RAILWAY INFRASTRUCTURE “Upside Transit Potential”

RESEARCH & KNOWLEDGE MANAGEMENT

20 JANUARY 2017

Railroad infrastructure

Table of content

1. Key highlights 3

2. Railway industry overview in Kazakhstan 4

3. Railroad infrastructure 6

4. International railway corridors 7

5. Special economic zones 8

6. One Belt & One Road initiative 9

6.1 Program overview 9

6.2 Bilateral trade between China and EU 11

6.3 Potential impact on Kazakhstan 12

7. Conclusion 15

REFER TO DISCLAIMER & DISCLOSURES AT THE END OF THIS PUBLICATION

Railroad infrastructure

1. Key highlights  Transportation sector plays an important role in Kazakhstan’s economy because of its commodity-based orientation, and immense territory. Rail transport is the basis of the national transport system, comprising about 46% of country’s overall freight turnover in 2016 (237 bln ton-km), while automobile transport accounted for 31%, pipeline transport 22%, air and water transport 1%.

Freight turnover structure by means of transport, bln ton-km (2011-2016)

600

500

400

300

200

100

0 2011 2012 2013 2014 2015 2016

Rail Auto Pipeline Inland water and marine Air

Source: Agency of Statistics, Samruk-Kazyna

 The One Belt & One Road (B&R) program, introduced by China’s government to improve connectivity between the Asian, European and African continents, is anticipated to enhance trade flows and drive long-term regional economic growth. The initiative comprises two physical routes, with several intermediate hubs along the way, connecting China with Europe, Africa and Southeast Asia. B&R will concentrate on the investments in a wide array of assets, including ports, roads, railways, airports, power plants, oil and gas pipelines and refineries, with total cost of already arranged projects in Asia region amounting to USD250bln. In addition, China’s government is expected to mobilize approximately USD1tln of state financing over the next 10 years to fund infrastructure projects in the countries along the B&R road.

 Kazakhstan’s economy is expected to benefit from upcoming infrastructure investments, with Asia-EU-Asia transit volumes transported via Kazakhstan are forecasted to increase to 1,700,000 TEU by 2020 from 47,400 TEU in 2015. In addition, B&R initiative will create USD776bln of infrastructure spending in Asia region, resulting in additional demand for cement and steel of 580 mln tons and 272 mln tons respectively. The program’s current infrastructure projects in Kazakhstan include Khorgos–Aktau railway construction, and further modernization of Khorgos Gateway, with total investments size amounting to USD3bln over the next 5 years. Consequently, our in-house preliminary estimates indicate that B&R will contribute additional of up to 0.1pp-0.2pp to the annual domestic GDP growth by 2021, creating over 100,000 jobs.

Railroad infrastructure

2. Railroad industry overview in Kazakhstan Kazakhstan is characterized by significant distances both between population centers and between suppliers of raw materials and their intermediate or end customers. The railway system is the key mode of transportation in Kazakhstan with an operational length of over 14,767 km, making it the third largest rail network among CIS countries after Russian and Ukraine in terms of track length. However, the density of Kazakhstan’s track network is lower (5.5 km per 1,000 km2) compared to Ukraine’s (35.9 km) and roughly at the same level as Russia’s (5.5 km).

Transportation sector plays an important role in country’s economy because of its commodity-based orientation, and immense territory. Water transport accounts for only negligible part of the total freight turnover due to the country’s continental location. Automobile transport is not favorable for long distances due to high cost.

Therefore, rail transport is the basis of the national transport system, comprising about 46% of country’s overall freight turnover in 2016 (237 bln ton-km), while automobile transport accounted for 31%, pipeline transport 22%, air and water transport 1%. However, by the volume of transportation (tons) automobile transport exceeds rail transport by more than nine times. This is due to the short average distance of the transportation by automobile transport, 50 km, compared to a rail transport, about 724 km. In addition, technological inferiority is the reason of deterioration of the competitiveness of rail transport in comparison with others in both freight and passenger transportation segments.

Freight turnover structure by means of transport, bln ton-km (2011-2016)

600

500

400

300

200

100

0 2011 2012 2013 2014 2015 2016

Rail Auto Pipeline Inland water and marine Air

Source: Agency of Statistics, Samruk-Kazyna

Investments in fixed assets in transportation sector amounted to KZT555,528mln in 2015, compared to KZT647,794mln in 2014. Investments in pipeline and railroad transport accounted for 89% of the total investments in 2015. Railroad infrastructure investments stood at KZT175,049mln, compared to KZT205,799mln year earlier. This implies that transportation sector optimizes its capital expenditures in the period of moderate macroeconomic conditions.

Railroad infrastructure

Fixed asset investments by transport type, KZT mln (2011-2015) 2011 2012 2013 2014 2015 Railroad 218,654 253,054 243,085 205,799 175,049 Automobile 24,257 27,687 29,875 27,778 46,531 Pipeline 148,017 193,177 635,956 385,459 320,491 Inland water 13 8 1 22 1 Sea 20,030 1,409 2,965 4,719 1,482 Air 10,298 19,866 51,938 24,017 11,974 Total investments 421,269 495,201 963,820 647,794 555,528 Source: Agency of Statistics, Samruk-Kazyna

During the last five years, the country’s freight turnover increased gradually, reaching 515bln ton-km in 2016. The largest contributor to the growth was an automobile transport, its share rose from 27% in 2011 to 31% in 2016. The country’s freight turnover highly depends on the GDP level, explained by high dependence of economy on natural resources.

Annual GDP growth and rail freight turnover growth, % (2011-2020f)

15.0%

10.0%

5.0%

0.0%

-5.0%

-10.0% 2011 2012 2013 2014 2015 2016e 2017f 2018f 2019f 2020f

Real GDP growth Rail freight turnover growth

Source: Agency of Statistics, Samruk-Kazyna

Tariffs in the railroad sector rose significantly during 2010-2012 due to intensive investment requirements. Tariffs for accessing mainline railway network (MRN) are set and approved by the Agency of the Republic of Kazakhstan on regulation of natural monopolies (AREM). The MRN tariff (domestic, import and export) methodology is cost-plus, reimbursing all economically justified expenses arising from the provision of services and corresponding investments.

Freight transportation tariff indices (2010-2015) 2010 2011 2012 2013 2014 2015 Railroad 119.1 121.5 114.8 101.7 105.7 120.8 Automobile 102.1 103.4 105.0 101.4 103.2 98.4 Pipeline 100.1 108.8 118.5 103.3 124.2 135.2 Inland water 164.9 114.7 104.5 100.4 103.1 99.5 Air 100.0 100.0 104.3 100.0 100.0 100.0 Source: Agency of Statistics, Samruk-Kazyna

Railroad infrastructure

3. Railroad infrastructure Under article 13 of the law of the RK dated January 6 2012 «On the national security of the Republic of Kazakhstan» the mainline railway network is the country’s strategic asset and is not subject to privatization. Kazakhstan Temir Zholy (KTZ) provides an access to private railway operators to the mainline railway network in accordance with tariff set by the Agency for Regulation of Natural Monopolies (AREM). KTZ is responsible for building, maintaining and modernizing railway system in Kazakhstan. The company is the only entity authorized to operate and manage the mainline railway track.

The track network stretches over 14,767 km, of which 4,216 km are electrified, and only 4,900 km is double - track railway. High share of single-track railway limits the capacity of additional freight turnover and significantly decrease the train speed, especially during high traffic density. High-speed lines with more than 250 kmh are not available yet. There is also a progressive depreciation of mainline railway network. The most problematic areas are: Aktogay - Shymkent, Aktogay - Beskol - Dostyk, Aktogay - Mointy, Petropavlovsk- Astana, Ozinki - Saryagash, Kandyagash – Makat, Makat - Nikeltau, Aktogay - Lokot, the border of the Russian Federation - Atyrau - Beineu, Iletsk - Zhaisan, Kyzylorda- Shieli.

Kazakhstan’s railway system consists of nine mainline railway networks and has 16 connection points with rail networks of neighboring countries, of which 11 are connected with Russia’s railway network, two with China’s and one with Kyrgyzstan, Uzbekistan and Turkmenistan, respectively. The majority of transport corridors have a north-south direction because most of railway lines were constructed during the period of Soviet Union. This implies interdependence between railway systems of Kazakhstan and Russia.

Mainline railway networks in Kazakhstan Freight turnover, Mainline network Brief Description Length, km bln ton-km Aktau - Beineu - Makat - Connects Western Kazakhstan to Kandyagash - Arys - the Kazakhstan-China border 29.6 4,121 Lugovaya - Almaty - Aktogay through the southern regions of -Dostyk Kazakhstan Connects the Kazakhstan-Russia Presnogorskaya - Kokshetau border to the Kazakhstan-China 22.6 2,043 - Astana - Dostyk border Petropavlovsk - Astana - Connects Northern Kazakhstan to 19.9 1,902 Dostyk the Kazakhstan-China border Connects Northern Kazakhstan to Tobol – Astana 14.4 665 Astana Iletsk - Aktobe - Kandyagash Connects Russia to Southern 11.3 1,754 - Arys – Saryagash Kazakhstan Ozinki - Kandyagash - Aurs - Connects Western Kazakhstan- Lugovaya - Almaty - Aktogay Russia border to the Kazakhstan- 22.9 3,708 - Dostyk China border Connects Southern Kazakhstan- Saryagash - Arys - Lugovaya Russia border to the Kazakhstan- 13.7 1,824 - Aktogay - Dostyk China border Connects Western Kazakhstan- Aksarayskaya - Makat - Russia border to the Kazakhstan- 7 826 Beineu - Oasis Uzbekistan border Source: Prospectus of KTZ, Samruk-Kazyna

Railroad infrastructure

4. International railway corridors Kazakhstan’s railway network contains a number of international transport routes, formally included in the system of Euro-Asian land corridors. Sino-Kazakh transport corridor in the East-West from the sea port of Lianyungang (the eastern coast of China) through the border crossing Dostyk - Alashankou and the territory of Kazakhstan, with access to the road network in Russia, takes a special place. Improvement of railway infrastructure in the corridors - a real step in the gradual increase of competitiveness of Kazakhstan's transport system in the Euro-Asian international transport routes.

Kazakhstan’s railway system forms part of five international transport corridors, which facilitate the delivery of freight between Asia and Europe. The Trans-Siberian and Trans-Asian railway corridor could potentially carry around 10% (1,700,000 TEU) of the total EU-Asia transport volume in 2020, provided that most physical and institutional barriers are removed and assuming constant trade volumes between the EU and China.

International railway corridors International railway Description Characteristics Comments corridors The second most developed corridor and China and Kazakhstan referred to as the “second The total distance is use different gauges. Northern Eurasian overland bridge”. 11,516 km, 89% of This poses a major Trans-Asian It runs from Lianyungang which is double tracked, problem since railway through Central and 29% -electrified. containerized cargoes Northwest China, have to be reloaded by Kazakhstan and Russia to crane. Western Europe. It starts from Lianyungang The different gauges and passes through The total distance is require transshipment at Southern Dostyk, Almaty, Tashkent, 10,989 km, 10% of two points. The Iranian Trans-Asian Iran and Turkey before which is double tracked, part is single track and railway reaching the 46% -electrified. not electrified. In Turkey, Mediterranean and Black trains have to cross Lake Sea ports. Van by ferry. Connects Eastern Europe This project includes Cargoes are shipped with Central Asia via Black Dostyk – Tashkent – mainly from west to east, Sea, and Caucasus and Ashgabad – with mostly empty Caspian Sea (Dostyk – Turkmenbashi – Baku – wagons travelling in the TRACECA Almaty – Aktau, including Tbilisi - Poti route with opposite direction. This Zhexkazgan – Beineu, sea ferry connections to has a negative effect on Akhalkali (Georgia) – Kars Odessa, Varna, the efficiency of Caspian (Turkey)) Constanta and Istanbul. and Black Sea ferry lines. Access of Central Asia and Russia to the Middle East and South Asia and the Indian Ocean. Kazakhstan, North-South The total distance is Turkmenistan and Iran corridor 6,191 km. made investments to develop this route, called Uzen-Kyzylkaya-Bereket- Etrel Source: EU-Central Asia Monitoring, Samruk-Kazyna

Railroad infrastructure

The TRACECA corridor, by contrast, has the potential to carry only around 1% of total transport volume, owing to the many obstacles along this route. The Trans-Siberian (TSR) and the Trans-Asian railway corridors are the most attractive ones at present, with the Kazakh corridor being slightly more attractive than TSR.

By 2020, TSR is forecasted to be most practical for railway transports from Northern Europe, followed by the Trans-Asian Route. This is partly due the fact that the TSR route involves the fewest number of border crossings and transshipments.

Nevertheless, the Trans-Asian Route potentially offers the shortest distance, shortest transit time, and lowest transportation costs for cargo from China’s coastal or inland provinces. If the transshipment at the Dostyk-Alashankou border crossing is improved, the Trans-Asian Route will be the most optimal option for railway transport from Northern Europe to Western China.

Railway corridors going through Kazakhstan

Source: Ministry for Investments and Development

5. Special economic zones To better complement the expected increase in cargo traffic passing through the new Eurasia land bridge, 10 special economic zones (SEZs), all with different sectorial focus and priority activities, are being founded and further developed across Kazakhstan, including the USD3.5bln Khorgos-East Gate SEZ near the Chinese-Kazakh border. SEZs are being established to encourage trade, and offers advantageous terms to businesses.

Khorgos-East Gate SEZ, located on the border between China and Kazakhstan, has fast become one of the anchor projects for transforming Kazakhstan into a major commercial and transportation hub of the Eurasian continent. The zone hosts several facilities: International Center for Boundary Cooperation (ICBC), a dry port, logistics and industrial zones, ready connection with the Zhetygen-Khorgos railway and West Europe-West China highway and a package of attractive fiscal benefits, including exemption from import tariffs, land tax, property tax and value-added tax.

Railroad infrastructure

Khorgos’s capacity currently is 200,000 containers per year and is expected to reach 500,000 by 2020. China was a major supplier of funds, whereby China’s Jiangsu province recently promised to invest more than USD600mln for developing the surrounding infrastructure in Kazakhstan.

KTZ Express, a subsidiary of Kazakhstan Railways, opened an international development office in Hong Kong. It aims to build a platform to promote multimodal freight logistics between Europe and China, via Kazakhstan. KTZ Express has also invested in a 21-hectare intermodal freight and logistics center at the port of Lianyungang in China. It has intended to provide direct access to Central Asia for cargo coming from Japan, Korea and Southeast Asia.

Special Economic Zones Year of Special Economic Zone Sectorial focus foundation Mixed (aviation, chemical, Astana New City 2001 light industry, automobile manufacturing) Mixed (chemical, light Sea port Aktau 2002 industry, metallurgy industry) Innovation and Innovation Technology Park 2003 instrumentation Ontustik 2005 Light and textile industries National Industrial 2007 Petrochemical industry Petrochemical Park Burabay 2008 Tourism Khorgos-East Gate 2011 Logistics Metallurgy and metal Saryarka 2011 processing Chemical and petrochemical Pavlodar 2011 industries Chemical Park Taraz 2012 Chemical industry Source: Kaznex Invest, Ministry of Industry and New Technologies, Samruk-Kazyna

6. One Belt & One Road initiative 6.1 Program overview The One Belt & One Road (B&R) program introduced by China’s government to improve connectivity between the Asian, European and African continents, is anticipated to enhance trade flows and drive long-term regional economic growth. The initiative comprises two physical routes, with several intermediate hubs along the way, connecting China with Europe, Africa and Southeast Asia. It represents a collection of all current, planned and future infrastructure projects, accompanied by a variety of bilateral and regional trade agreements. B&R will concentrate on the investments in a wide array of assets, including ports, roads, railways, airports, power plants, oil and gas pipelines and refineries, with total cost of already arranged projects in Asia region amounting to USD250bln. In addition, China’s government is expected to mobilize approximately USD1tln of state financing over the next 10 years to fund infrastructure spending in the countries along the B&R road.

Railroad infrastructure

B&R initiative coverage map

Source: PWC

B&R initiative will have a broad geographical coverage, involving more than 65 countries with approximately 4.4 bln population. The program will facilitate trade flow within the connected regions, with constructed infrastructure leading to shorter transit time and lower transportation costs.

As infrastructure investments are characterized by relatively long payback periods, they often require state financing to be successfully implemented. To finance massive projects under the B&R initiative, China founded several new financial institutions.

The Asian Infrastructure Investment Bank (AIIB) is an international financial institution, focused on building and modernizing infrastructure in the Asia-Pacific region. The bank has 49 member states. AIIB started operation after the agreement entered into force in December 2015, having previously being ratified by 17 member states holding more than 50% of the initial authorized capital. The bank’s equity amounted to USD89bln, in line with the capital of other development institutions.

Several European states – including UK, Germany, France and Italy joined the AIIB. Kazakhstan currently holds 0.82% of the shares and 1% of the voting power. AIIB membership is particularly important to the country, given that the institution is expected to play a pivotal role in supporting the development of infrastructure and other sectors along the B&R routes.

The Silk Road Fund is China’s state-owned investment fund founded to foster investments in countries participating in the B&R. The fund is capitalized mainly by China’s foreign exchange reserves and is intended to be managed like China’s sovereign wealth fund. Creation of the Asian Infrastructure Investment Bank and the Silk Road Foundation provides even more powerful and wider support for the B&R initiative. The bank will support the construction of infrastructure projects along the B&R, and the states participating in the project will establish close business and diplomatic relations.

Railroad infrastructure

The Export-Import Bank of China has been another active participant in reviving old trade routes. Some estimates indicate that the bank financed more than 1,000 infrastructure and industrial park projects in 49 countries along the B&R destinations for a total amount of USD80bln.

6.2 Bilateral trade between China and EU China is the main trading partner of Europe in the Far East. In 2015, China was the second largest exporter and the first largest importer partner in monetary terms. According to European Commission, total export volume from Europe to China amounted to EUR170mln, while total import volume to Europe from China stood at EUR350mln in 2015. China’s main exports to Europe are finished goods – accounting for about 95% in monetary terms. These include machinery and appliances (48%), textiles (11%) and other items. These commodities are suitable for containerized shipment. China imports mainly finished goods from Europe. Machinery and appliances accounted for 30% of total imports, while transport equipment – for 22%.

EU’s trade with China, EUR mln

400,000

300,000

200,000

100,000

0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Imports Exports

Source: European Commission, Samruk-Kazyna

Practically most of the goods traded between the EU and China are being shipped by sea. EU-China trade reached EUR520bln in 2015, and 60% transited by sea, according to Eurostat estimates, while rail and road accounted for 10% of China’s exports to the EU, and 3.2% of the EU’s exports to China. Distances by land between Europe and Asia are generally shorter than distances by sea. In addition, Chinese ports are severely overloaded. The lack of possibility to control marine routes prompts China to explore other geographic options such as land routes through Russia, Central Asia, the Caucasus and Iran.

The main advantage of land transport corridors is their shorter cargo delivery deadlines. Railroad route travel from Asia to Europe is at least two times shorter than marine route travel time. The shortest cargo delivery time from Eastern China and other Southeast Asian countries to Western Europe by rail or road is 2-2.5 times shorter than sea shipment via the Suez Canal, with shorter delivery time being a critical factor for certain cargoes (perishable goods or urgent door-to-door shipments). In addition, faster delivery means quicker receipt of cash from the bank and shorter transaction times.

Railroad infrastructure

Therefore, the time factor is a valuable competitive advantage that overland routes can offer for certain commodities, customers and for land-locked regions such as Xinjiang Uigur Autonomous Region, which has no viable alternative to rail and road transit. For example, the large Chinese port of Lianyungang has a direct railroad link to the Dutch port of Rotterdam. It currently takes 14 days to carry cargo by railroad from Lianyungang to Berlin (11,000 km) while sea carriage requires 30-35 days.

As European leaders consider the expansion of trade and transportation links, Kazakhstan has several competitive advantages. First, by virtue of geography, Kazakhstan forms a one-country link between China and the Caspian Sea, playing a dominant role in any land links between Europe and China. Second, Kazakhstan continues to deepen institutional cooperation with the EU, as evidenced by the signing of an enhanced EU-Kazakhstan Partnership and Cooperation Agreement in 2015.

Third, Kazakhstan offers an improving business environment crucial to the establishment of a trading hub: in the World Bank’s Doing Business 2016 ranking, Kazakhstan jumped 12 positions from 53rd the previous year up to 41st, increasing its investment attractiveness.

One container shipping cost and time from Breakdown of EU-China Trade Chongqing to W. Europe

Price Time Rail and others 8% Sea USD1,500-3000 38-45 days Road 7% Train USD3,500-5,500 16-20 days Air USD20,000-25,000 1-2 days

Air 23%

Sea 62%

Source: UNECE, Samruk-Kazyna

6.3 Potential impact on Kazakhstan In 11M16, China became the third largest trading partner of Kazakhstan, constituting 12.8% of the country’s total trade turnover. Several joint investment projects have facilitated trade between the two countries. As an important strategic partner in the B&R initiative, Kazakhstan has been one of the biggest recipients of Chinese FDI in the former Soviet Union, receiving a total of USD13bln in investment from 1993–9M16.

In 2015, the total volume of transit cargoes carried through Kazakhstan along the Europe-Asia route was about 47,400 TEU, while the Suez Canal marine cargo flow during the same period amounted to a staggering 14.6mln TEU. According to UN Conference on Trade and Development (UNCTAD), by 2020, the volume of trade between major markets in Eurasia will increase by 1.5 times to USD1.2tln from USD800bln in 2014, with the trade between China and the EU rising to more than USD800bln by 2020. Freight transportation is forecasted to increase from 117mln tons to 170mln tons (to about 17mln TEU). Meanwhile, bilateral trade between Kazakhstan and China is projected to reach USD40bln by 2020 from USD10bln in 2015, growing at 32% CAGR.

Railroad infrastructure

International trade turnover growth, USD bln

900 800 45 40 800 7% 40 700 CAGR 35 578 600 30 32% CAGR 500 25 400 20 300 15 10 200 10 100 5 0 0 2015 2020f 2015 2020f

China-EU China-Kazakhstan

Source: UN Comtrade, Oxford Economics, Samruk-Kazyna

In 2015, in Asia-Europe-Asia direction, the volume of transportation through the railway network of Kazakhstan amounted to 47,400 TEU, more than 10 times higher compared to 2012. Infrastructure improvements under B&R initiative are expected to boost Asia-EU transit traffic going via Kazakhstan to 1,700,000 TEU by 2020.

Asia-EU-Asia transit container traffic via Kazakhstan, ‘000 TEU

1,800 1,700 1,600 1,400 1,200 1,000 105% CAGR 800 600 400 200 4 7 21 47 0 2012 2013 2014 2015 2020f

Source: KTZ, Mckinsey & Company, Samruk-Kazyna

An exponential growth in transit volumes will require a considerable modernization of rail infrastructure as some part of Kazakhstan’s railway network is dated back to the Soviet Union period and depreciated substantially.

B&R transport corridors boast high potential, but they need massive investments to realize that potential. There are six potential transit corridors running across Eurasian Economic Union countries that can be used to deliver cargoes along the China-Europe route.

Railroad infrastructure

In the first route, the railroad transportation costs could be reduced to USD1,000 after an increase of cargo turnover due to the modernization program, which includes railroads improvements in Russia and Kazakhstan. Construction of six major logistical centers (including those already in operation) is estimated at USD6bln.

The main problem of all Trans-Caspian routes (regarding third and fourth routes) is that none of the existing Caspian ports is ready to process massive cargo flows. However, Kazakhstan’s successes in this area are much more impressive, even now, the Aktau port can transship up to 11mln tons per year.

B&R transport corridors and their potential Potential throughput Railroad Estimated Utilization capacity post- B&R routes transportation route capacity, ratio modernization, ‘000 cost, USD/TEU '000 TEU TEU Urumqi (XUAR) - Kazakhstan - Omsk - 1,300 300 20% Moscow - EU 1,000 Shanghai - Trans- Siberian railroad - 2,200 250 90-100% Brest Urumqi - Aktau - Makhachkala - 4,000 100 n/a Novorossiysk - Constanta 1,000 Urumqi - Aktau - Makhachkala -Tbilisi - 3,700 50 n/a Constanta Urumqi - Aktau - Baku -Poti - 5,000 50 n/a n/a Constanta Urumqi - transit via Kazakhstan - 1,700 300 n/a 1,000 Teheran Source: KTZ, Transcontainer, TRACECA, Infranews Research Center, Samruk-Kazyna

Target export groups include a broad range of products manufactured in China’s western provinces, and a limited selection of goods originating from its central and eastern provinces. Goods that may generate additional cargo flows along the China – Europe route include:

1) Exports goods originating from China’s western provinces (mostly Urumqi, the Tibet Autonomous region and Qinghai province). 2) Limited selection of goods originating from China’s central and eastern provinces. High unit added value products - electronic devices, automotive parts, pharmaceuticals, standard and costume jewelry and goods with critical delivery times (some food products, premium textiles). 3) The rout is already used to carry computer components (Hewlett-Packard) and automotive parts (BMW) from Europe to China.

There are number of barriers to the realization of Kazakhstan’s transit potential. Physical barriers include delays at the Dostyk railway terminal located at the Kazakhstan-Chinese border due to different rail gauges used by Kazakhstan and China. Transit goods must be transloaded or re-transferred by machine from China’s railcars to Kazakhstan’s railcars. In addition, high transportation and handling costs associated with the use of the railway transit in Kazakhstan also cap the growth of transit volumes.

Railroad infrastructure

Transportation costs in Kazakhstan account for 8% of the final cost of goods transported via railway, compared to industrialized countries, where transportation costs typically account between 4% and 5% of the final cost of the transported goods. This can be explained by the absence of adequate storage capacities at cargo terminals and warehouses at certain key rail cities in Kazakhstan.

Considerable infrastructure investments within the framework of B&R initiative will also result in spillover effects in a form of additional demand for construction materials and services. Developing nations in Asia are expected to spend USD776bln annually to fund infrastructure projects by 2020, creating over 580 mln tons of annual cement demand based on historical correlations with fixed-asset investment in the region. This accounts for more than 25% of China’s cement production. Average per-capita cement output is 380 kg in Southeast Asia and 300 kg in Central Asia, less than the global average of 600 kg and China's 1,800 kg, implying large potential demand.

B&R project may also drive the annual demand for up to 272 mln tons of steel. If investments in the new trade route over land and sea are funded and implemented, it may add as much as 5% per year (or 24% by 2020) to China's steel demand. About 34 tons of steel products may be used for every USD1mln of investments in railways.

Potential B&R spillover effects on Kazakhstan (2017f-2021f)

USD3bln of 0.1pp-0.2pp Over 100,000 jobs planned contribution to created by 2021 infrastructure annual domestic investments over GDP growth by the next 5 years 2021

Source: Bloomberg, FT, Samruk-Kazyna

This is expected to support the performance of Kazakhstan’s construction and manufacturing sectors, indirectly boosting the country’s GDP growth. Our in-house preliminary estimates indicate that the B&R program will contribute additional of up to 0.1pp-0.2pp to the annual domestic GDP growth by 2021, creating over 100,000 jobs. In addition, domestic economy will considerably benefit from ongoing infrastructure improvements, with total investments size reaching more than USD3bln over next five years.

7. Conclusion Kazakhstan has full potential to become a strategic hub between Europe and Asia, benefiting from rising transit volumes. EU-Asia transit traffic going via Kazakhstan is forecasted to reach 1,700,000 TEU by 2020. However, the country needs substantial infrastructure investments in order to improve the efficiency of railway operations and decrease transportation costs, as existing domestic railway networks are currently uncompetitive with alternative marine roads.

Railroad infrastructure

Investments in fixed assets in transportation sector amounted to KZT555,528mln in 2015, compared to KZT647,794mln in 2014. Investments in pipeline and railroad transport accounted for 89% of the total investments in 2015. Railroad infrastructure investments stood at KZT175,049mln, compared to KZT205,799mln year earlier. This implies that transportation sector currently optimizes its capital expenditures in the period of moderate macroeconomic conditions.

In 11M16, China became the third largest trading partner of Kazakhstan, constituting 12.8% of the country’s total trade turnover. Several joint investment projects have facilitated trade between the two countries. As an important strategic partner in the B&R initiative, Kazakhstan has been one of the biggest recipients of Chinese FDI in the former Soviet Union, receiving a total of USD13bln in investment from 1993–9M16.

Asia-EU-Asia transit container traffic via Kazakhstan, ‘000 TEU

1,800 1,700 1,600 1,400 1,200 1,000 105% CAGR 800 600 400 200 4 7 21 47 0 2012 2013 2014 2015 2020f

Source: KTZ, Mckinsey & Company, Samruk-Kazyna

Domestic economy is expected to considerably benefit from upcoming infrastructure investments within the framework of B&R program, with Asia-EU-Asia transit volumes transported via Kazakhstan are forecasted to increase to 1,700,000 TEU by 2020 from 47,400 TEU in 2015. In addition, B&R initiative will create USD776bln of infrastructure spending in Asia region, resulting in additional demand for cement and steel of 580 mln tons and 272 mln tons respectively. The program’s current infrastructure projects in Kazakhstan include Khorgos–Aktau railway construction, and further modernization of Khorgos Gateway, with total investments size amounting to USD3bln over the next 5 years. Consequently, our in-house preliminary estimates indicate that B&R will contribute additional of up to 0.1pp-0.2pp to the annual domestic GDP growth by 2021, creating over 100,000 jobs.

Railroad infrastructure

Disclaimer & Disclosures

The Research and Knowledge Management Department Strategy and Portfolio Investment Block of JSC “Samruk-Kazyna” (hereinafter referred to as “the Research Team”) is responsible for the analysis of this report. The Research Team certifies that all views expressed in this Research report (hereinafter referred to as “Report”) reflect the Research Team’s personal views.

The Report is based on the information taken from the sources which the Research Team considers reliable and takes every care and precaution to ensure that information related to the Report published on the corporate website of JSC “Samruk-Kazyna” is accurate and regularly updated, but neither the Research Team nor JSC “Samruk-Kazyna” make no guarantee, warranty of any kind, express or implied, or make no representation as to the accuracy or completeness of the information contained in the Report or otherwise, and it should not be relied on as such. The Research Team may change the information contained in this Research at any time without notice.

Neither the Research Team nor JSC “Samruk-Kazyna” or any of its officers, employees shall be liable for any losses or damage that may result from use of the information contained in the Report as a consequence of any inaccuracies in, errors or omissions, if any, from the information which the Report may contain or otherwise arising from the use and/or further communication, disclosure, or other publication of the information contained in the Report.

This Report is solely intended for general informational purposes and is provided for internal distribution within JSC “Samruk-Kazyna”. This Report is not in any sense a solicitation or offer of the purchase or sale of securities or any assets in any jurisdiction.

No part of this material may be copied or duplicated in any form by any means or redistributed without any prior written consent of JSC “Samruk-Kazyna”. Additional information is available upon request.