Earlier this year we had the opportunity to speak to Dr. Sabit Khakimzhanov,  the head of research at Halyk Finance, a leading Kazakh investment bank focused on Central Asia. Khakimzhanov is an authority on the Kazakh economy and investment climate, and has written and spoken widely on Kazakh monetary policy.

Dr. Khakimzhanov has a Ph.D. in Applied Economics from the University of Minnesota Twin Cities, where he specialized in international and monetary economics.

SD: The central bank’s intervention seems to have stabilized the tenge, at least temporarily. How long can the central bank afford to keep intervening and what might a more lasting solution be to ongoing currency struggles? 

Khakimzhanov: The struggles stem from the inability of the CB to coordinate the market’s expectations around the good, low inflation equilibrium. The expectations are all over the place and there is a real risk that they will coalesce around a bad, high inflation equilibrium, the one where the tenge weakens more than the economy needs to adjust to the terms of trade and real exchange rate shock. If the exchange rate runs away beyond that level and stays there for too long, it may become too costly to reverse the expectations. Two problems are standing in the way of a good equilibrium and both need to be addressed if Kazakhstan wants to make the tenge both flexible and resilient. One is the lack of consistency and credibility in the monetary policy. The central bank needs to describe good equilibrium, why it is an equilibrium, what it will do to achieve it and cover major contingencies. Another is the lack of market forces that pull the exchange rate towards the equilibrium. Even if the monetary policy is credible, sustainable and clearly articulated, the central bank alone cannot bring the exchange rate towards a good equilibrium. This has to be done by the market players. And at the moment there are too few market players who are sophisticated enough and have the balance sheet capacity to translate their expectations into actions in the FX market. This is a challenge for the regulator and for the banks. The central bank needs to liberalize prudential regulations which were originally erected to prop up the exchange rate. It also needs to convince the most conservative and least sophisticated investors– the households – to convert their Dollar savings into tenge. There is only one way to do so: keep tenge interest rates reasonably high and establish a trend for appreciation of the tenge which is identifiable by households and sustainable in the eyes of sophisticated players. For this to happen tenge may need to overshoot , but it should not stay there for too long.

What is happening right now is that the central bank fixed the exchange rate again. The free float is no longer a mode of operation, but rather an aspirational target. The level at which the exchange rate is now fixed is consistent with a moderate current account surplus and a level of inflation that is just above the pass through of unavoidable devaluation. The devaluation resolved the most immediate issues related to the overvalued exchange rate, which have plagued Kazakhstan since late 2014. But the market remains unconvinced: speculative pressure on tenge persists, households refuse to convert dollar deposits into tenge, interest rates remain very high and volatile, their visibility very low and there is no tenge yield curve to speak of. In other words, the challenges that Kazakhstan’s monetary authorities are facing are tremendous. And it does not help that the mandate and operational independence of the central bank are so limited.

SD: In terms of economic growth, Kazakhstan is by far the most successful of the Central Asian states. The economy has not, however, been able to show consistent, high growth, and some of its larger hydrocarbons projects have not moved the country’s economy as expected. Adding to this, the economy has been criticized for a lack of diversity, even though President Nazarbayev has spoken recently at length about the need of a more diversified economy. What steps do you predict the government will take in order to generate more consistent growth, and what might the government consider to reduce its dependence on hydrocarbons?

Khakimzhanov: I don’t think diversification can be a key policy instrument in achieving sustainable growth. It it can certainly be an indicator.  So far, however, it has been used as an instrument . In the past fifteen years the government produced a number of industrialization programs to support certain sectors, but lacked in persistence and execution for these programs to succeed.

An even more important barrier to diversification is a macroeconomic policy that amplifies the symptoms of the Dutch disease and procyclical macro policy. Kazakhstan is a small open commodity exporter. Changes in the commodity market expose us to huge swings in the terms of trade.

On the face of it the main problem seems to be with the monetary policy. Granted, fixed exchange rate cannot be credible for an economy like Kazakhstan because it results in an extremely procyclical monetary policy. So procyclical that it is immediately abandoned in the face of a falling oil price. Devaluations of 2009 and 2015 illustrated that. But we should not blame only monetary policy for the macroeconomic excesses. And in the last boom of 2009-2012 its role has been fairly limited. And even then there is only so much a good monetary policy, with a floating exchange rate and great monetary discipline, can do in a country that is dominated by large commodity exporters. The incomes of the households and, to a large degree, domestic demand, depend on fiscal outlays.

In one regard we are in a better position to withstand these shocks than other commodity exporters because of the government ownership of a large part of the commodity sector (the rest is owned by foreign capital). The government can control the inflow of oil revenues into the economy but is not using this opportunity effectively.

The fiscal policy fails to be austere when it matters the most – during the boom phase. The National Oil Fund would need to be a lot more disciplined in financing government spending when oil prices are high .

And macroeconomic issues only begin to scratch the surface of the deep structural problems afflicting the economy. We do not have enough human capital — our education and health care systems are not very good at producing it. We lack institutional and organizational capital that is necessary to run a modern market economy. Problems with corruption and highly concentrated decision making structure are indicative of that. This year the government initiated judiciary reform. They are badly needed because the quality of adjudication is very poor and that is huge barrier for investments and also for larger economic and social development. Whether the government has the capacity to implement these reforms is another question. The track record is not particularly good. Even with good will and under the best circumstances it would take time to change the attitudes of the public. There is only so much a government can do. The civil society needs to play a greater role, but does not appear mature enough to take it.

SD: The problem of corruption is one that seems to come up a lot when talking about the Kazakh economy. Does the government has an incentive to combat corruption if not for political reasons, then for economic reasons? Or is corruption just going to remain relatively unchanged moving forward?

Khakimzhanov: The government is doing something in terms of corruption. In the past 15 years, we’ve seen a massive change in attitudes. Back then, nobody talked about corruption, but now people do increasingly. There is greater understanding that corruption is bad, and not just for the economy, but also for social stability. There is less tolerance towards corruption. People look at what the Georgian government has done, what Ukraine has done, and it helps to create this “can do” attitude to the problem. It changes perceptions for the better.

SD: Upon entering the Eurasian Economic Union, one of Kazakhstan’s main interests appeared to be the consumer markets of other EEU countries – totaling approximately 170 million. Due to current economic difficulties, do you believe that the EEU is still viewed in the same light as it was prior to the Russian economic crisis? How can Kazakhstan benefit from the EEU in this regard if its members and their consumers are reluctant to spend? What other benefits does Kazakhstan seek from the EEU, apart from increased access to consumer markets?

Khakimzhanov: The Eurasian Economic Union is a misnomer: it peddles more than mere economic integration. And it uses non-economic instruments to advance the economic, but mostly political interests of the Russian Federation. It purports to open a larger market to Kazakhstan’s businesses, but this market could close to Kazakh businesses at a policymaker’s whim. Recent events showed just how real this risk is. The integration under EEU goes well beyond the free trade and free movement of labor and capital. The EEU aims to harmonize most businesses regulations, apparently on the basis of the Russian regulations. This may appear to benefit Kazakhstan because our regulations,  on average, are less efficient, less business friendly, but such benefits are transitory and in some areas our regulations are actually better. In the long run the costs of forgoing policy making sovereignty are going to be tremendous. With all due respect, Russian market institutions are not the best choice for imitation. They are still in their infancy. Borrowing them will force Kazakhstan to make the same mistakes that Russia has already made. But borrowing subpar regulation is not what bothers me the most in this arrangement.

I am mostly concerned that by surrendering policy making powers to another country, no matter how advanced, we, as a country, would fail to develop institutions of collective decision making. For regulation to be effective, it needs to be internalized by the regulator, understood by the market, and be compatible and consistent with the other elements of the legal, business and political environment. In other words, Kazakhstan needs to learn to produce its own regulations, to develop the expertise, the interest groups, the social and other mechanisms that ensure that the interest of the stakeholders are fed meaningfully into the policy making process. Kazakhstan needs to develop the entire ecosystem of business regulation. There are no short cuts here. To develop, a country needs to make its share of mistakes. Within the EEU, we would suffer from the mistakes that Russia made and we would also fail to develop our own decision-making and policy-making institutions. This is a developmental dead-end.

SD: The Kazakh government has been historically generous in extending benefits to foreign investors. Its “Invest in Kazakhstan” campaign, for instance, promised a wide range of tax exemptions and other incentives to investors, and emphasized that Kazakhstan has consistently risen in the World Bank “Doing Business” reports. These facts notwithstanding, the amount of foreign investment in Kazakhstan has shrunk over the past two years. To what do you attribute this?

Khakimzhanov: The benefits are temporary and discretionary. They cannot mask the lack of the rule of law, lack of human capital, ineffective and frequently changing regulation, lack of a due process in policy making, lack of actors with real decision-making power. There is a genuine desire to move toward more progressive policies. But there is also underappreciation of the role that the institutions of collective decision making play in that process. This seems like some magic dust. Investors feel it and they call it investor climate. The World Bank attempts to measure it very crudely and naively using its Doing Business survey. The government tries very hard to raise Kazakhstan ranking in investor climate survey, with little or negative results. The good policies matter, but how they are developed and adopted matters too.

SD: Once operational, Kashagan will be one of the world’s largest oilfields. It is slated to begin pumping barrels again by the end of 2016. Does Kazakhstan currently possess the infrastructure needed to support the transportation of its oil and gas products to key end markets or distribution centers like Russia, China, or Baku? And how will Russia respond to increased Chinese acquisitiveness when it comes to Kazakhstan’s exports, especially given its own pivot towards the East and away from the EU?

Khakimzhanov: I don’t think transportation or distribution is an issue. Once the oil starts flowing from Kashagan, the pipeline will be ready. I don’t think that Russia is in a position to choose who can and cannot be China’s suppliers. And China has been buying mineral assets across the world, and in Central Asia in particular, for the past decade. Russia’s pivot to the East is another factor of uncertainty for Kazakhstan, not least because Russia has become a less effective counterweight for China’s influence in the region. But China too, may soon be engulfed in its domestic problems. The problem with China is that it may perceive Kazakhstan as a solution to structural problems that are bound to afflict China in the short to medium term. China has its own integration project, dubbed “One Road One Belt”. The Chinese government stands ready to provide financing to a number of infrastructural and commercial projects in Kazakhstan. These projects may be financed by official Chinese financial institutions but are for the most part trade finance deals, bilateral very nontransparent transactions, with strings attached. Such non-market finance may help boost GDP, but such projects may produce smaller economic return, raise Kazakhstan’s sovereign debt and eliminate the incentive to address the problems in the domestic financial market.

SD: Nursultan Nazarabayev is 74 years old. Succession is still currently uncertain and poll numbers from April’s election, if they are to be believed, show that he obtained a staggering 97.5% of the vote. Most analysts have noted that Nazarabayev has made no public plans for a successor. Given the growing unrest surrounding poor economic conditions, what do you think his strategy is for handing off power? Are there any leading candidates?

Khakimzhanov: There has been a change in the way the government has approached this issue. Previously, the government did not even acknowledge it – there was no official policy, but everyone assumed that the president had a plan. The developmental problem, or cultural, is not the lack of a succession plan. It is that we are thinking about the issue in terms of succession. We are not discussing the existing institutions, the balance of powers, the constitution. We think, and this is true of the even most sophisticated actors on the scene, we think in terms of personalities.

And it appears that the government initiated a change in these attitudes. This year the president made several statements that suggest that he is not thinking in terms of personalities. The president acknowledged that there is a huge amount of centralization and concentration of power, and he emphasized the need to diversify this power. I assume towards legislature and judiciary. There is an identifiable intent to oversee this transition while remaining in power. This is reflected in the distinction between the office of the president and the first president.  But there is a great deal of uncertainty about the ultimate vision that the president has for Kazakhstan’s political system, let alone about how to implement it. I believe these issue will continue to be discussed, leaked and debated before the decision will be announced. And it is not necessarily final. Everything is and will remain very fluid.

I don’t think the president would favor one person – it goes against his idea of his own political legacy.