenge to the dollar. This surely causes pain to the international monetary authorities and seems an unnecessarily risky step for Kazakhstan’s fiscal managers.

Revenues. Kazakhstan’s revenue shortfall was described in detail by Arup Banerji this morning, and I share his conclusions. Here I will address the measures Kazakhstan has taken to deal with the shortfall, many of which many be counterproductive. Prime Minister Balgimbaev has reacted to revenue shortfalls by creating a new ministry for revenue and giving it a laser-like focus on revenue collection. The minister for revenue, Mr Kakimzhanov, has stated that Kazakhstan does not need low inflation and that the monthly depreciation of the tenge at 3% would be fine. First Deputy Prime Minister Dzhandosov, has taken the opposite view, namely that the money supply should grow in line with reserves. In any event, having two important government spokesmen pulling in opposite directions on such a fundamental issue is distressing. I question the step of creating a ministry for revenue.

Kazakhstan has amended its Tax Code and some of the amendments are ripe for abuse in the hands of overzealous enforcers. Particularly troubling are provisions which give tax authorities the right to determine criminal liability for nonpayment of taxes (squarely at odds with Kazakhstan’s constitution which gives courts the exclusive right to determine criminal liability), and the authority to redetermine prices which are more than 20% out of variance with the "market." The amendments also make net operating losses taxable.

Moreover, it seems that the burden from revenue shortfall is settled disproportionately on foreign investors—those who have the strongest record of tendering voluntary payment of taxes. There are growing numbers of reports from foreign companies operating in Kazakhstan of overreaching by the tax authorities.

Unemployment. Politicians in the United States are used to referring to a "misery index" composed of inflation and unemployment rates. Political scientists point to unemployment, particularly among young males aged 18-25, as a key indicator of civil unrest and violent crime. Throughout the former Soviet Union, unemployment is a sensitive issue. Kazakhstan’s official statistics agency puts unemployment at between 3½ and 4%. Most independent analysts consider this to be a serious understatement of actual unemployment, and some, like The Economist, have suggested that the number is twice as high at least. Opposition politicians have asserted that unemployment may be closer to 25%. We do not have sufficient reliable data to form a judgment on the unemployment indicator for Kazakhstan, and this area merits closer attention.

Credit Ratings. Standard & Poors, Fitch and Moody’s have all downgraded Kazakhstan’s foreign debt ratings in the last half year. These ratings reflect concern about trade relations with Russia and concern about commodities positions. They will almost certainly hamper Kazakhstan’s access to international capital markets in the near term.

Recession. Coming back to the theme of this conference, Kazakhstan clearly has entered into a recession that was triggered by factors beyond its borders: the meltdown in Russia; historically depressed commodity prices, especially for hydrocarbons. But the recession also has some roots in Kazakhstan, notably in the country’s poorest crop harvest in 30 years. Kazakhstan’s recession seems milder than the recession faced by most of the country’s neighbors, and Kazakhstan seems better positioned than its neighbors to pull off a recovery in the near term.

Overall, taking into account the "bumps" in the road and a few exceptions noted before, Kazakhstan’s economic policies are competent and sensible. Kazakhstan’s economic performance neither dazzles nor seems on the precipice.

Civil Society. A visitor to Almaty today is quickly aware of a strong sense of freedom of expression and of a great number of civic organizations: religious, social, professional, academic and so forth. The country has made solid progress on this score. This growth on the front has come notwithstanding the state, which has adopted an attitude fluctuating between ambivalence and hostility. The real test of this issue may come in the government’s treatment of opposition political parties, discussed before.

Many analysts anticipated that Kazakhstan could be a powder keg considering its population base which is nearly evenly split between Kazaks on one hand and Russians and other Slavs on the other. Thus far there is no basis to suggest that Kazakh society will unravel along ethnic lines.

Security Environment. To Kazakhstan’s south, in Tajikistan and Afghanistan, civil insurrection rages. Some point to fundamentalist Islam as a destabilizing factor for the region in general and call for urgent measures—usually in the form of repression—to combat it. However, Kazakhstan shares no border with these countries and there seems little credible threat of a spill over of these conflicts into Kazakh territory. Similarly, Islamic fundamentalism has not raised itself as a domestic challenge to the Kazakh government. Kazakhstan faces no apparent threat from external forces or from domestic insurgency.

Conclusion. This review of stability issues comes to quite a mixed bag, but on the whole Kazakhstan is probably racking up more favorable assessments that any of its neighbors. The World Bank’s World Development Report, released yesterday in Washington, shores up this analysis. It reaches alarming conclusions about Russia, Ukraine and the former Soviet space in general, but eqivocates in extending many of these conclusions to Kazakhstan. The question is whether being the best performer in a dismal neighborhood will be enough. Investment in the natural resources will be continue to be tied to the performance of the commodities markets, taking into account transportation issues. It seems reasonably clear that Kazakhstan will garner more investment in both the oil and gas and mining sectors. But Kazakhstan most needs investments in other areas to diversify its economy, and on this score any prognosis must, for the time being, be more guarded.