Kazakhstan - arguably better than before

Michael Carter of Visor Capital

W ith inflation spiking to 19%, a residential real estate bubble unwinding, banks facing a very difficult funding environment, the government increasing the tax burden on the oil and gas and mining sectors, and the negotiations with foreign oil firms over the Kashagan field showing a more assertive state, one might assume the investment climate in Kazakhstan had taken a severe negative turn. But we believe that, on the contrary, the investment climate is improving: we believe that investors have more access, more investment opportunities and better investment return potential than one year ago.

To lay out the reasons behind our optimism, we look at the positives and negatives that investors have seen in Kazakhstan over the past few years, and our view of how these have changed in the past months.

First we look at some of the positive aspects:

The economy has slowed on the back of the construction and banking sector downturns, but is still at healthy levels. In the resource sector, commodity prices have continued to rise, and production volume increases are expected for most resources in the coming years.

Even so, Buckley notes that a big change in the CEE market has been arrival of more classical buyouts with the use of a significant amount of debt as part of the capital structure. "This has enabled many of us to go into slower growing assets. If you have stable assets but want private equity returns, the answer is to introduce leverage," says Buckley.

Another positive factor for private equity in the region has been the long overdue development of a decent stock market that enables private equity firms to exit via an IPO rather than through a straight trade sale to another firm. Despite the recent mayhem in the world's markets, the head of the Warsaw Stock Exchange, Ludwik Sobolewski, told bne he expects about 70 new listings this year, which would again put the WSE at the forefront of European exchanges when it comes to drawing in new business. Last year was a record breaker for the WSE with 81 entrants, second only to the London Stock Exchange with 99 IPOs. Its regional rival in Vienna had just seven IPOs last year and expects another seven this year.

Further down the private equity ladder at the venture capital level, Central Europe is looking good too. Tomas Bohrn, chairman of Chiplnvest, a Czech-based very early stage funder of technology companies - "we're a start-up of start-ups," he quips -says business has actually improved since the credit crunch struck last summer. "The downturn has been good for us," he says. "People in big companies are not taking their ideas inhouse because they know they won't get funding so they're more willing now to step outside the company and find funding from people like us."

In general, Bohrn says he's noticing a sea change also in the attitude of entrepreneurs and innovators. Whereas before they would sit on their ideas, unwilling to let go until their ideas became obsolete, they are shedding this risk aversion and are more willing to give up some control in order to the financing necessary to take advantage of the market opportunity. •
While the government has moved to increase its influence in the resource sector, it has done so in a way that has not had a negative impact on the value for asset owners. The pre-emptive rights that the government has in the resource sector give it the right to buy at a market price, with the transactions seen to date bearing this out. We have seen the government signaling its intentions to give it pre-emptive rights in infrastructure sectors that are key to the development of the economy, which could give some investors some concerns. In other sectors, we do not see any such measures, with recent international strategic investments into the banking sector being a good example. At the shareholder level, international minority investors have been able to successfully seek legal redress in the past year.
Kazakhstan is regarded by many international companies as a base for Eurasian operations. This choice is due to the good business environment. Regulation, taxation and easy capital movement are some of the major elements in these decisions.
Looking at the Eurasian region, Kazakhstan places better than its regional peers on issues such as regulation, shareholder rights, legal rights, government effectiveness and corruption. Essentially, doing business in the region is best done from Kazakhstan.
Corporate taxes are currently 30%, personal taxes 10%, and VAT has just declined to 13% from 14%. The tax code is in the process of being revised, with the stated intent of raising taxation for the resource sector, and lowering it for other sectors.
The government is channeling most of the income from the resource sector into the National Fund. This is done both to sterilize the impact of this inflow of foreign exchange, and to give the country a fund to weather difficult times. This means the government runs a balanced budget without counting this significant income.

What were the negatives that people considered?

Even before the recent spike in inflation, inflation was a major concern for the economy. Inflation was averaging 7.5% in the three years prior to 2007, and spiked to 18.8% in 2007. This spike was largely driven by food prices, which accounted for almost 40% of the basket last year and even more in 2008. The government has taken a number of measures to bring food inflation under control; the slowdown in the economy may well assist these efforts.
Low population density, and a low population in general, is an issue to some investors. It makes logistics challenging, and limits the total potential of the market.
Capital markets are not very developed due, in part, to the ease with which entrepreneurs were able to borrow all necessary funds for their ventures from the commercial banks. Commercial banks made very good spreads on this business, and had few incentives to create an efficient capital market. The funding issues that banks suffered in the past year have caused many businesses to suffer from a shortage of capital, which has led them to explore the possibilities of the capital markets, but bond and equity issues are not an overnight process.
The banking regulator was worried about the sector's over-reliance on foreign funding. International credit markets took care of the problem before regulatory measures could have their desired (perhaps softer) impact. It is likely that future growth of the banking sector will be based on more balanced funding sources, and more discriminating lending policies. The global credit crunch has been painful for Kazakh banks, but not fatal. A number are ending up in the hands of foreign banks, which may well bring greater efficiency and sounder practices to a banking sector that already has better practices than banks in the region.

In conclusion, the macroeconomic story is still very strong. The recent downturn has lowered asset valuations, and made private equity transaction and bond and equity issues more likely. This is the time to be considering investing in Kazakhstan. •

Michael Carter is head of research at Visor Capital

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