eotN.382K Republic ofKazakhstan CountryEconomicM Report No. 30852-KZ Report No. 30852-KZ Republic of Kazakhstan Country Economic Memorandum
Public Disclosure Authorized Disclosure Public Getting Competitive, Staying Competitive: The Challenge of Managing Kazakhstans Oil Boom
June 2005
Poverty Reduction and Economic Management Unit Europe and Central Asia Region Public Disclosure Authorized Disclosure Public Public Disclosure Authorized Disclosure Public emorandum
Document of the World Bank Public Disclosure Authorized Disclosure Public
Produced under the Joint Economic Research Program of the World Bank and the Ministry of Economy and Budget Planning
Republic of Kazakhstan: Getting Competitive. Staying Competitive: The Challenge of Managing Kazakhstan’s Oil Boom
EXECUTIVE SUMMARY...... i ... 1) Economic Policy ...... 111 2) Human Capital ...... iv 3) Infrastructure ...... v Public Sector Institutions ...... vi 4) ... 5) Sectoral Policies ...... vu1 6) Innovation and R&D ...... ix Summary ofDiagnostics and Recommendations ...... 1 I. CONTEXT: A TASTE OF tHE FUTURE ...... 1 A . Transforming Kazakhstan within a Decade ...... 1 B. 2004: The Two Faces ofKaza~stan ...... 2 11 . CATCHING UP WITH HIGH-MIDDLE INCOME ECONOMIES ...... 5 A . The Challenge’s Perspective ...... 5 B. The Key Ingredients ofCompetitiveness in Kazakhstan ...... 7 1. The Framework ...... 7 2 . A Simple Benchmarking Exercise ...... 9 a. Economic Management ...... 9 b . Labor Productivity ...... 13 c . Infrastructure ...... 13 .. d. Institutions...... 15 e . Summary ...... 17 11I. THE STRATEGIC POLICYAGENDA ...... 19 A . Policy Context ...... 19 1. Current Policy Stance ...... 19 2 . Additional Considerations ...... 22 B. The Economic Management Agenda for Competitiveness ...... 28 1. The Oil Windfall: Benefits and Risks ...... 28 2 . Policy Choices ...... 31 a. Fiscal Policy ...... 31 b . Exchange Rate Policy ...... 37 c . Supervision and Regulatory Policy and Policies towards Capital Inflows...... 38 C . The Structural Reform Agenda for Competitiveness...... 40 1. Infrastructure: the Case ofTelecommunication Reform ...... 40 a. Market Liberalization ...... 41 b . Tariff Rebalancing ...... 42 c . Interconnection ...... 42 d. Roles and Responsibilities ofDifferent Players ...... 44 e . Promoting Universal Access in Rural Areas ...... 45 2 . Sector Policies: The Case ofLocal Content for the Oil and Gas Sector ...... 48 a. Background: Partnering with Multinationals ...... 48 b . Obstacles to Domestic Supply into the Oil and Gas Sector ...... 49 c . A Three-Pronged Strategy to Foster Competitiveness ofSuppliers ...... 51 Annex Table 1: Kazakhstank Key Economic Indicators. 1999-2004 ...... 59 Annex Table 2: Kazakhstan: GDP Growth. 1999-2005 ...... 60 Annex Table 3: Kazakhstan: Structure ofGDP. 2003 ...... 60 Annex Table 4: Kazakhstan: Value Added in Regions, 1996-2003 ...... 61 Annex Table 5: Kazakhstan: Real Exchange Rate, 2000-2004 ...... 61 Annex Table 6: Kazakhstan: Savings and Investment Rates, 1999-2004 ...... 62 (% OfGDP) ...... 62 Annex Table 7: Kazakhstan: Exports ofKey Commodities, 1999-2004 ...... 63 Annex Table 8: Kazakhstan: Consolidated Govemment Fiscal Accounts, 1999-2007 ...... 64 Annex Table 9: Kazakhstan: Commercial bank loans by sector, 1998-2004 ...... 65 Annex Table 10: Selected indicators for Kazakhstan and Comparator Countries, 1990-2003 ...... 66 Annex 2: List ofBackground Papers and Activities ...... 68 Annex 3: References ...... 70 List of Text Tables, Figures, Boxes, and Diagrams Table 1: Performance in Venezuela and Kazakhstan during Selected Oil Boom Periods Table 2: Kazakhstan: Composition of Investment in Fixed Assets, 1999-2004 Table 3 : Volatility of Exchange Rates and Prices, January 1997 to September 2004 Table 4: Kazakhstan: Use of Oil Inflows and Overall Spending Priorities, 2000-2007 Table 5: Kazakhstan: end-2002 Net Wealth under Alternative Assumptions Table 6: Kazakhstan: Key Economic Indicators, 2000-2007
Figure 1: Kazakhstan: Two transitions, 1990-2004 Figure 2: Kazakhstan: Gross Foreign Direct Investments, 1993 - 2003 Figure 3: Kazakhstan: Real GDP Growth, 1997-2005 Figure 4: Kazakhstan: Oil Revenue Saved and Spent, and Total Spending Levels, 1999-2005 Figure 5: Kazakhstan: Real Exchange Rate Index, 2000-2004 Figure 6: Kazakhstan: Saving and Investment Ratios, 1997-2003 Figure 7: Kazakhstan: Structure of GDP, 2003 Figure 8: Kazakhstan: Exports of Selected Goods, 1997-2004 Figure 9: GNI per capita in new EU and Common Economic Space Countries, 2003 Figure 10: Kazakhstan: Convergence with EU8, 1990-2024 Figure 11 : Fuel Exports in Selected Oil Countries, 1970-2002 Figure 12: Kazakhstan: Total Savings Ratio, 1995-2003 Figure 13: Kazakhstan: Total Investment Ratio, 1992-2003 Figure 14: Kazakhstan: Non-oil Investment Ratio, 1999-2003 Figure 15: Kazakhstan: Government Spending, 1993-2003 Figure 16: Kazakhstan: Manufacturing Labor Productivity per Worker, 1992-2003 Figure 17: Kazakhstan: Agriculture Labor Productivity per Worker, 1992-2005 Figure 18: Kazakhstan: Infant Mortality Rate, 1990-2002 Figure 19: Kazakhstan: Public Spending in Health and Education, 1995-2001 Figure 20: Kazakhstan: Selected Benchmarks ofTransport and Telecommunications Infrastructure Figure 2 1: Kazakhstan: Selected Benchmarks for the Institutional Framework, 2002 Figure 22: Growth Experience in Selected Oil Rich Countries Figure 23: Kazakhstan: State Budget Spending in Major Categories, 1999 - 2007 Figure 24: Kazakhstan: Potential Oil Production, 1999 - 2035 Figure 25: A Simulation of the New Saving Rule
Box 1: What Kind of State Support for Agriculture? Box 2: Strengthening the Contribution of Education to Kazakhstan’s Economic Transformation Box 3: Approaches to Industrial Policy Box 4: Strategic Directions for Telecommunication Reform
Diagram 1: A Framework to Study Competitiveness in Kazakhstan Diagram 2: Key Players in the Oil & Gas Value Chain in Kazakhstan Diagram 3 : Pyramid of Supporting Industries Diagram 4: The Upstream Value Chain-Where Local Companies Can Most Effectively Integrate? Diagram 5: Strategic Direction to Transform Local Content System
ACKNOWLEDGEMENTS
The World Bank and the Government ofKazakhstan have had extensive discussions on the issue of competitiveness over the past two years. In the process, ten independent Policy Notes were produced focusing on issues that the government and other stakeholders consider most relevant (Annex 2). This report synthesizes those discussions and the Policy Notes. In addition, the Bank provided written comments on various official programs, and organized workshops and training sessions on topics of strategic importance and of special interest to government counterparts. The discussions included a brainstorming session with high level government officials and a panel of international experts on rules for the management ofoil revenues.
These activities are part ofthe ongoing Joint Economic Research Program being conducted by the World Bank and the Ministry of Economy and Budget Planning. It is the result ofsubstantial collaboration among numerous govemment officials. In particular, we would like to thank Messrs./Mmes.: Erbol Orynbayev of the Administration ofthe President; Kairat Kelimbetov, Kairat Aitekenov, Bakhyt Sultanov, Shamil Dauranov, Zhasser Jarkinbayev, and Maulen Utegulov ofthe Ministry ofEconomy and Budget Planning; Arman Dunaev, Gani Uzbekov, Ruslan Dalenov, and Arystan Kabikenov ofthe Ministry ofFinance; Nurlan Kusainov, Kuanysh Bishimbayev, and Madina Abylkasymova ofthe Center for Marketing and Analytical Research under the MEBP; Aset Issekeshev and Zhanar Aitjanova of the Ministry of Industry and Trade; Evgeny Dominov ofthe National Innovation Fund; Anvar Saidenov, Gulbanu Aimanbetova, Askar Elemesov, Aigul Buranbaeyva, and Daniyar Akishev of the National Bank ofKazakhstan; Bolat Zhamishev and Yelena Bakhmutova of the Financial Supervision Agency; and Yuri Shokomanov, Dametken Kairova, and Emma Tlepbergenova of the National Statistical Agency ofKazakhstan.
This report was prepared by a team consisting ofBank staff and consultants. The team was led by Pedro L. Rodriguez and composed of Sweder Van Wijnbergen, Madi Umbetaliev, Ilyas Sarsenov, and 'Laura Lucas. Background notes were produced by Nina Budina (PRMEP); Gregory Jedrzejczak, and Alfred Jay Watkins (ECSPF); Thomas Glaessner and Joaquin Gutierrez (OPD); Gareth Locksley and Howard P. Williams (CITPO); Thilakaratna Ranaweera (DECDG); Sweder Van Wijnbergen (University ofAmsterdam); Ricardo Hausmann (Harvard University); Roberto Rigobon (Massachusetts Institute of Technology); Gary Gereffi (Duke University); and Artur Radzwill and Paul Domjan (Consultants). This report benefited from a background note on the Transport Sector prepared by Henry Kerali, Motoo Konishi, and Loup Brefort. Training on oil and gas value chain analysis was provided by Gary Gereffi and Sheikh Jahan (Duke University), and training on economic modeling is being planned as a follow up activity.
The peer reviewers were Peter Thomson (ECSIE), Michael Lewin (DECDG), and Ibrahim Ahmed Elbadawi (DECDG). Additional comments and guidance were provided by Samuel Otoo (ECSPE), Loup Brefort (ECCKZ), Maurizio Guadagni (ECSSD), and Michael Mertaugh (ECSHD). The team appreciated the various discussions and exchanges with Aasim M. Husain, Peter Keller, Tony Lybek, and Peter Lohmus (IMF). The team would like to thank Ainoura Alzhanova and Aida Mukhanova for their administrative assistance, and Linda Tatem for editing the final report.
EXECUTIVE SUMMARY Kazakhstan has made substantial progress in its economic transition and faces a potentially bright future thanks to its oil wealth. The challenge is to increase the country’s competitiveness and expand the benefits of growth, while avoiding the economic and social risks typically associated with oil wealth. i. During the past decade of transition, Kazakhstan has made commendable progress in stabilizing its economy and carrying out structural reforms. The country is blessed with significant oil reserves that are now in the process ofbeing tapped through three large oil field development projects. Oil production in Kazakhstan could triple to 3 million barrels per day within a decade and a half. The associated flows to the budget have been estimated to be as large as seven billion dollars a year two decades from now. .. 11. Against this backdrop, a vigorous debate is taking place in Kazakhstan over the strategic use ofits growing oil revenues and the challenge ofensuring sustainable and broad-based economic growth. Many of the questions raised by the oil windfall debate are not easy to answer: (a) how to increase the competitiveness of the non-oil sectors and diversify the economy; (b) how to transfer some of the forthcoming oil revenue to the population given that the oil sector only employs a handful ofpeople; (c) how to adopt world standards that would guarantee a presence in the global economy; and, more generally (d) how to avoid the so called “oil curse”? iii. The last question is the most complex in many ways because it is heavily influenced by political economy considerations. Oil has changed the policy environment in Kazakhstan, and will do so more in future. Oil has in particular reduced cash constraints. But there are risks: volatility issues, quality ofspending, inflexibility in uncertain environment, and boomhust cycles that tend to plague oil-rich countries. Oil revenue relaxes the usual constraints on government expansion and, thus, oil rich economies run the risk of getting “too much government.” In general, there will be a lot a pressure on governments to allocate oil funds to domestic investment. While clearly some increase in domestic investment isjustifiable, in many oil economies it tends to be excessive and strains domestic capacity so that the quality ofpublic investment falls drastically, i.e. both the ability to spend efficiently (for results) and effectively (least-cost). Another typical issue that oil economies face is that it tends to exaggerate the role of government. While there will still be enough scope for government interventions in the provision of basic public goods (health, education, infrastructure, and institutions), the temptation for the government to meddle with market driven allocation ofresources proves often difficult to resist. As a result, managing oil windfalls has not been easy for developed (UK, Holland and even Norway) and developing (Venezuela, Saudi Arabia, Mexico, and Nigeria) countries alike. iv. A key problem for oil rich countries is the so called Dutch Disease. Essentially as oil revenue increases, the associated fiscal, monetary, and credit expansions can ‘overheat’ the economy, possibly leading to excessive currency appreciation (beyond the equilibrium exchange rate). Overheating exerts negative pressure on tradable sectors such as agriculture and manufacturing, whose output declines in relative terms. It also creates bottlenecks for skilled labor, infrastructure, utilities (water, electricity, telephones), housing, and real estate. Often (e.g., Mexico and Holland), the fiscal expansion creates inflexible spending programs (social or infrastructure related), and almost always the quality ofpublic spending deteriorates (e.g., 11
Venezuela, Saudi Arabia, and Nigeria). Beyond these basic symptoms ofDutch Disease, international experience suggests that windfalls also lessen the imperative to address corruption and other general business environment problems, which serves to further weaken investment and performance in the non-oil economy. v. The GOK is aware ofthe pitfalls ofnatural resources windfalls and looks to international experience for key lessons to guide its strategy and policy choices. Delegations visiting South Korea, Singapore, Norway, the European Union, the US, Ireland, Dubai, and other countries have enriched the debate as have returning Kazakhstan national graduates trained overseas.
The overarching theme of the report is how to exploit the strengths of the Kazakhstan economy in the new oil environment, while avoiding the pitfalls that oil income typically brings. vi. This report, which is the product of extensive consultations between the GOK and the World Bank, does not try to provide unique answers to the questions raised above. Rather, it presents a framework that can be used by Kazakhstan’s policy-makers and stakeholders to establish priorities and trade-offs among the various options, and draws on international experience to illustrate key points. vii. The report provides benchmarks for key aspects of competitiveness in Kazakhstan vis a vis Ukraine, Russia, and the eight most recent members ofthe EU rather than with other rich countries. This is done for two reasons. First, Kazakhstan’s leadership has set as one ofits strategic objectives to catch up with the EU over the long run in terms ofliving and production standards, and levels ofproductivity and income. The country wants also to compete for investments and markets with Ukraine, Belarus, and Russia. Second, because although oil and gas already represents a large proportion ofexports, this does not mean that the direct impact of oil in Kazakhstan is as large as in, say, Saudi Arabia or Venezuela (see Background Paper No. 10). In fact, high production cost in the oil and gas sectors, and a relatively diversified economy (although to a large extend this diversification is towards other extractive industries), suggest Kazakhstan should follow the examples of Norway and Malaysia where non-oil sectors continue to develop, and their non-oil exports volumes to grow and increase in sophistication, even after oil took-off. Our analysis still draws upon lessons from oil rich economies, viii. Using oil revenues effectively. A key benefit ofoil wealth is that it relieves fiscal and foreign exchange constraints. Whether it is used effectively to diversify the economy and increase competitiveness in non-oil sectors will significantly depend on appropriately answering the following fundamental questions: a. How much should be saved or spent out ofoil revenues, bearing in mind the macroeconomic consequences that such spending could bring about (Le. overheating, and Dutch Disease)? b. What are the long-term priorities for spending oil and non-oil revenues? c. What role should be ascribed to the government to increase competitiveness in the non-oil sectors? And how much of that role is to be played out through direct government spending 111
and how much through general policies and creation ofthe right enabling environment, i.e. removal ofobstacles? ix. Six areas for action. The policy agenda will, ofcourse, have to go beyond these fundamental questions and formulate detailed policies and public investments. In this regard, interventions in six broad areas must be developed and prioritized (see Background Paper No. 4)-in most cases by building on and better focusing the already designed Public Programs (e.g., Rural Development, Food Security, Railway Development, Telecommunications Reform, Industrial Innovation, Housing, Health, Education, and e-Government). The six areas are discussed below.
1) Economic Policy x. Policies and oil have increased savings levels, but the drivers ofinvestment have been the oil and government sectors, while the investment ratio in the non-oil tradable sectors has been falling since 2001. High savings levels must be maintained as they are essential for growth and productivity, but the policy mix (Le. combination offiscal, financial, trade, and monetary policies) must also care about stimulating private investments in tradable sectors and increasing size and sophistication ofnon-extractive exports. This will require: (1) controlling aggregate demand (Le. rapid expansion in public spending or credit, which are the indirect result of the boom in oil and other commodity prices); and (2) maintaining the real exchange rate at around its long-run equilibrium trajectory. Only this way the country can avoid excessive volatility in prices and exchange rates and, thus, maintain the desired pace ofnon-oil industrialization. Instruments to smooth out the impact ofthe oil cycles in the economy include:
0 Anchoring fiscal policies on an improved formula to regulate the amount ofoil revenues saved in the NFRK and spent through the budget, and a budget rule under which the non-oil deficit (total or primary) is financed exclusively by the transfer from the NFRK (i.e. no borrowing in net terms other than perhaps to cover interest payments). These measures must be complemented by: (1) a Debt Issuance Strategy that monitors the net savings ofthe consolidated public sector, while determining gross borrowing and disbursements from domestic and external sources, and the actions that the state budget and other public institutions (e.g., SOEs, DBK, and the NBK) will be taking to facilitate the further deepening ofthe financial sector; and (2) a limit, to be established through the budget formulation and approval process, on the Aggregate Investments and Borrowing levels that quasi-fiscal development institutions and SOEs could undertake (see Background Papers No. 3,6, and 10).
0 Focusing financial sector policies on: (1) slowing down the pace ofcredit expansion (through reserve requirements on foreign borrowing, and possibly measures to signal the need of prudent cross-border lending and commercial bank’s offshore operations or, if necessary, by more direct means); and on (2)further strengthening the institutional set up within and across agencies (Le. MEBP, MOF, FSA, and NBK) that will need to serve as the “eyes” and “ears” ofthe policy makers regarding structural and business cycle- related risks in the financial sector. Emphasis will have to be given in particular to supporting efforts ofthe Financial Supervision Agency (FSA) to strengthen key functions iv
including: comprehensive consolidated supervision, prompt corrective action and resolution (including the role of the deposit insurance fund), and onsite examinatiodoff- site analysis in the case of both banking and non-banking services (see Background Paper No. 8).
0 Further developing instruments for monetary policy. Monetary markets are shallow, and the NBK does not have instruments to affect interest rates in the market posing an important agenda for the NBK. At the same time, the NBK needs to formulate a clearer plan for intervention in money and foreign exchange markets (part ofwhich is to be made explicit to the markets).
0 Resistingprotectionistpressures as well as the lobby for sector-specific subsidies or tax exemptions. In this regard, Kazakhstan is well placed to use the process ofWTO accession to drive an important domestic agenda that includes: (1) “locking-in” a much more transparent and simplified tariff regime than the one currently in place; (2) modernizing the legal and institutional framework for standards; and (3) introducing important sectoral reforms in areas such as telecommunications, railways, and other services that are key for the competitiveness ofa land-locked and far from markets country. 2) Human Capital xi. Kazakhstan’s labor productivity has been stagnant in manufacturing for the last three years (relative to the EU8 countries, Ukraine, and Russia); and in agriculture, which generates the livelihood for a significant part of the population, the picture is worse as productivity has been falling for over a decade. Trends in key determinants oflabor productivity (e.g., health, education investments) are not encouraging, and the extent to which the current housing policy will facilitate labor mobility is unclear. Human capital investments enhance everyone’s opportunity and, in that respect, they are not only essential for productivity reasons but also needed to mitigate the potential worsening of income distribution that oil inflows may create. Successful competitive countries are those that invested heavily and well in human capital - not just narrow elite but broad-based. The emphasis here should be on quality rather than quantity of spending. For instance, there is no reason to increase budget allocations for higher education or for hospitals before the ministries formulate a detail plan on how the higher education institutions (as well as hospitals) are to be reformed and in some cases downsized or restructured. Similarly, there are significant efficiency gains in the procurement ofcertain supplies (e.g., drugs) ifthe systems are systematically addressed. xii. Kazakhstan’s education programs will need far more flexibility than they currently have and life-long learning opportunities will need to be developed rapidly in order to prevent skill shortages from emerging as a serious constraint to Kazakhstan’s anticipated growth. The system-private and public-to provide basic health care needs to be significantly enhanced, while its affordability is preserved for the poor. At the same time water and sewerage facilities are in dire need ofrehabilitation and need urgent attention as indicated by the cases of hepatitis last summer. V
3) Infrastructure xiii. Kazakhstan’s telecommunications system is both primitive in terms of choice and quality, and expensive relative to EU8 countries, Ukraine, and Russia; and, the road and air transport infrastructures are underutilized. Policies in these sectors need to focus mainly on enlarging the market size and promoting new entry (domestic and foreign) and competition. These are the only sustainable ways to reduce the economic and money cost ofusing the infrastructure. Unfortunately, the current policy stance undermines entry by private investors (domestic and locals) and constrains market growth:
0 For air transportation, the opening ofthe Astana Airport and the possibility of reconstructing the Atyrau facilities offer a unique opportunity for strategic decisions regarding the size of the air transportation market. In particular, adopting an open sky policy for cargo and passengers, coupled with strong competition among the country’s airports for landings, is likely to be the best path to enhance the countries transit and cargo potential, and lead to a truly globalization ofall the companies (air carriers, airport management, and ancillary service industries) in the sector.
0 In road transportation, growing budgets for O&M and construction also provide a unique opportunity to modemize the road maintenance systems by developing: (1) improved road management systems and introduction ofmodem standards comprising a comprehensive asset inventory, annual condition surveys, traffic characteristics, unit costs ofmaintenance, and other pertinent data; (2) efficient institutional, administrative and management arrangements for rural roads to ensure that towns, villages and local communities have all year access to markets for their inputs or products; and (3) better standards among local contractors through the introduction ofperformance based contracts and the delivery of targeted training and monitoring schemes and better capacity to supervise and hold them to account. The speech ofthe President on the 2004 results highlighted a number ofimportant deficiencies in the quality and cost ofroad construction coming from the current process. The speech should be followed by the formulation ofa specific Action Plan to address those issues, and the World Bank could contribute to the preparation ofsuch plan if deemed appropriate.*
0 For telecommunications, the ‘infant industry’ policy that is currently followed must be abandoned. Currently KazakhTelecom (KT) is protected from experiencing real competition and resources are transferred from the rest ofthe economy to the company via highly distorted relative prices (Le. prices are too low for local calls and prohibited for international calls) in the hope that these privileges will be used by management to modemize and prepare well to compete in an open market. Although KThas private shareholders, highly distorted prices and monopoly rents will neither lead to the appropriate investment decisions nor position this enterprise for a more competitive environment. A three-pronged strategy is advised: (1) a unified regulator must be created to focus exclusively on fostering competition (such regulator should not oversee shares of the state in the sector nor manage public administration reform programs such as the e-
’ See the Thesis of Speech Made by the President ofthe Republic of Kazakhstan at the extended Government session on Results of the Year 2004 (Astana, February 1, 2005). vi
government program); (2) tariffs must be quickly rebalanced, and real competition for intemational and local calls must be introduced; and (3) the creation ofexpensive public subsidization schemes must be avoided by piloting a system ofsmart subsidies for services in rural areas once the sector is liberalized or by carrying out international rather than national tenders (see Background Papers No 9 and 11).
0 More generally, new ways to finance infrastructure must be developed, including the possibility ofusing selectively partial credit risk guarantees to foster public-private partnerships, or to enhance the financial conditions currently offered by the domestic and foreign financial markets to large infrastructure companies. Infrastructure financing does provide a perfect match for domestic institutional investors (e.g., pension funds), but that market will need to be developed. Investments by the electricity transmission and railways companies, if soundly assessed for their costs and benefits and with appropriate implementation arrangements, are prime candidates to develop new financial instruments. Needless to say, this focus on infrastructure finance will also help the purpose offurther developing financial instruments and capital markets (bonds, IPOs, guarantees, etc.). 4) Public Sector Institutions xiv. Progress made in the past not withstanding, institutions in Kazakhstan are still ill-suited to address the challenges posed by rapid economic expansion and oil wealth, and are well behind those in the EUS-even if they score relatively well vis a vis Russia. A selected set of investments should therefore be launched particularly for those institutions that determine the quality ofpublic spending, and those institutions responsible for regulating business activities. Progress, ofcourse, has been made in terms of improving the institutions for public spending (e.g., a new budget code was passed in early 2004), but the agenda is still vast. For instance, while the new budget code requires that every investment program prepare a rigorous cost benefit analysis, in practice neither the government nor non-government institutions have the capacity to do so in accordance with international standards. Costing, in particular, is an area where current government investment programs will need greater attention, as well as the design of implementation arrangements. The Ministry ofEconomy and Budget Planning should also be reorganized to accommodate this new phase ofpublic spending. xv. In addition to the further solidification ofthe FSA as a single and independent regulatory agency and the planned modernization ofcustom administration, in itself a must to facilitate trade, the initial focus ofthese institutional investments could be:
a The Ministry of Economy and Budget Planning and the Ministry of Finance, where highly professional departments must be created in areas, such as: (1) public investment (including the monitoring, with a view ofpossible inclusion into the budget, ofthose made by SOEs); (2) debt management (including advising the government on the debt issuance strategy to be followed by the treasury as well as the broadly defined public sector); (3) monitoring the efficiency ofdevelopment programs (in terms ofcost benefit and impact analysis, as opposed to the internal auditing currently carried out by the MOF); and (4) the revamping ofthe procurement and financial management structures under MOF. vii e The modernization of the civil service is still a vast agenda, including enhancing the transparency of the system by rationalizing grades, the current bonus system, and by introducing an appropriate policy to compensate for regional differences. In addition, a proper payroll system is urgently needed to eliminate the current practice ofappropriating wage allocation even for vacant posts. (see Kazakhstan Public Sector Wage Reform: Policy Note; forthcoming.) This and other structural measures to revamp the civil service, needs to be undertaken before any significant increase in the remuneration ofcivil servants. While some aligning of the public sector and private sector wages is desirable this is, in and on itself, a challenge. First, overheating and other macro-constrains limit the scope of adjustment that can be made every year-to avoid an unsustainable growth ofthe government’s wage bill. Second, issues ofincentives must be decided (e.g., whether the profile of payments over the overall employment term should be back-loaded or frontloaded, and even tied to important consumption items such as housing). Third, the degree ofwage compression must be decided for the short and medium term taking into account, among others, the need to compensate better management and strategic positions to attract the most qualified workers. e The recently adopted E-Government Program needs to be an instrument for agencies to simplify administrative processes imposed on businesses and households, rather than a vehicle to computerize processes. To do this, the program must avoid becoming a vehicle to finance large investments in data-handlindrelated processes, and rather focus on providing tools to those agencies that are most critical to reducing transaction costs for the private sector (e.g. registration of land, real estate, vehicles, workers or individuals).
e Kazakhstan will benefit significantly from joining the Extractive Industries Transparency Initiative (EITI). As Norway’s experience shows, avoiding the oil curse requires the creation of institutions to inform and foster participation in the decision making process by society as a whole. In this regard, Kazakhstan will gain a lot by joining EITI. Three obvious commitments can be made immediately: (1) unilaterally commit to disclose the oil revenues received by the treasury from each ofthe 5 1 legal entities operating in the oil and gas industry (and any new one that may be established); (2) encourage each legal entity operating in the sector, beginning with all the companies under the umbrella of Kazmunaigas and in the operating companies where the government owns shares, to make available to any interested party the amounts oftax they pay, as well as detail reports of their social and local content initiatives they pursue in the fulfillment of their Production Sharing or Operating Agreements with the state; and (3) revamp the information base available to the general public on the National Fund of the Republic of Kazakhstan, including publishing the auditor’s opinion and management letter, as well as detailed reporting of the financial results ofthe fund. A second set of steps to be taken over the next 1-3 years include: (1) create consensus among oil operators for the disclosure of the local content and social programs clauses ofthe old and new PSAs; (2) require oil operators to subcontract annual evaluations (by civil society institutions) of their social and local content initiative programs; and (3) expanding the commitments made to non-oil extractive industries (e.g., copper, gold, silver, and other mining). These simple and cost-free measures could bring about viii
significant positive reputation effects for Kazakhstan (both domestically and abroad), but more importantly would enhance the accountability framework for oil revenues.
0 Courts and Judicial System. The quality ofcourts, measured as the percentage of enterprises that think that court decisions are never or seldom impartial, comes out significantly worse in Kazakhstan than in the EU8, and at a similar level to Ukraine and Russia. The agenda ofstrengthening the mechanisms to enforce the rule oflaw has been also highlighted in the February 18,2005 Address ofthe President to the Nation. Like in the case ofroads a detail implementation plan to achieve the objectives laid out in the Presidential Address would be needed. 5) Sectoral Policies xvi. Sectoral policies are needed (consisting both of“carrots” and “sticks”) to support the development ofthose sectors where Kazakhstan has obvious strengths or potential, such as agriculture, services (including transport-cargo, business services), and oil field services. In this latter area, the international experience is rich on win-win schemes to ensure maximum exposure of the labor force and local companies to the technology and standards ofmultinational firms working in Kazakhstan (e.g., joint-ventures, suppliers development programs, and centers of excellence) (see Background Papers No. 2 and 5). In particular, Kazakhstan must overhaul its current “Local Content Rules” which in theory are in place to promote the development ofa local oil service industry but in practice they mainly offer opportunities to extract rents and could only end up creating inefficiencies rather than economic de~elopment.~Thus, a very strong case can be made for abolishing all local content provisions associated with oil operations and insisting instead on: (1) the use ofopen and transparent tenders based on the publication of procurement plans and public opening of biddings; (2) a revamped framework to foster joint ventures in oil service industries (with the supplies provided by these JVs counting as local content); (3) active programs to help local firms upgrade their skills and obtain the most relevant industry certification for their products; and (4) a complete streamlining ofKMG, the country’s main operator to ensure it focuses on its core businesses while at the same time freeing up resources (such as research centers) that could work for any operator. The cluster initiative launched by the authorities, and administered by the Center ofMarketing and Analytical Research under the Ministry ofEconomy and Budget Planning, could become an important instrument to understand the issues ofdevelopment faced by different industries. As such, consultations and problem solving mechanisms will eventually need to be institutionalized more formally through programs under the umbrella ofthe SME department ofthe Ministry of Industry and Trade or the various development institutions.
’ There is a strong correlation between the “supply” multiplier effect associated with direct oil expenditures and (i) the distance of the oil producer from developed country markets; and (ii)the per capita GDP of the producer. In the UK it has been reported that the multiplier effect associated with investment in the North Sea was as high as 7, i.e. every dollar of direct investment generated 7 dollars of associated economic activity. In Kazakhstan, such multiplier is probably small (i.e., it was reported that every dollar spent by Tengizchevoil brought about 52 cents in outlays by related industries, see Chevron Texaco in Eurasia www.chevrontexacom.com), suggesting that the current state of development of oil field services is incipient. Ifthis diagnostic is correct, Kazakhstan would need to use instruments such as the promotion ofjoint-ventures and new entry over imposing rules on contracting for companies that might not yet exist. ix xvii. Other sectoral policies to promote industrialization should be modeled after modem “business promotion” initiatives that provide assistance with the sole objective of increasing the productivity and competitiveness of domestically based firms. Ifthe key issue faced by SMEs are the lack of qualified personnel, then the authorities could for instance develop programs to compensate individual firm initiatives to train their workers (including the cost ofintemships in similar firms abroad) (see Background Paper No. 1). In this context, the recently created development institutions could play a significant role in identifying market imperfections and key constraints for new businesses and then developing the instruments to address them. These institutions should not take for granted that the key bottleneck faced by SMEs in Kazakhstan is lack ofcapital. 6) Innovation and R&D xviii. Kazakhstan inherited a number ofindustries (metals, ores, uranium, and oil itself) that are intensive in R&D and new technologies to maintain production levels and increase efficiency. The country also inherited a defense-related scientific base from the former Soviet Union, some of which has been eroded through emigration and aging. There is therefore a need to determine whether the skills and systems of this scientific base could be still adapted at reasonable cost to serve the needs ofthe extractive industries or if the required expertise should be sought from external commercial sources. Serious revamping ofhigh education system, at present completely “cut off’ from industries and the needs ofthe economy at large, is needed. Integration will require quantum leap in transforming scientific circles. xix. In any case, Kazakhstan in close partnership with the private sector must develop its scientific capacity in areas where the country has significant economic potential and whose technical challenges must be mastered by its enterprise and scientific communities (oil and gas, metallurgies and minerals). Long term research grants could be provided to scientific teams (composed ofinstitute, university, and industrial scientists and engineers) to support graduate and post-doctoral studies and research. Such small grants could help attract a new generation of scientists to those fields, improve laboratory facilities, modemize teaching facilities and curricula, attract world class professors from abroad and meet other specified scientific and economic development needs. Small amounts of funding could also be used to develop a pilot group ofgovernment-sponsored incubators and techno-parks with a cadre of internationally experienced consultants and mentors. These specialists would provide expert advice on such topics as marketing of R&D, management, business plan development, links to financing, and in- depth understanding of global business and industry trends. These and other small-scale interventions in the area of competitiveness and innovation could be carried out by the recently created development institutions, technoparks, incubators, research institutes, and univer~ities.~ The key here is to keep such initiatives modest in terms offinancial costs and to target specific issues that promise very high externalities and scope for commercial application. xx. Sequencing the agenda: the short vs. the long-term. With the exchange rate, real estate, and wages already pressuring the cost structure of enterprises based in Kazakhstan, the short-term agenda is extremely important:
Ongoing work in these areas is being carried out by the Innovation Fund and the World Bank. X
0 Quick payoffs in terms of enhancing competitiveness of all enterprises are most likely to come from an aggressive implementation of the telecommunication and transport agendas.
0 Further payoff may come from restructuring the e-government program to address real bureaucratic bottlenecks faced by enterprises (ideally by simplifying or eliminating excessive procedures rather than by simply computerizing them), and from measures on the modemization ofcustom administration that can be applied early on.
0 In the short-run, the most promising sectoral policy is to overhaul the local content policies for oil field service enterprises.
0 And ofcourse, the macroeconomic agenda-of which containing the fiscal expansion and improving the quality of fiscal spending are perhaps the most important ofall- could also have significant indirect impact on diversification as the experience ofthe 1999-200 1 period suggests.
0 However, the ultimate determinant ofcompetitiveness is always and everywhere the quality ofhuman capital, and the old soviet systems are now very inadequate for the needs ofthe 21” century. Kazakhstan must start improving its human capital today, beginning with carefully-targeted interventions in health, education, and water. xxi. The agenda suggested in this report is very consistent with the lessons from international experience:
a. Permanent gains in competitiveness will only be made if the county better equips its human capital base. Kazakhstan needs to develop a productive labor force, at all skill levels, which is more difficult than just creating an educated elite. This endeavor will require sustained efforts with an extended period before pay-off is clearly observed. Investing in people is also essential to mitigate the rapid growth in income inequalities associated with oil booms.
b. Competitiveness can be increased in the short and medium term if the economic cost of linking suppliers and consumers moving products globally to markets (time and money) is reduced (e.g., telecom, customs, railways, irrigation); and, if access to knowledge and international standards is improved (e.g., for agriculture). Efficiency gains (i.e. cost reductions) in these and other sectors will not be achieved just by allocating funds to a sector to “fix” its problem.
c. Prudent macroeconomic policies are essential. Oil-rich countries have often found it difficult to maintain budget discipline and the quality ofpublic spending. Increased spending levels contribute to the overheating ofthe economy, and ultimately create too much real exchange rate volatility. The government will need to better manage the upcoming monetary and fiscal shifts resulting from changing oil prices and production levels; an excessive appreciation ofthe exchange rate that will make non-oil exports less competitive in international marks. Prudent macro policies should, nonetheless, be xi
accompanied by pursuit ofan active structural reform agenda and appropriate sectoral policies to enhance the productivity ofthe non-oil sector.
d. Three major risks must be avoided: (1) overheating the economy (Dutch Disease) through fiscal, financial and local content policies; (2) ignoring growing vulnerabilities that are typical of booms (e.g., worsening ofthe quality of fiscal spending, and unsustainable expansion in the financial sector); and (3) the temptation to use interventionist measures for quick but unsustainable results (e.g., creating state entities and administrative mechanisms to foster the goal of diversification and competitiveness). xxii. Summary of recommendations and next steps. The matrix below outlines priority areas for action and suggested next steps. Some recommendations are under implementation, in some cases with World Bank support (e.g., new savings rules for the NFRK). The range oftopics covered in the matrix is by no means exhaustive. For instance, there is limited or no discussion of foreign direct investment policies or policies affecting such high-value service sectors such as tourism. More detailed further work will also be needed in many areas (e.g., public expenditure management, air, road, railways, and on the vast agenda ofhuman capital investments). Nevertheless, it is hoped that this report and the associated background papers will prove helpful to the ongoing debate on a broad strategy to achieve efficient diversification ofthe Kazakhstan economy and sustainable growth in the competitiveness ofits non-oil sectors.
Summary of Diagnostic: and Recommendat ions Elements of Competitiveness Recommended Next Step 1. Economic manataement: The main objective i: '0 minimize economic volatility, avoid overheating, and create an environment to foster privi ? investments in non-oil tradable sectors. 1 Maintain budget discipline and quality of public Introduce balance budget rule, new NFRK spending; use financial assets to help smooth rules, and a revised asset management policy, consumption out of oil. with the 2006 budget. 1 Focus the 2006-08 MTFF on non-oil deficit, real growth of public spending, sectoral priorities for government spending, and key elements of the fiscal/monetary policy coordination. Monitor the overall savings of the consolidated public sector (State, NBK, National Companies, and State Financial Institutions), and add an addendum of this to the 2006 budget. 1 Develop a blueprint for assets and liabilities management and an overall debt management strategy for the public sector. 1 If a small government is to be maintained, commission a report on the effective ways to reduce taxation for non-extractive sectors. Reduce vulnerabilities in the financial sector. . Curtail rapid credit expansion, currency mismatch, and excessive rate of leveraging. 1 Strengthen financial sector supervision. 1 Use trade as yardstick for measuring success in Resist protectionist pressures (which will diversification. emerge as the exchange rate appreciates). . Simplify current tariff schedule, and adopt standards for trade (e.g., valuation) that are WTO compliant. 2. Labor Droductivitv: Develop stronger base for human capital. Create a highly productive work force at all 1 Make sure that human investments are a key levels through health and education policies; priority for the budget over the next 5-10 and, ensure labor mobility IS not a constraint to years (education, health, and water sector growth and competitiveness. reforms). . Commission a report to assess labor productivity, level of structural unemployment, and bottlenecks that may arise in regions or in professional skills. Review the immigration framework for attracting key skills from abroad. 1 Review the housing program to ensure it will facilitate labor mobility.
* Steadily reduce costs (time and money) of . Develop a comprehensive transport sector moving goods and increase quality of service. strategy; avoid committing to large investment programs. . Create opportunities for public/private partnerships in rail, air, and roads. Focus CES on liberalizing the process of moving qoods through Ukraine, Russia, and Kazakhstan with minimal disruption. Reduce costs and increase aualitv of I 1 Strengthen the requlatory framework (tariffs communication services; create opportunities rebalancing, interconnection regime,' and for private investments within a competitive management of spectrum). framework. 1 Rapidly phase out monopoly rights and liberalize entry. 1 Modernize KazakhTelecom with or without privatization (but with demonopolization).
1 Continue to improve quality of basic 1 Supply of power (distribution), water, trash infrastructure (at national, oblast, rayon, and collection, gas distribution, and others merit a city levels). review at the relevant government level. 1 Further improve the tariff and regulatory framework (telecom, railways, electricity) Elements of Competitiveness Recommended Next Step
r regulating businesses Close unnecessary government institutions that 1 Introduce a program to semi-annually monitor deal with businesses, and improve services of progress in the government’s regulatory those that are essential. framework and service provision. This could be in the form of a survey of all enterprises. 1 Remove obstacles and opportunities for rent- 1 Introduce downsizing or modernization seeking behavior. programs for ’worse offenders’ (e.g., gosta nda rds) . 1 Make tax and customs administrations friendly to business, and focus CES agenda on the integration of customs administrations. 1 Expand the capacity of the court system to handle contract and economic issues. 1 Improve quality of public spending and general Continue work on civil service incentives administration, through better policies and (including remuneration policies) and training. greater accountability for key institutions. 1 Modernize policies and institutions for 1 Improve capacity to better link inputs and procurement, financial management, and outcomes and measure impact of public program evaluation. spending. 1 Build capacity (in and outside the government) for evaluating investment projects. 1 Build debt (liability) management capacity, including MOF/MEBP/NBK issuance of joint debt issuance strategy. . Avoid expensive computerization initiatives, unless they are used to drive a true simplification of processes imposed by government on enterprises.
Increase competitiveness in agriculture. 1 Review aaricultural suDDort t)olicies (trade and fiscal) with a view ‘of formulating a clear strategy to increase the competitiveness of the sector.
1 Introduce win-win schemes to foster Promote joint ventures. interaction between oil companies, and local 1 Improve business environment, competition, suppliers, workers, and research institutions. hard budget constraints and exit mechanisms. 1 Develop three-pronged strategy to: (1) train and develop skills for Kazakh workers irrespectively of whether they work for a supplier or an operator; (2) simplify rules and regulations about local content imposed on operators; and (3) institutionalize best practice supplier development programs. 6, Innovation, R&D: Better use of Kazakhstan’s scientific ootential and create available environment for firms to innovate. Att, ct FDI in key sectors. 1 Promote R&D and enterprise innovation in . Creation of Centers of Excellence in such Kazakhstan, starting with the most obvious disciplines as petroleum extraction, metallurgy, strengths of the economy (agriculture, metals, biotechnology, and environmental science. etc.). Develop clear technology commercialization programs and processes that would inter alia link Kazakhstani scientific output to foreign and domestic markets; identify specific commercialization strategies for each commercially viable technology; provide management and entrepreneurship support for incubators that would support small, innovative enterprises, and link entrepreneurs with appropriate sources of finance. I. CONTEXT: A TASTE OF THE FUTURE
A. TRANSFORMINGKAZAKHSTAN WITHIN A DECADE
1. A difficult transition. From 1991 to 1995 real GDP fell by 39 percent and exports collapsed (Figure 1). Fiscal and external imbalances led to hyperinflation which peaked in 1994, and there were widespread arrears in pensions and wages. Production ties with the Commonwealth of Independent States (CIS) were severed, which created massive underemployment - particularly in defense-related industries where those ties were strongest. Livestock became the main safety net for the rural population. Its exports - among the highest in the CIS - collapsed (World Bank 2004b).
2. The government focused on the most obvious comparative advantages. Aggressive efforts were made by the government to attract investments into mineral and energy resources, and to provide opportunities for the country’s relatively well-educated population (Figure 2). Between 1994 and 1996 the country liberalized most prices, imposed hard budget constraints on enterprises and banks, reduced trade distortions, and privatized all small and most medium-scale enterprises. Vigorous banking and pension reforms followed, together with liberalization and unbundling in the electricity sector. Late in the 1990s, the government began to concentrate its efforts on institutions. The framework for public resource and civil service management was introduced; and, in mid-2001, the National Fund ofthe Republic ofKazakhstan (NFRK) was set up-an important, albeit initial, step towards oil revenue management and transparency.
3. Strong supply response after the regionalfinancial crisis. A vigorous recovery started in 2000 and has continued through 2004, led mainly by the oil sector (Figure 3). Oil production increased from 0.5 million barrels per day (mbd) during the 1997-99 period to one mbd in 2003, with substantially more to come in the future. This and the global increase in commodity prices (e.g., grain, steel, copper and gold) had important spillovers into the non-oil sectors. The food and construction industries and financial and business services sectors experienced true development, even if from a very small base.
4. Stability was achieved, butpressures from capital inflows began. Since 2001, inflation has been below ten percent. Between 2000 and 2003 the real exchange rate index depreciated against the euro and the ruble, and appreciated against the US dollar. This stability was underpinned by a cautious fiscal stance, during which about half ofoil revenues were saved in the NFRK abroad, and government’s spending levels were kept to approximately 22.5% ofGDP (Figure 4). A sharp real appreciation vis a vis the US dollar has occurred over the past year, despite interventions by the National Bank of the Republic ofKazakhstan (NBK). If defined as the relative price oftradable to non-tradable goods, the real exchange rate has followed a trend similar to that ofthe tenge/dollar although not as accentuated (Figure 5). The pressure on the exchange rate, due to ongoing capital inflows, continued as ofend-2004.
5. Increase in savings. The savings rate, driven by fiscal surpluses, has more than doubled since 1997 (Figure 6). The government accounted for one-quarter ofthe country’s savings in 2003, and its assets in the NFRK reached US$5.0 billion by last year (12 percent ofprojected GDP), an amount similar to the country’s total (external and domestic) public external debt. 2
Private savings have also increased, with deposits in commercial banks and pension assets reaching 23 percent and 9 percent ofGDP, respectively, last year. Given this pace ofasset accumulation, credit rating agencies have continuously upgraded Kazakhstan’s sovereign-bond ratings (Moody’s:Baa3; Fitch:BBB-; S&P:BBB-). Investments are also up, but this increase has been driven by oil and the state investment programs (Figure 6).
6. Simple recipe for success. First, the overall macro-economic framework was put in place through hard budget constraints and a fiscal policy that restrained aggregate demand. Second, opportunities for private (domestic and foreign) investors were quickly created in all sectors, including strategically important ones, such as electricity generation. Finally, key government institutions were strengthened. Maintaining these three policies is a precondition for continued success. But as will be discussed later, the road ahead requires efforts in other areas as well.
B. 2004: THETwo FACESOF KAZAKHSTAN
7. Financial indicators are strong, but the country’s manufacturing base remains weak. While Kazakhstan is modernizing its extractive industries -a process helped along by high commodity prices-there is significantly less economic activity outside ofmining and metals. Construction, trade, commerce, transport, and financial services are all increasing, but these trends are likely to be the result-directly or indirectly-of the demand generated from high oil investments and spending. This poses the question ofwhether growth in these sectors can be sustained when the oil boom recedes, as one day it must. Naturally, the country’s economy is now heavily dominated by oil and gas, mining, and metals, which directly accounted for thirty percent ofGDP (Figure 7), nearly 80 percent ofindustrial output, and more than 80 percent of exports. But exports in all other industries have been stagnant at approximately US$2 billion dollars since 1997 (Figure 8). This weak manufacturing base hampers illustrate the magnitude of challenge to diversify the economy.
8. Social indicators. While the percent ofthe population that can not afford a minimum amount of food has fallen from 18% to 12% between 2001 and 2003 (although mainly in urban areas); nearly 27% of the population lives in crowded conditions with less than 6 square meters per person. Also, an estimated 11 % of the population is poorly educated- defined as those persons 15 years or older who at most have completed primary school (World Bank 2004a). The trend for income inequality is unclear, but since oil is the driving force ofthe economy authorities should expect it to worsen and prepare to mitigate its effects through human capital policies (e.g., health and education) and by strengthening the taxation ofproperty (housing and vehicles). 3
~ ~~~~~~ ~ ~~ ~~ ~ ~ ...... Figure 1: Kazakhstan's Two Transitions Figure 2: Kazakhstan -- Gross Foreign Direct Investments, 1993-2003
~~ ~~
01- . 03 -
02. ~- .. ~ ..-. ~ - - ?< * ,n c F x > = - r/ 'I I' 3>m2zg2~g~~g~==33- ww _---- 1993 1991 1995 1996 1997 1998 1999 ZOO0 2001 2002 2003 Real GDP (1990=1) I -Per Capita GDP in US%(aperage for new EU counhies = I)
~ -. ~ ~~ ~ -__ ___ F~gure3: Kazakhstan: Real GDP GmwZh 1 Figure 4: Kazakhstan -Oil Rekenue Saved and Spent, and (I%, change over previous penod) Total Spending Levels
u5 0 011 revenue I 11' L_._ _. saved 2003e 0 011 revenue 2002 spent
2001 0 Total eqendaure 2000 n16 _.^ " 00 1999 IO 123 I 199- 1998 19YY 2000 2001 2002 2103 20041. 200~ Percent of GDP
~~~ GEDP &Total GDP-
Figure 5: Kazakhstan - Real Exchange Rate Index Figure 6: Kazakhstan - Saving and Investment Ratios (Dec 2000 = 100), down = appreciation
I I> 30 ~ 110 111) Ill0 pi 911 85 XI) ,"7i . j -~ ~~~- ~ ~ i 1997 1998 1999 1000 2001 2002 2003
Figure 8: Kazakhstan: Exports of selected goods Figure 7: Kazakhstan: Structure of GDP 2003 I products (US$ bilhon)
- ~ ~~ - E Fenous metals ~~
7% '"'O ~ 0 Copper and Construction honoil mmg '0 copper 4% 3% 6 products 5 Trade commerce 4 0 Gam 011services 3 12% 13%
011 and gas * 12% E Other 198i IWR 1999 mn 2nii >no? mi 2003 m Public sen,ices Other sewices Ic% 5% '% Share ofoil andgas,ferrous mtala,copper,andgrain in total .. ..
~ Sources: Annex Tables 5, 6, 7, and 8. 4
9. Health indicators are not good either. Life expectancy at birth is lower than the average for the CIS, while adult mortality rates are higher. Part ofthe health problem results from low access to safe water, particularly in rural areas where only 6.4 % ofhouseholds have access to piped water (44 % of the population lives in rural areas). The country also faces major health threatening environmental challenges, related to water availability, water and air pollution, and a legacy ofmismanagement of natural resources. Problems in the water and sanitation sector are already at critical levels as suggested by the multiple hepatitis outbreaks during last summer.
10. Negative consequences. Were these health and social trends to continue, it is likely that labor productivity will stagnate or fall over time, affecting the overall level of competitiveness in Kazakhstan. Oil inflows will clearly lead to real exchange rate appreciation over time, which in turn will push wages costs up in sectors that have no direct or indirect link to the oil industry. Thus, unless labor productivity increases, it will be too costly to produce goods without link to the oil industry in Kazakhstan. 5
11. CATCHING UP WITH HIGH-MIDDLE INCOME ECONOMIES
A. THECHALLENGE'S PERSPECTIVE
11. The three strategic objectives. The authorities have set up very clear long term objectives. First, to catch up with the EU in terms ofliving and production standards, levels of productivity, and income. Second, it also wants to compete for investments and markets within Ukraine, Belarus, and Russia-exploiting current and earlier links as well as vicinity and by creating a common economic space. Third, Kazakhstan aims at becoming a transit hub between East and West, i.e. between China and Europe. Given these objectives, it is appropriate to benchmark Kazakhstan against: (1) EU countries, and, in particular, its eight new members (EU8);5 and (2) Ukraine and Russia (U&R).
12. The objectives in perspective. Kazakhstan's income is already at the level ofUkraine and not far from Russia's, but whether Kazakhstan manages to outpace these two countries will depend on its overall competitiveness. As for the EU8 countries, even if Kazakhstan's per capita income would grow twice as fast as income in the EU8, it will still take it 20 years to catch up to them.6 (Figures 9 and 10).
I Figure 9: GNI per capita in new ELI and Common Figure 10: Kazakhstan' ConFergence Challenge I Economic Space Countries, 2003 I1.. 1 12000 IO
09 0 loo00 0 ox . 8000 07 c . 06 . 05 * . 04 03 02
13. Growth without development. As difficult as it seems (i.e. 20 years ofgrowth at twice the pace ofEU8 countries), catching up with the income ofthe EU8 is achievable based only on the prospects for oil exports, and the subsequent boom in public spending (by the state, SOEs, and state agencies), and non-tradable sectors. Of course, such a scenario assumes that there will be no macroeconomic disruptions, natural disasters, conflicts or other major negative shocks. But these sources ofgrowth are unavoidably temporary, and will anyhow not be enough to get
Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovak Republic, and Slovenia. In constructing Figure 10; we assumed a 10% growth in Kazakhstan, vis a vis 5% in the EU8. Average annual growth of dollar income per capita in new EU countries has been 13% between 2000 and 2004, while in Kazakhstan it has been 19%. 6
Kazakhstan where it wants to be. For instance, rather than becoming a long term hub between China and Europe, the oil boom could well lead to a more narrow focus on moving imports and consumption goods associated with the oil boom-unless appropriate sectoral policies are adopted for, in this example, the transport sector. In that case, transport related sectors will fade when the oil bonanza recedes. Thus, an excessive focus on the oil industry might lead to a highly volatile development path, as for example Venezuela demonstrates.
14. Venezuela easily tripled its income per capita within an eight year-period (see Table 1 below). This was led by the upsurge in exports created by Figure 11 Fuel Eyorts m Selected 011 Countnes high (percentage ofuerchandise bo,orts) oil prices, and the associated increase in public spending. In hindsight, it is clear that such an increase in income was unsustainable. Non-oil GDP in Venezuela grew mainly to . . the oil and consumption industries, and did not achieve productivity gains in the agriculture or manufacturing 0, -+-Venezuela -+-Kazakhstan Indonesia \omay sectors. Non-oil exports in -~ -~ - Source: World Bank databases. Venezuela never increased during the 1970s (Figure 11).
15. Venezuela tried to diversify its economy, and in fact it used its oil money to “industrialize” and for “large-scale infrastructure projects,” rather than for human capital (note the rapid expansion of SOEs in Venezuela in Table 1). In the end, the country had little gains in social indicators, and the country did not achieve its diversification goals. As a consequence, Venezuela fell on hard times when oil prices went down: by 1990 income per capita had fallen back to only about US$2500, although it has recovered somewhat more recently with the new oil bonanza.
16. The real challenge. Similar to Venezuela in the 1970s, Kazakhstan is expected to triple its income per capita by 2007 on the basis ofoil and gas exports. But Kazakhstan would like to avoid the vulnerability to oil price declines that has caused so much adversity in Venezuela in the period after the oil booms in the seventies and early eighties. Income per capita can certainly continue to grow on the basis ofincreased volumes ofoil exports, unless oil prices collapse. But ifKazakhstan’s catching up with the EU8 is purely based on its oil exports, the process may be hard to sustain through periods with low oil prices, and such periods will come. The authorities are therefore rightly looking for ways to foster competitiveness in the non-oil sector. Achieving high income growth, while maintaining a certain degree ofdiversification in the economy’s structure, is the real challenge for policy makers. 7
Table 1: Performance in Venezuela and Kazakhstan
Venezuela.. ----I_- Kazakhstan ______- 1973 1981 1999 2004 2007 Actual Actual Actual Prelim. Proj. a GDP per capita, current US$ 1,693 5,026 1,130 2,714 4,170 Exports of goods and services, US$ bn 5.0 20.9 6.9 22.4 23.4 Gross domestic savings, % of GDP 39.3 29.4 20.1 30.5 27.3 Total expenditure, % of GDP 21.0b 30.0 23.1 23.4 24.0 Investments by SOEs, % of GDP 5.5 9.0 n.a. n.a. Operating spending by SOEs, % GDP 6.0 11.0 n.a. n.a. Life expectancy at birth (total) , years 66.0 68.8 65.7 65.8 Health, education, and housing, YOof total expenditure and net lending 34.5 26.0 e 26.4 27.2 32.9
Source: World Bank staff estimates based on official statistics for Kazakhstan and various databases for Venezuela. Most projections for Kazakhstan are taken from the Country Partnership Strategy, 10/08/2004. a/ 2005-07 Medium Term Socio-Economic Development Plan and 2005-07 MTFF (updated in March 2005 to include possible budget amendments following the February 2005 Address to the Nation). bi From WE! Country Economic Memorandum (1995), "Living with Oil", Chapter 3, Figure 3.7, Report No. 12849. c/ Data for 2003 d/ Average for the 197 1-73 period. e/ Average for the 1974-8 1 period. f/ Average for the 1997-99 period. g/ Average for the 2000-04 period. h/ Average for the 2005-07 period. i/ Excludes investments in the petroleum sector. A significant part of the spending in SOEs was financed from budget transfers. Note that the upsurge in both operating and capital investments reflected investments in industrial, mining, and petrochemical sectors. Data from WE! Country Economic Memorandum (1995), "Living with Oil", Chapter 4, Figure 4.3, Report No. 12849. n.a.: not available.
17. Initial conditions are against the country. First, most competitiveness and diversification indexes place Kazakhstan behind Ukraine and Russia in many respect^.^ Second, location and market size are a disadvantage. Third, Kazakhstan will unavoidably increase its dependence on oil and other extractive industries at least for the next 15 years. This makes it more susceptible to "Dutch Disease" phenomena, the adverse impact on non-oil sectors ofoil induced real appreciation (see IMF 2004). Moreover, oil economies are highly volatile, which in turn makes it even more difficult to develop a favorable environment for investment and growth in tradable sectors. However, these adverse initial conditions can be overcome with good structural policies and other elements that are reviewed below.
B. THEKEY INGREDIENTS OF COMPETITIVENESS IN KAZAKHSTAN
1. The Framework
18. Tools for diagnosis. There is an extensive literature on the key determinants of competitiveness. However, factors limiting competitiveness are country specific, so any program
7 One of the only indexes that include these three countries is the UNIDO Competitive Industrial Performance Index, which ranked Kazakhstan in the 79'h place (out of 155 countries), behind Russia (53rd) and Ukraine (34'h). (See http://www.unido.org/doc/5 156.) Kazakhstan is not yet rated in the Competitive Index of the World Economic Forum, which list Russia and Ukraine. 8 to boost competitiveness will always be country specific. In some countries, the ‘digital divide’ (the gap between those that have access to the information highway and those whose access is limited or obsolete) may be the most important obstacle to competitiveness; while in others it may be the infrastructure for research and development (R&D) or for moving goods (ports, railways, air), or the macroeconomic framework, that needs the utmost attention. It is therefore essential that a thorough diagnosis ofthe various strengths and weaknesses ofKazakhstan from the competitiveness point ofview is made.
19. Such a diagnostic exercise could most usefully focus on six main areas where improvements are likely to have a major impact on Kazakhstan’s competitiveness:
a. The macroeconomic environment, in light ofthe challenge that oil revenue management will impose on the country;
b. The quality of the country’s labor force, in light ofthe deteriorating social indicators discussed above on the one hand, and wage pressure likely to emerge from the oil boom on the other;
c. The cost and quality ofinfrastructure, given that the country is remotely located and landlocked;
d. The efficiency of government institutions, particularly those responsible for regulating businesses (small, medium or large) and those responsible for the quality ofpublic spending (especially investments);
e. Sector policies, particularly in those sectors where Kazakhstan has an advantage or significant potential, such as agriculture; and in oil and gas where Kazakhstan needs to develop the technological capacity to meet the technical challenge that it will confront for many decades to come; and
f. The framework for innovation and R&D; this is particularly important because Kazakhstan inherited a high quality scientific community without, however, the experience to commercialize its services, and that is not involved in finding solutions to the technical challenges posed by the extraction ofoil and minerals.
20. Diagram 1 outlines these 6 areas and provides examples ofpolicies that would need to be developed within each area. 9
Diagram 1: A Framework to Study Competitiveness in Kazakhstan
+ + Health/water + Housing, labor market Education (pre-sckol, policies elementary, vocation; + Fiscal policy + Regulation policies - NFRK rules\ J (telecom, railways, air) - Non-oil deficit + Private-public partnerships Public investment programs
Public guarantees + Role of development institutions
+ Monetary and Regulation of financi '"uurrrrrrJ ss + Trade policy (WTO/C@ 2 I- AT
+ Oil and gas ------P Corruption (civil servants' - local content compensation, procurement) - linkages (R&D) + Regulatory framework + Agriculture t - Standards and certification - Support policies - Licensing, inspection regimes - role of government + Technology - Entry, exit, competition + Credit and financial sector policies commercialization + Legal and ]udiciary system - CaDital market develoment + Innovation system (enterprises, / - Contract enforcement. collateral - Credit to SMEs I universities, research centers) + Tax and customs administration + Clusters (Tourism, Textile, Oil + Intellectual property rights - Trade related regulations/processes services, Construction, Food Industry, Transport/cargo)
Source: Background paper No. 4. Note that this framework was updated from the one presented in that paper
2. A Simple Benchmarking Exercise
21. Given the objectives stated in Paragraph 11 above, this section benchmarks Kazakhstan against the EU8 and U&R for the first four areas in the above framework. In each case, a few simple indicators are selected and compared with similar indicators in the EU8 and U&R over time. The comparison is done by 'normalizing' the indicators in Kazakhstan by either the average ofthe EU8 or the average of the U&R (averages for these two groups ofcountries are weighted by population). In this way, when an indicator is equal to one, it means that the value of such indicator for Kazakhstan is equal to the value for the average ofthe EU8 (or the U&R). a. Economic Management
22. Good saving rates, weak non-oil investment rates. Kazakhstan's total savings and investment ratios have outperformed the EU8 since 2001, and are close to U&R rates (Figures 12 and 13). While accumulating savings is an achievement, it is the investment ratio that determines future growth. Unfortunately, the investment ratio for non-oil sectors (Le. non-oil investments over non-oil GDP) in Kazakhstan is only about 60 percent of the EU8 and about 70 percent of U&R (Figure 14). The upward trend since 2001 is encouraging, but Table 2 below (and Figure 6 in Section I)suggests that this trend has been driven by government investments. In fact, the level ofinvestments in tradable sectors has been stagnant at about three percent ofGDP. The only other thriving investments are in infrastructure where national SOEs dominate. Whether public investments (state government and SOEs) are or are not complementary to private 10 investments is an issue that will need to be investigated more carefully.* A further concern is that the bulk of investments outside oil and government have been going into non-tradable sectors since 2001. These trends are determined by the relative price ofnon-tradable and tradable goods. As this relative price increases, non-tradable sectors become more profitable relative to tradable sectors and, naturally, enterprises and banks invest in them. Thus, it is the economic policies (financial, fiscal, and monetary policy) rather than the banks' lending policies, which excessively increase the profitability in non-tradable sectors and send signals to private investors to move resources into them.
Table 2: Kazakhstan: Composition of Investment in Fixed Assets, 1999-2004 (% GDP) Yo GDP 1999 2000 2001 -- 2002 2003 20046m Total Investments 18.3 22.9 29.0 29.1 28.8 16.6 e Non-extractive sectors 5.6 6.4 7.2 6.9 7.7 6.6 Tradables a 2.3 2.9 3.3 2.9 3.0 2.3 Non-tradables 3.3 3.5 3.9 3.9 4.7 4.3 Oil, gas and miningd 9.1 13.6 16.9 16.3 14.8 10.0 Infrastructure 1.6 1.7 2.5 2.6 2.7 2.0' Public services 2.0 1.3 2.5 3.3 3.6 2.7' Memorandum item: Tradable % non-oil GDP 2.8 3.6 4.1 3.7 3.8 -- Source: Statistics Agency ofthe Republic ofKazakhstan, National Accounts ofKazakhstan. a Includes non-oil manufacturing and agriculture. Includes trade, hotels and restaurants, construction and real estate services, and services to enterprises. Includes power, non-oil transportation, communications, and other infrastructure. dIncludes oil & gas extraction, services incidental to oil & gas extraction, whole mining, geological exploration & engineering related to oil & gas, and transportation via pipelines. The latter includes fixed capital for the CPC construction. ' Due to procurement and other reasons, public investments usually take place during the 2"d half ofthe year. As an indicator, the total investment rate for the first six months of2003 was only 19% (the annual one was 29%) due mainly to public services and infrastructure.
23. Low export performance (outside extractive industries). Another worrisome sign that the various economic policies are not supporting diversification is that exports ofnon-extractive commodities have been stagnant at about $2 billion for the last three years, as was shown in Figure 8. These exports, which include manufacturing commodities as well as processed agricultural products (other than grain), are more likely to respond to domestic relative prices (e.g., domestic economic policies), than exports tied to world commodity prices. As such, enhancing this export base is an important indicator to monitor. Needless to say, the export base has been very dynamic in a country like Hungary, both in terms of levels and degree of diversification, as well as in most ofthe other EU8 countries.
* The Government is planning to hire an external evaluator for the Innovation Industrial Policy, which created a series ofstate-owned financial enterprises. A broader evaluation on whether the activities ofthese institution and other SOEs contribute to private investments should also be carried out. 11
I Figure 12: Kazakhstan's Savmgs Raho Figure 13: Kazakhstan's Investment Raho
~ -- ~ -~ O4 ~~ 04 1995 1996 1997 1998 1999 2000 2001 2002 2003 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 I _- hew EL8=1 -Russia and Ukrame-1 - - \eu EL8=1 -Russia and Ukrame=l
Figure 15: Kazakhstan's Government Spending
07 ~
07 -
~ 06 1 / / // /
~ 1: _--- - 04 2000 2001 2002 2003 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 - - Yew EL8=I -RussiaandUkrare=l - - \ew EL8=1 -Russia and Ukrm=l
-~
~~ Flgure 16: Kazakhstan's Manufacmg Labor Produch\ity I (perworker) (per worker) 15 - 0 60 0 50 /------, / 040 - \ / 0 30 1-/ 4- /- -' 0 20 03 0 IO ------.- 0 00 -~ 00 ~- 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 - - Yew €US=] - - New EU8=I -Russia and Lkrame=l I' -~~~ - -~~_____- Source: Annex Table 10.
24. Volatility is down but not to EU8 levels. It is also important to benchmark economic volatility, which is the main channel through which the economic framework affects the investment climate for all private enterprises (whether in tradable or non-tradable sectors), Table 3 below shows the standard deviation of nominal and real exchange rates, and inflation. It was calculated over the last 7 years, and thus includes the volatility generated during the regional financial crisis because this is something that investors (local or foreign) review when making decisions. In all cases, Kazakhstan's volatility is lower than Russia's, and almost always lower than Ukraine's (except for the real exchange rate). This is the result of good economic management vis a vis these two countries. However, volatility in Kazakhstan has been twice as high as in the EU8 countries.
25, Kazakhstan lacks an anchor to control expectations. Investor's decision may be affected by their future expectations about volatility rather than by events over the past 7 years. In this case, there is an extensive body ofliterature suggesting that such expectations are affected by the credibility of the institutions responsible for economic policy (fiscal and monetary policies). In 12 tum, such credibility depends on the “anchor” these institutions use to ‘tie’ their hands and fulfill their commitment. For instance, the most recent eight members ofthe EU have anchored their fiscal policies to the European Monetary System, and have adopted the euro as their currency which in effect means they have given up monetary policy altogether. Given that a lot ofwhat investors will be looking at is the relative price of tradable and non-tradable sector, which in turn is determined by the pace at which oil revenues are spent, Kazakhstan clearly needs a strong ‘anchor’ for fiscal policy (e.g., a balance budget rule, like in Chile, which can be combined with more credible mechanisms for deciding how much to spend or save out ofoil revenues). As for monetary policy, the NBK is making an effort to replace the nominal exchange rate as an anchor (used, explicitly or implicitly, for over 6 years) with a pre-announced target on inflation. For this to work, the NBKR will need to establish a strong reputation in fighting inflation, together with building appropriate mechanisms oftransmission through interest rates.
Table 3: Volatility of Exchange Rates and Prices (YO),January 1997 to September 2004
Kazakhstan Russia Ukraine EU8
Nominal Exchange Rate Depreciation a - Mean 12.9 46.7 21.6 1.4 - Standard deviation 24.0 92.3 32.2 9.2 Real Exchange Rate Depreciation - Mean 1.1 0.6 -4.4 1.1 - Standard deviation 12.4 19.1 6.3 3.5 Inflation - Mean 8.1 29.9 12.7 5.2 - Standard deviation 4.1 31.5 9.8 2.8 Source: IMF International Financial Statistics and National Bank of the Republic of Kazakhstan. Note: The mean and the variance are calculated on the first difference of each variable (e.g., for prices it refers to the average inflation and its standard deviation). Data is monthly and the first difference is taken against the same month of the previous year, a/ vis a vis US dollar bi real effective exchange rate ci Simple average for all EU8 countries, except for the real exchange rate which does not include the Baltics.
26. Small government. Kazakhstan does have a fundamental advantage over the EU8 and U&R: its govemment is approximately 40 percent smaller (Figure 15). This implies that Kazakhstan can sustain lower marginal tax rates on labor and capital for its non-extractive industries than the two sets of benchmark countries. This is a strong advantage as the experience of, for example, Ireland suggests. However, since Kazakhstan has expanded its public spending by 21% in 2003, by 17% in 2004, and by an estimated 18 % this year, all in real terms; the size ofthe government may actually end up closer to the EU8 and U&R five to ten years from now eroding this advantage.
27. Overall macroperformance does not yet outperform the EU8. On the basis ofthe past performance ofprivate investment levels, low export diversification, the observed levels of volatility, and the current expansionary trend ofthe public sector, it is clear that Kazakhstan has much to achieve before it outperforms the EU8 countries. In addition, Kazakhstan will increasingly be exposed to the vagaries ofintemational oil market developments. To escape the associated Dutch Disease problems, the government will need to manage the upcoming monetary and fiscal shifts, resulting from changing oil prices and production levels well through the 13 introduction ofcredible fiscal and monetary anchors. These issues are discussed in Chapter I11 below. b. Labor Productivity
28. Labor productivity trends are not encouraging. Kazakhstan's labor productivity, measured as dollar value added per worker, in manufacturing has improved relative to the EU8 during the strongest period ofreform (1996-2001) and reached halfthe level ofthe EU8 in 2001 (Figure 16). However, productivity has remained stagnant at this level since 2001. In agnculture, labor productivity (when normalized by either the EU8 or U&R) has been falling for more than a decade (Figures 17). These trends should be of significant concern to policy makers, as clearly the country is moving in a direction that is opposite to the established goals. It also suggests that if a true CES were to be established with U&R, Kazakhstan's local producers will lose markets due to the relative uncompetitiveness ofthe labor force here.
29. Explaining labor productivity trends. Key determinants oflabor productivity are: the quality of education, health and water services, the quality of investments taking place in non-oil sectors (which may not do enough to lift labor productivity), labor market policies (including policies to increase mobility), pace of technological change, and Dutch Disease problems (through which labor is drawn into sectors where productivity is not increasing much). A detailed analysis would be needed to understand which ofthese factors most explains the above trends for Kazakhstan.
30. However, it is safe to say that the quality of the health and educational systems in Kazakhstan may not be contributing as much as they could to enhance labor productivity. Figures 18 illustrates how health indicators in Kazakhstan have been systematically worsening relative to both the EU8 and U&R for over the last fourteen years. Similarly, efforts to increase the quality of education. A crude measure ofeffort in these areas, i.e. per capita spending in education and health, shows a disappointing trend (Figure 19).
-~ ~~~~ ____ ~____ F~gure18: Kazakhstan's lnfant Vortahtj Rare Figure 19: Kazakhstan's Per Capita Pubbc Spendlng m (per 1,000 tibe births) Education and Health IO 11
8 / * I I( I( A:---.
ox---- \ \ 07 . 06 ----. . 05 ---- 04 - 1990 1995 2000 2002 1995 1996 1997 1998 1999 2000 2001 -- New EM=] -Russia and UG"1 -- \ew EL8=1 -Russia and Lkranie=l
~ ~~ ~-~~~ ~~ - ~ ~ Source: Annex Table 10. c. Infrastructure
3 1. Overcoming geography. Kazakhstan is both landlocked and remotely located relative to large markets. This disadvantage for competitiveness can ofcourse be corrected by reducing economic costs. The important element is not the physical distance, per se, but the economic 14 distance from markets, or the sum of all the different time and cost expenditures ofmoving a consignment to a particular market, and the ease with which people can communicate and access information through the telecommunication network. This measure ofeconomic distance reflects all the time and money expenditures that are related to the movement of a consignment to a particular market, or linking with the rest ofthe world via voice or data. Thus, a reduction in economic distance can be realized by not only improving physical infrastructure, but also by improving information flows, simplifying procedures, or reducing corruption. In this way, even remote landlocked countries like Kazakhstan can transcend their physical disadvantages and reduce their ‘economic distance’ to enhance their competitiveness.
32. A significant infrastructure policy agenda. Kazakhstan lags behind the two sets of benchmark countries in transport infrastructure. Figure 20 illustrates this point with a few indicators for use of roads and air infrastructure, and cost of communications. Each bar shows the ratio ofa given indicator in Kazakhstan divided by the average for the same indicator in the EU8 or U&R countries. Anything below one for the first four indicators, and above one for the last two, signals that Kazakhstan is behind these two groups of countries.
3 3. Underutilized Figure 20: Kazakhstan - Selected Benchmarks for Transport and transport infrastructure. Telecommunications Infrastructure, 2002/2003 Kazakhstan’s road and air 40 infrastructure is used less 35 - - ___ - ~ ~____ intensively than in the
~~~~ ~~ ~ ~~~~ benchmark countries. While 30 ~ ~ it is easy to conclude that this is the result ofgeography and the country’s size, it is more likely that Kazakhstan is in this situation by its own choice (Le. due to bureaucratic barriers and misguided sectoral policies). Goods hauled Aircraft Air freight Telephone Mobile Cost of call io lntemet (million ton- departures (million ton- mainlines per phones per U S (3 (Total For instance, it is worth km) (000s) km) I000 people 1000 people minutes. in monthly price 20 hours of asking if a policy ofopen 0 Ratio of KazakhstaniAverage of EU8 use. in US%) skies and the professional (3 Ratio of KazakhstaniAverage of U&R and independent management of the country’s largest airports Source: World Development Indicators and World Bank staff competing with each other for calculations. landing would result in more aircraft departures and air freight than the current policies. Such a policy would be a win-win situation since it would lower costs for all businesses and, by enlarging the ‘pie,’ it would also increase profits for all market incumbents, including the national operator. Depending on the selected strategic direction, the national carrier could become a global operator (Le. a relatively small company in a very large global market), or a national monopoly (i.e. a large company in a very small market). Either way, it appears that Kazakhstan has scope for intensify the use ofits air and road infrastructure. 15
34. Railways ’performance is difficult to benchmark. In 2002, the average commercial speed on the railways was approximately 40 kdhour. This suggests that on a 24-hour travel basis a speed of nearly 700 km/day could be attainable. Unfortunately, the real performance is far below this level: the average transit speed of container shipments on selected routes can fall to less than 200 km/day, far below the rates attained by maritime or road transport. From Istanbul to Almaty, the transit time for conventional rail transport varies between 30 to 35 days, giving a commercial speed of a little more than 150 km/day. If the commercial speed were 700 kdday, as it is technically achievable, the shipper would save up to 22 days. The financial value ofthe time saving is estimated to be almost 20 to 22% of the transport cost. The message here is that policy implementation will necessarily have to precede large investments because it is in policies where the larger social payoff is most likely to be.9
35. Telecommunications is underprovided and expensive to use. Access to telecommunications services in Kazakhstan is lower than in the EU8 and U&R, as measured for instance by the number of lines (including both fixed and wireless lines) per 1,000 people. This measure, of course, masks the fact that a third of Kazakhstan’s fixed lines are not digital and that access to broad bond services is extremely limited and costly. Thus, in addition to lagging in access, Kazakhstan also lags in quality of service. Furthermore, the cost of calling from Kazakhstan abroad is significantly higher than in the EU8 and U&R. This is not the product of distance or geography, since a three minute call from Australia to the US costs 1/6thof the cost of a similar call from Kazakhstan. Rather, these costs are associated with a lack ofreform in the telecommunication sector (see Part C of Section 111, below). As in railways, policies must precede investments-but in this case there is little justification for an active role for the government (or an SOE) in investments. d. Institutions
36. Competitiveness requires that key govemment institutions function well, particularly those that affect the cost of doing business. Essential among these institutions are customs, tax administration, the courts, and the staff of the line ministries, agencies and, more generally, the civil service.” There is a number of additional institutions whose reform is equally important for Kazakhstan, such as those related to the quality of spending (procurement,’ ’ public investment management, financial management, and local governments), but here we focus only on the first group.
It should, however, be noted that technically feasible speeds are never achieved on rail networks where passenger and freight flows share a network as they slow each other down enormously. loKazakhstan still faces a significant agenda to modernize its civil service as outlined in “Kazakhstan Public Sector Wage Reform: Policy Note.”, forthcoming paper for the Public Expenditure and Institutional Review under the Joint Economic Research Program. ” On procurement, see the forthcoming paper “Republic of Kazakhstan: Assessment of Efficiency of Public Procurement System For Public Expenditure: Findings and Recommendations” and “Kazakhstan Electronic Government Procurement (e-GP): Contribution to the Efficiency Study of the Public Procurement System”. These two reports were producing under the forthcoming Public Expenditure and Institutional Review of the Joint Economic and Research Program. 16
37. The benchmarks in Figure 21 below are based on five questions taken from the 2002 Business Environment and Enterprise Performance Survey (BEEPS) 11: l2
i. Unofficial payments, measured as the percentage of enterprises reporting as always paying bribes, frequently, or usually paying bribes; .. 11. Tax compliance, measured as the percentage of enterprises reporting that the typical firm in their business reports less than 80 percentage oftheir sales to the tax authorities; ... 111. Business regulations, measured as the percentage of enterprises reporting that more than 10 % ofsenior management’s time is spent interpreting regulations or maintaining access to public services; iv. Customs processing, measured as the percentage of enterprises reporting that it took more than 10 days to clear customs; V. Quality ofcourts, measured as the percentage of enterprises that think that court decisions are never or seldom impartial.
38. Similar to R& U; worse ~ ~______~______than the EU8. In all cases, a Figure 21 : Institutional Framework, 2002 large number represents the Unofficial proportion of enterprises that 40& consider the services of the underlying institutions as bad. Kazakhstan’s business regulations, tax compliance and the quality ofthe courts, are similar to those in Ukraine and Russia, but the country fares slightly better than these two countries in terms ofunofficial payments and customs. EU accession Kazakhst Kazakhstan fares worse than -- Russia and the EU8 for all indicators. ~~ ~ ~~ ~~ Source: BEEPS 2002
39. Left behind (potentially). Institutional reform is an area where the EU8 countries have made a sustained effort prior to joining the EU, and these efforts will continue. For instance, the EU8 countries needed to meet a set ofminimum standards in relation to its customs system prior to accession, and Hungary has been twinning key institutions (e.g., the accounts committee) with the best around the world for a sustained period of time. Evidence is accumulating that quality of the institutional environment is a key determinant ofeconomic growth. Thus institutional reforms are likely to have a pay offthat is high, although difficult to quantify precisely.
I’ BEEPS isjointly owned by the European Bank for Reconstruction and Development (EBRD) and the World Bank Group. It is accessible through the web site: www.worldbank.org 17
40. Based on the background studies, we suggest that the government:
0 Refocus its e-government program away from the increasing connectivity between large data bases (e.g., tax payers records) and towards smaller - agency-by-agency driven - investments in the areas that will ease business regulations, and reduce unofficial payments. Good candidates for this include all the registries (for land, titles, permits, etc.) as well as local offices handling driver licenses, id cards, permits.
0 Just like in the cluster approach, some institutions should be selected for intensive modernization and investment efforts. Likely candidates should include: (i)the Ministry of Economy and Budget Planning and the Ministry ofFinance, which need strong departments for public investment management, debt management, internal evaluation of programs, and procurement and financial management; (iii)consolidated supervision in the financial sector; (iv) the civil service; (v) the regulatory agencies, particularly the Informatization Agency, which need to lead Kazakhstan towards the information highway ofthe 21" century; and (vi) local governments which implement the bulk of social spending. e. Summary
41. Reverse trends against the EU8; outperform U&R. If Kazakhstan wants to catch up to the EU8 in a sustainable way, it must outperform U&R and reverse the trends in relation to the EU8 in all ofthe four areas covered above. This also needs to be done in the two other areas not covered by the benchmarking: (1) the infrastructure for innovation and R&D; and (2) sectoral policies.
42. Maintaining focus and resolve will help. The government is aware ofKazakhstan's great potential from its past reform efforts, its large amount ofnon-oil natural resources (e.g., extensive pasture land and reserves of ferrous and non-ferrous metals), its resourceful people, and its strategic location between the East and West. But they also understand the challenges. First, the country is behind its trading partners and competitors, although more in some areas than others. Second, the experience of some ofthe oil-rich economies have not been good (e.g., Saudi Arabia and Venezuela), despite commendable goals that these countries adopted (Figure 22). In particular, the gains in income per capita and diversification could not be sustained because the various policies did not match the goals that were set. Unfortunately, because ofthe long business cycles observed by oil prices, it was only after more than a decade that these countries realized their economic policies were not working. Long periods ofhigh oil prices may mask underlying problems for a long time, only for those problems to come back with a vengeance once fortunes are reversed and prices go into a prolonged slump. It is thus key to push through the reform process in good times, so as not to be caught out when revenues slump and harsher measures will have to be taken when times are bad already. 18
Figure 22: Growth Experience in Selected Oil Rich Countries
enezuela Productrvrty per worker m the norroil economy Saudra Araba PPP per capaa
4usi7 J
leOQl-~ __ 1950
lexico: PPP GDP per capita Indonesia: PPP GDP per capita
6467 4 R i782 ’I 1 d
Source: Hausmann R., Rigobon R. (2002), “An Altemative Interpretation of the ‘Resource Curse”’ Theory and Policy Implications”, National Bureau of Economic Research, Working Paper No. 9424. 19
111. THE STRATEGIC POLICY AGENDA
A. POLICYCONTEXT
1. Current Policy Stance
43. Plenty of initiatives. To achieve their strategic goals (Paragraph 11) the government has launched an ambitious policy agenda summarized in long-term plans (Kazakhstan 2010 and 2030), and in the Indicative Plan of Social and Economic Development for 2005-2007 (IPSED),13 Medium-Term Fiscal Framework for 2005-07 (MTFF), Basic Directions for Monetary Policy for 2004-2006, and sectoral programs such as:
Rural and Agricultural Development Program Industrial and Innovation Program Reform and Development ofthe Public Health System Development ofthe Educational System Development of Science and Innovations Telecommunication Program Housing Policy Development ofthe City of Astana e-Govemment program
44. Strategic choices still unclear. While the objectives and principles that have been laid out in the various programs are appropriate, three strategic questions have not been addressed directly:
i. How much of the oil windfall will be saved and how much will be spent?
ii. What are the priorities for spending those amounts (together with government revenues from other sectors)? ... 111. What role should be ascribed to the government to increase competitiveness in non-oil sectors? And how much ofthat role is to be played through expenditures as opposed to policies?
45. The answers to the above questions are important for two reasons. First, they will help the authorities balance efforts among the six building blocks ofcompetitiveness presented in Chapter 1. Second, they will help select the types ofpolicies that are supported within each individual area ofcompetitiveness.
l3Key elements of the IPSED for 2005-2007 include, inter alia, WTO accession, intemational standards in the financial system, regulatory principles that stimulate the adoption of power and resource-savings technologies, and improving the economic and social infrastructure at the aul (village) level. In addition, the IPSED also envisages that comprehensive measures will be taken to: (1) implement the Agro-Food and the Industrial and Innovation Development Programs; (2) modemize the science, education and professional development systems of the population; (3) develop industrial and social infrastructure; and (4) foster small businesses development. 20
46. The evolution of spendingpriorities. Choices have, ofcourse, been made in the past few years in regard to the above three questions, and future directions are indicated in the MTFF and IPSED. On the base of these we can characterize such choices as follows:
Cautious steps: the 2001-03period. This period can be characterized by frugality and cautious public spending choices. As illustrated in Table 4, Kazakhstan saved 63% ofits oil-windfall in the NFFK, which by all standards represents a remarkably prudent fiscal stance. As for the priorities, public investment was boosted from 2 to 4% ofGDP during this period. These investments focused on roads, rural and agricultural development and, the capitalization of funds and enterprises under the industrial policy. To achieve this within a relatively tight level ofspending, recurrent outlays were compressed. Consequently, real wages and pensions were kept relatively constant between 2002 and 2003.
Growing confidence: the 2004-05 period. Judge against the recently approved budget for 2005, tight fiscal policy has been abandoned. Only one third ofthe oil inflows are expected to be saved and government's debt is expected to increase as a share ofGDP. However, since oil price assumptions in the budget are conservative, it is likely that ex- post the level ofoverall savings achieved could be slightly higher than what has been projected. At the same time, the focus on transport, agriculture, and industrial policy are expected to be maintained, but housing has become a stronger priority-its allocation was raised to the level ofthat ofagriculture. Although the importance of industrial policy in the budget decreased, the focus on it has not. Instead ofreceiving further capitalization, institutions like the Development Bank ofKazakhstan (DBK) have started to raise capital overseas. In addition to an increased level ofspending for 2004, non-oil taxes were reduced and thus the non-oil deficit increased. For 2004 tax reductions were across the board (VAT, and social tax). Further tax reductions for non-oil sectors were recently approved, and were targeted to specific economic industries (e.g., petrochemicals) or to firms located in certain areas (e.g., technoparks).
~ ~~~~ ~~ ~ ~~~~ ~ ~ for various targeted populations Figure 23 Kazakhstan's State Budget Spending In Major Categones
(disabled, newborns, etc.). As a 800 - m IhlCrCIl
consequence, pressures to increase 700 001herimcl Vel expenditures are mounting. 600 - B 500 0 Trmspon and cOnlIunrdilOn 47. Figure 23 summarizes the E 400 changes in the level ofspending as 5 300 well as the shifts in policy priorities for ?O0 the entire 1997 to 2007 period- 100 - 0 21
dollar has not eroded as much.
Table 4: Kazakhstan: Use of Oil Inflows and Overall Spending Priorities, 2000-2007 2000 2001 2002 2003 2004 2005 2006 2007 Actual Actual Actual Actual -Prelim. Proj. a Proj. a Proj. a Total oil inflows, YOGDP 3.2 8.0 5.0 7.4 6.1 5.9 4.7 4.0 Total oil inflows, % of total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Saved in NFRK 0.0 70.9 54.6 63.7 40.5 21.1 6.3 -2.7 Spent through budget 100.0 29.1 45.4 36.3 59.5 78.9 93.7 102.7 Total expenditure, YOGDP 22.8 23.0 21.4 22.5 23.4 25.6 24.1 24.0 Total expenditure d, YOof total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Economic classification: Current expenditures 91.8 90.7 83.8 80.2 76.5 71.9 75.4 76.9 Capital expenditures 8.2 9.3 16.2 19.8 23.5 28.1 24.6 23.1 Functional classification: GPS e, Defense, Public order 17.9 21.1 20.7 21.4 20.9 20.6 20.8 21.6 Education 14.7 15.2 15.6 15.6 15.3 14.8 15.3 16.7 Health 9.4 8.9 9.2 9.4 10.5 11.5 12.3 12.5 Social security and welfare 29.7 26.7 25.9 25.0 21.9 21.8 22.5 21.6 Housing 3.8 4.4 3.2 3.6 5.5 7.0 6.8 6.7 Agriculture 2.0 3.3 3.7 4.9 5.8 6.6 6.8 6.2 Industry and construction 1.2 4.5 2.1 6.5 2.8 5.2 3.4 2.8 Transport and communication 6.6 6.3 7.4 8.6 8.4 7.4 8.1 7.9 Other 14.6 13.4 13.7 11.0 11.5 10.4 7.6 6.7 Memorandum items:
Total public debt to GDP, YO 25.5 20.4 17.7 15.0 12.1 12.3 11.4 10.5 Average monthly pension 4462 4565 501 1 5964 6570 8762 8560 8367
Average monthly wages g, 9669 11238 12109 12478 14835 ...... Source: World Bank staff calculations based on the official data from the Kazakh authorities, ai 2005-07 Medium Term Socio-Economic Development Plan and 2005-07 Medium Term Fiscal Framework (updated in March 2005 to reflect possible amendments to the 2005 budget). b/ Oil tax revenues (CIT, excess profit tax, royalty, bonuses and PSA receipts), investment income and capital revenue (sale of oil shares and similar transfers) saved in the National Fund of the Republic of Kazakhstan (NFRK). c/ Oil tax revenues (CIT, excess profit tax, royalty, bonuses and PSA receipts) spent through the State Budget. di Excluding Net lending. e/ General public services. fi Including Financial assets operationsiCapitalization of development institutions. gi Constant tenge of 2000. hi Public sector, including civil servants, and health and education workers. 22
2. Additional Considerations
48. Positive savings by the state budget. The increase in spending over the past four years has been based on slowing down the pace of savings, rather than on borrowing against future oil income. The government’s consolidated fiscal balance has been in surplus since 2001, and the overall level ofpublic debt has fallen as a share ofGDP.
49. But the net savingsposition of thepublic sector is unclear. Although the State Budget remains in surplus, the public sector as a whole may not be. Given that the Development Bank, the Mortgage Corporation, the national companies, and the NBK, have all increased borrowing, the overall public sector’s savings could well be falling or even be negative. The Economic Council ofthe government needs to carefully monitor and evaluate these trends. Since there is no central quality control on the expenditures financed by the aforementioned institutions, the expenditures may not all have an equally sound pay-off, nor is it clear that they reflect the country’s policy priorities.
50. Role of the Government. Finding the appropriate role ofthe government in promoting competitiveness will still require further analysis at general and specific levels. The evolution of spending suggests that the government has gravitated towards a greater role for itself (Le. spending levels have increased from 22% ofGDP in 2000 to 26% ofGDP in 2005). The number of state-owned financial institutions has also increased and with that the scope ofextra-budgetary financial interventions. A greater role may be justified for those situations (e.g., agriculture, transport, health, and education) where the government may have previously withdrawn to an undesirable extent. However, a proliferation ofextra-budgetary activities has in many countries eventually led to loss offiscal control and serious adverse macroeconomic consequences. The trend is certainly worrisome.
5 1. Quality ofpublic spending. The quality ofspending is more likely to deteriorate when spending grows too fast. This is especially true if concurrent investments in government capacity to prioritize and manage public spending programs are not made (e.g., local governments, line ministries, public investment management). The rapid increase in public spending may well be straining the Government’s capacity to implement the new policies without jeopardizing the quality ofspending. Effectiveness of spending programs of course not only depends on the quality ofthe institutions that manage the funds, but also on the quality ofthe underlying sectoral policy. Clearly, just increasing resources to, for example, agriculture or education may in fact lead to more waste and less growth when the underlying sectoral policies are misguided and/or not yet reformed. (see Boxes 1 and 2).
52. The importance of settingpriorities. Since the various initiatives (whether health, education, or e-government) add to claims on scarce public resources, both human and financial, it is important to prioritize. While at first sight it may appear that thanks to high oil revenues there are no trade-offs. However, trying to implement too many programs at the same time will unavoidably reduce the quality and depth ofthe work. Building consensus around the most important elements ofcompetitiveness is, therefore, ofthe utmost importance to ensure resources remain focused on areas with the biggest payoff. 23
53. Defining implementation arrangements. At the general level, it is important to define the role ofthe government in addressing key bottlenecks to competitiveness. In sectors such as telecommunications and transport, much can be accomplished through policies that attract investments from the private sector; but, funds need to be given to strengthen specific functions ofgovernment, such as regulation. In most cases, impediments to competitiveness can be addressed by policies rather than by more money. Since, thanks to oil, fiscal revenues are not likely to be a tight constraint in the short run, there will be a temptation to resolve problems by simply by allocating more funds, through the budget, SOEs, or through other mechanisms. At the specific level, it is important that specific agencies be made responsible for specific pillars or spending programs, to avoid bureaucratic delays and red tape (see Box 3).
54. Building consensus. When making decisions about the level ofsavings, spending priorities, and the role of government, sufficient national consensus needs to be built. Building consensus increases sustainability. This is not an easy task, and in many ways the right process to derive answers to these questions may be just as important as the answers.I4 Since concentrated efforts over long periods oftime will be needed to ‘fix’ any one area (e.g., infrastructure or human capital). The downside ofnot setting clear priorities is that the country is loosing and will continue to lose.
55. In the next section below we discuss in greater detail the policy options for two ofthe six areas ofcompetitiveness: (1) economic management; and (2) sectoral policies, in particular, focusing on two specific areas: the linkages between oil and non-oil sectors and telecommunications. l5
14 This issue refers to the political economy offiscal policy and economic management in oil exporting countries, for which there is an extensive literature (see, for instance, Eirfert, Gelb, and Tallroth, 2002). It is also important for modern industrial policies, where the diagnostic and the process ofconsultation are often as important as the actual choice ofpromotion tools and policies. I’ Under this year Joint Economic Research Program, the World Bank is preparing sector policy pieces for transport, education, and health. 24
__~ -_- __ Box 1: What Kind of State Support for Agriculture?
While the oil sector generates high revenues but little employment, agriculture is at the other end of the spectrum. Since agriculture has below average productivity, it generates relatively more employment (22% ofthe total) than revenue YO of the total GDP). In addition, agriculture is pro-poor as it generates employment in rural areas where poverty is concentrated. This, and the fact that a volatile real exchange rate threatens this important source of employment, is a powerhl argument for justifying investing part of the oil revenue to support agriculture. In Kazakhstan, the agricultural budget has increased sevenfold during the past 5 years. In relative terms, it increased from one percent of the national budget in 1998 to eight percent in 2003. Yet, in the context of the discussions leading up WTO accession, and during budget hearings, the debate on what kind of support the government should provide to the sector is ongoing. No one disagrees with the objective of boosting agricultural productivity so that agribusiness remains competitive even with a stronger exchange rate, but the means for doing this are not clear.
Many developed countries provide farmers with a variety of budgetary subsidies (e.g., for inputs. for prices, for production) and strong trade protection. Their aim is to compensate for the shortfalls in competitiveness that local producers have relative to foreign ones. Subsidies are relatively easy to implement even with weak institutions and are politically appealing. But it creates “welfare dependency” and destroys all incentives to innovate.
An alternative approach has been followed by New Zealand, Australia, Chile and others, whose agricultural sector became very competitive without introducing any major subsidization scheme. From the start, the budget of these countries was tight; they could not afford expensive subsidies schemes. These countries also did not want to reduce the incentives that entrepreneurs need to achieve efficiency. Thus, public support in these countries focused mainly on assisting farmers through the provision of public infrastructure (e.g., irrigation, feeder roads), research and development, farmer-driven extension services and quality enhancement mechanism, insurance for a very specific set of risks faced by farmers, and helping farmers to organize themselves in associations that provided certain services (e.g., milk collection centers and marketing).
In a country expecting a significant oil windfall, with limited institutional capacity, and facing pressure from rural areas due to the real exchange rate appreciation, it will be difficult to avoid adopting the first approach. Still the risk is there that agriculture will become permanently dependent on transfers from oil and other sectors and will not survive in the event of a fall in oil prices. To avoid this, Kazakhstan should not overlook the strategy followed by the second set of countries. In both cases, it will be spending significant amount of resources in rural areas, but one may Drove to be more sustainable than the other. 25
, ...... ,. .. , ...... , Box 2: Strengthening the Contribution of Education to Kazakhstan’s Economic Transformation
I Aggressive exploitation of Kazakhstan’s petroleum resources will involve much sharper changes in labor-market
~ skill needs than the other Central Asian countries will face. Kazakhstan’s current education and training system is still characterized by rigidities inherited from the soviet system. Education programs will need far more flexibility than they currently have, and life-long leaming opportunities will need to be developed rapidly in order to prevent skill shortages from emerging as a serious constraint to Kazakhstan’s anticipated growth.
The goals of the education reform. Kazakhstan’s education reform aims to support the country’s economic transformation by: a) moving to a new concept of lifelong leaming, and b) making Kazakhstan’s education system i appropriate to the “global educational environment”. The second of these objectives has two aspects:
- First, to develop an education system which supplies the labor-force and life skills which will make Kazakhstan competitive in the rapidly evolving global economy, in which Kazakhstan’s role focuses on high- ’ technology industries and high-value exploitation of its natural resources -- especially, its petrochemicals and I mineral resources, and
8- Second, to equip its citizens to function effectively in the new information age.
All of the transition countries aspire to these objectives. But few of Kazakhstan’s neighbors have the means to achieve them that Kazakhstan does. Fewer still have focused on these objectives with the same level of commitment and determination that Kazakhstan has. For these reasons, this education reform plan is a crucially important opportunity for the country. Apart from the benefits that it should provide to Kazakhstan’s people, it could serve as an exemplar for education reform in all the transition countries. But the education reform will be more likely to attain its objectives if it includes a serious effort to address the following needs.
More resources for core education programs and inputs. Kazakhstan’s inherited education system is traditionally very strong in basic science and math skills. But the quality of basic science and math programs has been undermined by resource deprivation and neglect over the past decade. The lack of budgets to maintain science and laboratory equipment in schools is part of the problem. The decline of teacher salaries - both in absolute terms and in relation to other professions which use the same skills - is even more serious. It has made it difficult to attract and retain competent teachers. It has also required many teachers to take on additional jobs in order to supplement their income from teaching, effectively marginalizing and de-professionalizing their teaching. This decline in teacher salaries will undermine the education reform unless it is reversed.
More attention to educational approach. At present, the education reform is too focused on structural change, and gives too little attention to the content and approach of education. It also gives too little attention to the incentives which are necessary to bring about the needed change. The provision of education is focused on accumulation of knowledge in traditional areas and gives too little attention to the skills that are in greatest demand in the global economy. The current education reform sees this problem largely in terms of the need to add new subjects to the curriculum. It is of course important to develop and strengthen education programs in new subject areas like economics, business, information technology, and it is entirely appropriate that these programs are expanding. But a more basic question is how the teaching and leaming processes need to change in order to equip school leavers with the skills they will need to adapt successfully to rapidly evolving skill requirements in the labor market. Increasingly, success in the global labor market will require higher-level skills in synthesis and application skills for problem solving. It will also require more emphasis on teamwork and communication skills, including effective communication in foreign languages. Formal education and life-long leaming need to stimulate inquiry, critical thinking, teamwork, and application skills. They need to encourage people to ask the right questions and to equip them to find the right answers to those questions. 26
Box 2-Continued
A new role for teachers. These changes in the approach to teaching and learning imply a fundamentally transformed role for teachers. Getting teachers to take on this new role and to do it well will require a major effort to change pre-service and in-service teacher training and teacher support. It will require a new generation of education materials. Most importantly, it will require the professionalization ofthe teaching profession, involving new performance standards for teachers, new forms of support to equip them to attain those standards, and better material rewards (including higher salaries which are linked to teaching performance).
Providing the incentives for change. Incentives are a key instrument for successful education reform. Salary and professional incentives for effective teaching under the new approach are crucial. Another powerful incentive instrument to drive education reform is the use of external assessment of student achievement. If important outcomes - like university entrance, or teacher salaries, or school budgets - depend on the results of external examinations, examinations can be used to bring about desired changes in learning outcomes. In the United States, for example, secondary schools stress application skills because they figure prominently in the examinations which most universities use to admit new students. Participation in the OECD’s PZSA international student assessment would help motivate the new application-oriented approach to teaching and learning.
Improving education equity. In all of the transition countries, decentralization of education management and the diversification of education financing (including requiring parents to purchase or rent textbooks that formerly had been provided free) have led to increasing disparities in school resources and school performance between richer and poorer communities. Rural and remote schools are consistently less well equipped and perform at lower levels than urban schools. Rural schools suffer from smaller community contributions and higher unit costs (because of smaller class sizes) than urban schools. The education financing formula and other elements of the education strategy need to specifically provide for the needs of rural schools and schools in poor communities.
Integrity. Integrity has suffered in the education systems of all the transition countries because the collapse of resources has caused some teachers and school administrators to solicit informal payments in order to finance essential educational inputs and to supplement their income. Often, this situation leads to perverse incentives, including the incentive to teachers to withhold part of the curriculum in order to motivate paid tutorial instruction. Sometimes, it leads to clearly corrupt practices, such as selling grades or admission to university programs. These practices are detrimental to any education system. They undermine the credibility of education and deny serious teachers and students the recognition that they deserve for their efforts. The elimination of these practices should be a prominent feature of the Government’s education reform. Determining university admission through high-quality external assessment is one instrument for restoring integrity in education programs. Another is to publicize and enforce strict sanctions for abuse. Less obtrusive interventions should also be used, such as raising schools’ accountability to local communities by publicizing the amounts and uses of finds received from parental and community contributions, and developing a self-managed accreditation process for higher education institutions. 27
,...... ,. , ...... ,.....,., , , ...... , ...... , ...... , ...... ,..,...... , ...... ,.... , ...... , ...... , ... .,. , ...... ,..
I, Box 3-Approaches to Industrial Policy
Available savings and the level offinancial intermediation in Kazakhstan have both improved significantly over the i last few years. However, investments in non-extractive industries, which are essential to reduce the volatility I associated with oil prices and to spread the benefits ofgrowth to the population, remain stagnant. Rightly, the : authorities’ objective is to accelerate the pace ofeconomic diversification.
For its industrial and diversification policies, Kazakhstan needs not to follow the example set by East Asian countries 50 years ago, nor that ofLatin America around the same time. Instead, the country should develop an “industrial policy” along the basis of: (1) modem “business promotion” initiatives; (2) good macroeconomic management (interest rates, taxation, and conservative management ofthe oil fund proceeds), and improved infrastructure.
Modem “business promotion” initiatives focus on issues (Le. promoting steady gains in productivity and competitiveness in the non-extractive sectors) rather than sectors.
I The first task ofindustrial policy is to gain greater understanding about the reasons why credit and capital markets j are not channeling greater amounts ofresources to non-extractive industries and, what is most important, to outline and rank the most significant (non-financial) bottlenecks faced by non-extractive sectors. Then interventions can be
~ developed-hosted by the newly created development institutions, such as:
! 1) Fostering opportunities by improving business environment and trade policies, while at the same time develop an i infrastructure to assist micro and SMEs to adequately use these opportunities. The subset ofproactive policies that j appears most relevant for Kazakhstan’s present conditions are related to promoting:
-The creation, integration and strengthening ofproduction chains (starting, but not limited, to oil and other extractive industries and government procurement); - Technological modernization (equipment and know how); - Private sector investments in human capital and research and development (R&D); and - Assistance to collective arrangements ofmicro and SMEs, such as policies to support including integration of production chains, clustering, and network of enterprises (groups offirms using combined resources to cooperate on joint projects). i, 2) Given that the non-oil industries in Kazakhstan are dominated by a few conglomerates, and key other sectors are i still based on highly integrated industries, it also appears to consider the need to promote and protect competition through:
~ - Strengthening the institutional arrangements to enforce anticompetitive provisions i - Promoting spinning offs in private conglomerates
3) Targeting specific industries under the umbrella of“production chains”, rather than under the umbrella of i. , investment and credit policies. For instance:
- Mexico targets the production chains ofeight sectors: 1) high-technology industries; 2) the automotive industry; 3) light manufacturing; 4) the petrochemical industry; 5) mining; 6) agribusinesses; 7) forestry; and 8) public sector providers. - Colombia targets significant non-traditional exporters that are threatened by external competition (e.g., cotton- fibers-textile-apparel, leather-leather manufactures-footwear, automotive parts-cars, sugar cane-sugar- confectionery-chocolates, oleaginous seeds-cooking oil-fats-soap, aquaculture, tuna production, toiletries, cleaning products and cosmetics, and potatoes and their industrial processing), and those value chains that generate important linkages and are significant in the country’s intemal trade (petrochemicals and plastics; steel; electric and electronic appliances; forestry, wood products, and furniture; vegetables; fruits and their industrial transformation; cocoa and chocolates; beans; rice; shrimp; fish; cereals; dietetic foods; poultry fanning; porcine production; dairy fanning; medical services; engineering services; consulting services; software; tourism; jewelry; and crafts). 28
Box 3-Continued 4) Developing new avenues to increase the access ofmcro and SMEs to credit and know-how including fostering FDI to non-extractive sectors and, as mentioned earlier, by evaluating options to foster R&D and human capital investments by private firms.
It should, however, be noted that the most obvious policy interventions to promote competitiveness (or offset the potential loss of it that could come from Dutch disease type of developments) will need to be used first, such as reducing inflation and the cost of capital (through monetary and fiscal policies), and the cost of doing business (through reductions in taxes and red tape). The govemment must also carry on well its normal duties: (1) tax policy and collection; (2) provide key infrastructure (following strict Economic Rate of Retum analysis), education (with some specific initiatives to match skills with labor demand), health, and social protection; and (3) safeguard macroeconomic stability by maintaining its conservative approach to fiscal management, the management ofoil revenues, and the regulation ofpension funds.
Against these vast needs of legitimate public interventions, there appears to be a need to temper the expectations about the amounts of resources that the Government of the Republic of Kazakhstan can in reality devote to actively promoting industrialpolicies. Modern “business promotion” initiatives are in any case relatively cheap (if appropriately monitored and supervised during the implementation phase) although intensive in process.
B. THEECONOMIC MANAGEMENT AGENDA FOR COMPETITIVENESS16
1. The Oil Windfall: Benefits Figure 24: Potential Oil Production 1999-2035 and Risks
56. Kazakhstan is at the front 1 40 - end ofits oil windfall (Figure 24). The windfall is a net benefit to society since oil revenues will lift the traditional constraints that availability offiscal revenues and foreign exchange pose to development. But oil is often a mixed blessing, because the ~ $9 &)“ %@ $+ +P +dQ @9 %@ associated capital inflows and fiscal .$ .e.” I1 revenues complicate fiscal, 0 On-shore OfF shore monetary, and financial sector I- ~- policies-and often weaken public Source: World Bank staff calculations. policies and institutions
57. Estimates ofthe oil-related wealth.” These range from US$ 27 billion to US$ 96 billion, depending on the specific path ofkey variables over the next 20 to 30 years including, among others, oil prices, total economic reserves and extraction profile, cost of extraction, pace of company-level investments, and the rate of return on the assets in which oil-related wealth is maintained (see Table 5).lS Converted in per capita terms, this wealth ranges from US$ 1,800 to
l6 This section builds on Background Papers No. 3 and No. 6. ” Defined as the net present value of oil-related fiscal revenue flowing into the budget or the NFRK, plus the current level of assets in the NFRK, and minus the public and public guaranteed debt. ’’This work is based on the IMF (November 2004) and the WBiIMF oil-fiscal model. 29 average annual rate ofretum of about 4 percent can be achieved on this wealth, Kazakhstan could increase its level ofspending by between $72 and $260 per person a year. This is not large relative to the expected per capita spending ofabout $750 in 2005 (see Figure 23 in the previous section).
58. Wealth is small and uncertain. Oil wealth in Kazakhstan is small in per capita terms, even if reserves prove to be large and prices end up being high. This is because Kazakhstan has relatively high extraction and transportation costs, currently ranging from between $10 to 12 per barrel. Also, most ofthe oil wealth comes far in the future and is subject to high levels of uncertainty: it changes significantly with relatively minor changes in key parameters. Clearly, the priority for oil and gas sector policy makers in Kazakhstan is to ensure that the expected oil production materializes as planned, without technical or transportation disruptions. This way, the uncertainty of oil wealth will be reduced mainly to that coming for world conditions and oil prices.
Table 5: Kazakhstan: end-2002 Net Wealth Under Alternative Assumptions Constant US$ million at 2002 prices Total Oil Reserves' Oil price (Brent), Net oil Net oil wealth Annuity US$/bbl' wealth per capita per capita3 ~ 21 960S8 6490 260 High Case: 7.4 bln tons or 53.9 bln barrels 19 75576 5107 204 16 477 16 3224 129 21 670 12 4528 181 Base Case: 4.8 bln tons or 35.2 bln barrels 19 520 12 3514 141 16 33543 2266 91 21 47 160 3186 127 Low Case: 4.1 bln tons or 19 38631 2610 104 29.6~ bln barrels I6 16640 I800 72 Source: World Bank staff calculations. Note: In addition to the assumptions about oil prices and exploitable oil reserves, the above simulation makes assumptions on the profile of the extraction, the pace of investments, the taxation regime in the PSAs, and the financial and operational decisions of the operators. Each of these may change the path of revenue to the govemment. ' Onshore petroleum reserves are estimated to be 2.5 bln. tons (without taking into account the possible upward revision of the Tengiz oil reserves); Kashagan alone is estimated at 1.7 bln. tons. In addition, the oil recoverable reserves in Kazakhstan's sector of the Caspian Sea are estimated at 4.4 bln. tons according to the Caspian Sea Development Program. Thus, the working assumption for reserves of the government is about 6.9 bln tons, or close to the high case. Proven reserves are much lower as Kashagan has not yet come on-stream. Of course, whether these reserves are economic or not-particularly those offshore-will depend on oil prices. We assume oil prices to be between SI6 and $21 per barrel of Brent over the long term (20 years), which is an interval that contains the average and median prices for oil over the last 50 years. This annuity can be interpreted as the sustainable level of per capita spending. The assumption is that oil wealth will yield an annual return of 4 %, and that the discount factor is also 4 percent.
59. But associated capital inflows will exert pressure on the macroeconomic framework. By the time production peaks in 2020 the country could potentially receive between US$ 3 to US$ 7 billion annually for well over two decades." Kazakhstan has begun to face, and will
19 See IMF Country Report 041362, November 2004, and, in particular, Chapter 111, An Analysis of Kazakhstan's Petroleum Potential (www.id,org). 30 continue to face, the economic pressures that actual and potential future oil-related capital inflows pose to the macroeconomic framework.
60. The downside of spending. While Kazakhstan’s social or economic needs are high, care should be taken not to spend too much in good years, only to have to cut back severely in bad years. Such a volatility ofpublic spending creates real exchange rate volatility, damaging the investment climate in non-oil sectors. And excessive spending in “good” years may lead to overheating and the associated “Dutch Disease” problems. As oil income is spent in the economy (either through fiscal, monetary, or credit expansion), the local economy could ‘overheat’, which in turn may lead to excessive exchange rate appreciation. The extent ofoverheating will of course depend on the degree ofunused capacity in the economy (labor and capital), and the degree ofdevelopment ofthe economy (the greater the level ofindustrialization, the greater amounts ofoil inflows that the economy can absorb productively).
61. Once oil spending takes off excessively (i.e. above levels that can be sustained once oil prices come down), real wages and the exchange rate rise (appreciate) above sustainable levels. This will exert pressure on agriculture and manufacturing, whose output will decline in relative terms. The demand that oil-financed spending supports, also tends to create bottlenecks in skilled labor, infrastructure utilities (water, electricity, telephones), housing, and real estate. Often the fiscal expansion creates inflexible social or infrastructure related spending programs (e.g., Mexico and Holland), that are difficult to adjust when oil prices fall; and almost always the quality ofpublic spending deteriorates (e.g., Venezuela, Saudi Arabia, and Nigeria).
62. Overheating in Kazakhstan is possible. Since the non-extractive economy in Kazakhstan is relatively shallow and its labor force small and expensive (relative to its productivity), the country is at tremendous risk ofoverheating despite its recent good macroeconomic performance. There are currently three major drivers ofincreased demand pressure: (1) large (FDI financed) oil investments, (2) fiscal and public sector expansion (Le. the government and SOEs); and (3) a credit-fueled private boom.
63. Ongoing investments in the oil sector are estimated to be US$4 billion per year for the rest ofthe decade. While much ofthis spending is on imports and hence does not put pressure on domestic resources; there is in fact, a domestic component that is both direct and indirect (inter alia, through the domestic expenditures ofexpatriate workers). At the same time, public spending by the Government grew 21 % in real terms in 2003,17 % in 2004 and is expected to grow by 18 % in real terms in 2005 (see Table 6).
64. Also, total loans by commercial banks, in constant prices, grew by about 42 % last year (see Table 6). This is a major credit boom by international standards and, unlike the growth in 2000 and 2001, cannot be explained as a rebound after a currency collapse. In part, this expansion is accelerated by capital inflows, which are attracted to Kazakhstan given the improvement in economic prospects. Dollar-denominated borrowing is also stimulated by the fact that expected real appreciation makes the anticipated real interest rate on dollar loans very low. 31
Table 6: Kazakhstan: Key Economic Indicators, 2000-2007 2000 2001 2002 2003 2004 2005 2006 2007 Actual Actual Actual Actual Estim. a Proj. a Proj. a Proj. a 1. Fiscal Indicators : Overall fiscal balance b, % GDP -0.1 5.4 3.1 4.0 2.3 -0.6 -0.3 -0.7 Non-oil deficit ‘, % GDP -4.2 -3.2 -2.6 -3.7 -4.0 -6.6 -5.0 -4.7 Real growth ofspending, % change 12.7 16.1 2.2 20.8 16.8 18.2 1.0 6.6 2. Monetary and financial indicators, YOchange: Inflation (pa) 13.2 8.4 5.8 6.4 6.9 7.0 7.0 7.0 Nominal appreciation (-) (pa) 18.9 3.2 4.5 -2.4 -9.1 -4.4 0.0 0.0 Real appreciation (-) (pa) 8.6 -2.0 0.3 -6.2 -12.7 -8.9 -4.7 -4.7 Real average wage growth (pa) 4.5 16.4 10.6 7.0 14.3 15.2 10.1 13.3 Real broad money growth (eop) 32.0 36.4 24.6 18.9 27.3 16.3 11.5 12.0 Real banks’ lending growth (eop) 80.9 66.7 28.8 36.2 41.8 19.7 13.9 14.3 Source: World Bank staff calculations based on the official data from the Kazakh authorities. a/ 2005-07 Medium Term Socio-Economic Development Plan and 2005-07 Medium Term Fiscal Framework (updated in March 2005 to reflect possible amendments to the 2005 budget). bi Including privatization to the budget and total savings in the National Fund of the Republic of Kazakhstan (NFRK). ci Excluding oil revenue. di Period average exchange rate, KZTIUSD.
2. Policy Choices a. Fiscal Policy
65. The challenge. Fiscal policy will be the main channel through which the oil boom has its impact on the economy. This is because the budget in Kazakhstan will be the main recipient of Kazakhstan’s oil income, either in the form of tax revenue or, some time in the future, dividends from shares in the three major fields. There are also fiscal add-on effects, since imports of consumer goods increase, which in turn increases collection oftrade, excise and value added taxes. Oil inflows also fuel spending in construction and services such as transport, whose tax payments to the budget increase. In the face ofso much oil related public income, Kazakhstan may find it difficult to maintain: (1) budget discipline; and (2) the quality ofpublic spending. This has been a major problem in other countries after sudden upsurges ofoil- and non-oil revenues.
66. Maintaining budget discipline. There is a clear conflict between expansionary fiscal policy and maintaining a competitive exchange rate. While the fiscal expansion ofthe past two years is by no means a sign ofbudget indiscipline, it has fuelled demand for non-tradables, hence putting pressure on their price and thus on the (real) exchange rate. A modest fiscal policy-one where growth in spending does not exceed real growth ofthe economy, and the non-oil deficit is maintained, say, below 4 percent ofGDP’O-brings a number ofindirect benefits to the non-oil economy. First, it helps to implement monetary policy by not putting too much pressure on the
*’A more rigorous calculation would need to be performed to determine the level of the non-oil deficit that can be consistent with a relatively tight fiscal policy stance. 32 exchange rate; there will then be less need for sterilization and other interventions, so the NBKR can ease up on interest rates. Second, the economy will be shielded from the volatility in oil income. Third, by maintaining a binding budget constraint, it will force public choices and thus a better use ofpublic funds.
67. The policy dilemma. Kazakhstan needs to find an appropriate balance between spending now and spending in the future when deciding on how to use its oil windfall. On the one hand, the windfall could be used to support an expansionary fiscal stance that will aim at addressing bottlenecks, redistributing the oil wealth, or addressing social imbalances, but this could lead to overheating and reduced efficiency ofpublic spending. It could lead to substantial waste if spending systems and the policy framework are inadequate. On the other hand, spending can be contained to help the economy cool down (like in China), but then Kazakhstan will, to a certain extent, be postponing the need to address important needs. Economic theory provides no guidance for finding such balance. Certainly, a well designed public investment program (on the basis of a full economic cost benefit analysis and in line with the absorptive capacity ofthe economy and the Government’s implementation ability) should proceed. Monetary authorities should only neutralize the macroeconomic effects of an expanded investment program when these are expected to be transitory.
68. Instruments for making choices. The government has two key instruments to reach consensus on the degree ofbudget discipline: (1) the MTFF; and (2) the rules for accumulating savings in the NFRK.
69. The MTFF needs to clearly focus on the choices that are made in relation to:
0 The real rate of growth of total public spending (including local governments and, ideally, SOEs), in particular, as it compares to the rate at which the economy can absorb the increase (e.g., vis a vis the expected real growth ofthe non-oil economy).
0 The magnitude of the non-oil public sector deficit, as defined by the total expenditures minus non-oil fiscal revenues; this is the proper measure ofthe external resources (from oil revenues or borrowing) that are being injected into the economy in a given period- either through an increase in spending or through a reduction in public non-oil revenues.
0 The priority spending areas over the medium-term (including easing the tax burden on non-extractive sectors). To do this, an effective system to cost the various programs (most ofwhich are expected to take around a decade to complete) needs to be developed. In this way, the tables offunctional classification ofspending will accurately reflect the likely path of some programs-and provide an estimate ofthe headroom for changing policy priorities.
0 The balance budget rule. As will be argued below, rules for the NFRK without clearly pinning down the overall deficit position ofthe government will not work, as the government can save and borrow at the same time. To avoid such case, the government will need to commit to run a budget balance under which the primary deficit (the overall deficit ofthe state minus interest payments) is equal to zero. This, in other words, imply 33
that oil will finance the entire non-oil deficit except for interest payments (currently at about 0.5% ofGDP) that could be financed through borrowing.
0 Ideally, the MTFF will bejointlyformulated with the monetary authorities to ensure close coordination offiscal, financial, and monetary policies.
70. Current NFKR rules should be improved. The current rules for placing resources in the NFRK would allow the government to deplete the balance if prices were to fall significantly below $19 bbl., the rules are not applied consistently, as the definitions ofoil income and oil enterprises can be easily changed if there is the intent to save less or more than the rule currently commit the government to. Finally, although the rules look simple it is actually quite difficult to compute: establishing the trigger point for contributions to the NFRK requires an estimate ofoil- related revenues, taxes, bonus payments, etc. that will be transferred to the Treasury by each of the nine companies reporting to the NFRK currently. That the saving rule alone is not enough to maintain fiscal discipline has been shown in 2004: inflows to the NFRK are expected to be the lowest since its creation although oil prices are at their highest levels in a decade.
71. A much more important shortcoming of the current rules is that they can be undermined by the debt-issuance policy ofthe government. Thus, the govemment has occasionally both contributed to the NFRK and borrowed at the same time, thereby de facto reducing net savings below the level ofcontributions. In fact, such behavior is expected to take place in the 2005 budget, when the debt ofthe government is expected to increase but there will be positive contributions to the NFRK. Obviously, if as much debt is issued as is contributed to the NFRK, then no net savings takes place; moreover, since the cost ofdebt most likely exceeds the return on NFRK assets, issuing debt while contributing an equal amount to the NFRK deteriorates the position ofthe budget even when it does not increase net debt. There are two possible balanced budget rules that will “tie up the hands” ofthe fiscal authorities to some extent:
0 A balance budget rule under which the non-oil deficit ofthe state is financed entirely out of the NFRK (in fact it is given by the formula explained below and, thus, given a level of revenue collection effort from the non-oil sectors expenditures will be determined residually). In this case, the level ofgovemment debt (currently about $5 billion) will be constant in dollar terms (except for real exchange depreciations ofthe currency pool), but will fall rapidly as a share ofGDP. The pace ofgross borrowings-and in turn the new commitments-will be primarily determined by the debt service due, but can also be influenced through debt swaps (e.g., extemal for internal debt, short term for long term) and re-openings.
0 A slightly softer variation ofthe above rule, under which the transfer from the NFRK will finance the primary deficit (overall deficit minus interest payments), so the primary deficit, and not the overall deficit, will be zero. In this case, the level of government debt will growth by an amount up to the interest payments, but it will still fall as a share of GDP as long as the GDP continues to grow.
72. In both the above cases the deficit must be balanced over a business cycle rather than year by year. However, since oil-related business cycles could be unpredictable, the adjustment 34 for the business cycle could be made on the basis ofa simple three-year moving average. Obviously, control should be also exerted over the borrowing policies of the rest ofthe public sector (i.e. quasi-fiscal financial institutions and SOEs) because they, and not the state, are likely to account for the bulk of the public sector’s borrowings. Reporting to parliament their basic operation is one way of introducing some control if parliament is authorized to set an overall limit for their aggregate borrowing.
73. Thus, the current rules should be improved to adhere to the following objectives:
0 Maintain a rainy day fund that will ensure the financing ofthe budget during bad times (Le. when oil prices are low or when export volumes are disrupted);
0 Stabilize the level of government spending in order to reduce real exchange rate volatility;
0 Save a part ofthe oil revenue for future generations, in particular those that will come after the oil boom;
0 Provide some control over the long-term level ofthe fund (addressing the question of how much money can a political system stash away without creating excessive pressures to change the rules); and
0 Facilitate the management ofthe Treasury and the conduct ofmonetary policy within a given year.
74. Suggested changes. Rule with the above properties is described in detail in Background Paper No. 6. The rule is a combination oftwo well-known approaches on how much to save and how much to consume out of oil revenues:
The Bird-In-Hand (BIH) rule where only the income earned by the NFRK will be consumed (Le. around 300 million dollars in 2003); this is the rule that Norway would like to eventually adopt, but it may be too restrictive for a country with vast development needs like Kazakhstan; and
The Permanent Income (PI) rule which effectively suggests that the long-term return on total oil wealth (whether this wealth is already in the NFRK or still underground) can be consumed (Le. between 1 to 3 billion dollars a year depending on the assumption; see Table 5). This rule would lead to spending ahead ofoil revenues when oil revenues are expected to rise substantially; but such a rule would create major problems if the anticipated rise does not take place or comes later and/or is less than expected.
75. Under such a hybrid rule, combining the BIH and PIU approaches the annual amount spent out of oil revenues for a given year can be calculated with the following formula, where Y is the amount spent out ofoil income annually, A is a parameter estimated on the basis ofwhat can be consumed out oftotal wealth, b is a coefficient between 0 and 1, and F the level of assets 35 saved in the NFRK (at the end ofthe previous year). By setting the parameter b to be equal to the expected long-term rate ofretum on assets, this part ofthe formula reflects the BIH rule:
Y(t) = A + b * F(t-1)
76. By selecting various parameters for the rule, the government would be able to decide how much ofthe oil windfall would be spent-and leave as a residual the amount to be saved (Figure 25). The specific value for the parameters will determine how much ofthe volatility in prices and quantities will be transferred to the economy via the fiscal framework.
Figure 25: A Simulation of the new Saving Rule 77. The asset management strategy. Since ~~~~ ~~~~~~ ~~~~~~~~~~ ~ ~~ ~~~~~~~~~~~~~~~~ Total Oil Revenue (T), Oil Revenue to the Budget (Y). and NFRK Kazakhstan is likely to accumulate sizeable Assets (Ft). in billions of US$ resources in the NFRK, it is important that these (b=0.04) assets be invested wisely. The current 30 7 140 arrangement is that the Ministry ofFinance (MOF) owns the NFRK but it is managed by the NBK. This is a good arrangement. Ifthe suggested rules are adopted, the organization of the NFRK will need to be adjusted somewhat. The NFlUS will need to be divided into two parts: one part that would be transferred to the budget during the year, and the other part would be the rest ofthe fund. This is because the new rules would require that all oil revenues go first Source: World Bank staff calculations. to the NFRK, and from there, a certain amount (given by the above formula) be transferred to the budget. Thus, the current division of the NFRK into savings and investment portfolio would disappear.
78. Under these new conditions, the entire balance in the NFRK can be managed as ‘stabilization’, except for the part that the budget will need to receive during the year (which would be known when the budget is approved). To invest this ‘stabilization’ part ofthe NFRK, the NBK and the MOF would need to choose a set offinancial assets that would smooth the consumption out of total oil revenue-as opposed to only its financial component. This approach is elaborated in Background Paper No. 7. The key to this approach is that the NFRK would be invested in those countries and currencies that correlate the least with oil prices and, thus, hedge the country against oil fluctuations.
79. Safeguarding the quality ofpublic spending: creating the ability to spend efficiently ($or results) and effectively (least-cost). Despite an overall fiscal rule, and a rule for saving and spending out ofoil revenues, spending can be expected to increase and, therefore, the time is now to ensure that its quality will be safeguarded. Progress has ofcourse been made in terms of improving the institutions for public spending (e.g., a new budget code was passed in early 2004), but the agenda is still vast. For instance, while the budget code requires that every investment program be subject to rigorous cost benefit analysis, in practice neither government nor non-government institutions have the capacity to do so in accordance with international standards. Costing, in particular is an area where current government investment programs will need greater attention, as well as the thinking that needs to go into designing sound 36 implementation arrangements. The structures ofthe Ministry ofEconomy and Budget Planning should also be changed, as investments programs are the responsibility ofthe debt management unit. The Ministry ofEconomy and Budget Planning lacks also capacity to evaluate the various flagship programs ofthe government (industrial development program, housing program, e- government program, health program, and education program) not for their merits, but for the results and effectiveness. Such capacity must be created for ongoing as well as new programs.
80. Other steps to be taken include allocating sufficient budget for the preparation of programs (e.g., a World Bank financed investment program usually requires between $300,000 to $500,000. The bulk ofit is really for the government to prepare the program, including procurement and implementation plans, and cost it appropriately). Second, the pace ofspending should not grow too fast (both in sectors as well as in aggregate), as this always leads to a lower quality ofspending. Third, institutions for public spending must be strengthened, through, among other way, determined efforts to modernize and build capacity in the civil service, line ministries, and local governments. The training ofcivil servants should be revamped to focus on public expenditure management issues, such as procurement, financial management, evaluation of investment projects, and the monitoring and evaluation ofpublic interventions. Finally, regulations and institutions responsible for procurement, financial management, and accountability must be strengthened.21 These are all areas where Kazakhstan will need to make significant efforts not only to catch up with the standards adopted by the EU8 countries, but also meet the challenge of maintaining good spending policies.
8 1. Of special importance are the institutions responsible for the preparation ofpublic investment programs and asset and liability management, both ofwhich must be strengthened. The recently approved Budget Code includes a number ofsound steps for preparing and reviewing public investments ofthe government; but, in most cases neither the line ministries nor the economic authorities have the capacity (financial or human) to rigorously implement those steps with sufficient quality.
82. A few safeguards for taxation. Now is a good time to simplify taxation for the non- extractive sector, and possibly also to reduce the overall tax burden. However, if such a reduction is based on a sectoral case-by-case approach (for certain industries or certain places), the integrity (and discipline) of the tax system isjeopardized, creating loopholes and facilitating tax avoidance. In fact, this is an additional lesson from countries that were unable to manage their oil-windfalls well: they loose control not only over spending, but also taxation. A detailed tax policy strategy needs therefore to be developed, which will consider the pros and cons ofthe various options for reducing the tax burden in non-oil sectors. Our preference is to continue to reduce taxes on labor and capital across the board and to widen (rather than reduce) the tax base for all taxes, including the VAT whose base is eroded by a number ofkey exemptions. A broader tax base will allow lower rates, which in turn will improve taxpayer's compliance, as Russia has shown clearly. As part of this general direction, the consolidation ofthe social tax and income tax should be considered, with the bulk ofthe collection staying with local govemments. But this issue requires further analytical work, specification and discussions.
*' The WB and the MEBP have agreed to produce a Public Expenditure and Institutional Review (PEIR). During the first year, the PEIR will focus on the policies and institutions for the management of civil servants, procurement, and intergovernmental relations. 37 b. Exchange Rate Policy
83. Oil income has a major impact on the exchange rate and the prospects ofthe non-oil sectors. Oil income will unavoidably exert upward pressure on the exchange rate unless every penny ofit is invested abroad; and even then anticipations offuture spending may lead to upward pressure today. The issue is not whether or not the exchange rate will appreciate, but rather the pace and manner at which it will do so, and the volatility that it displays in the process. In the face ofa commodity inflow, many countries have seen their currencies become overvalued only to experience a foreign exchange crisis afterwards. This is the type ofvolatility that destroys manufacturing and agriculture.
84. During its short history as an independent country, Kazakhstan has already experimented with a variety of exchange rate regimes. The 1994 stabilization program was successful because ofa credible monetary policy entirely built on the exchange rate as an anchor-an almost fixed exchange rate regime of a crawling peg type. This policy was maintained-with various minor adjustments-during the East Asia crisis in 1997, and the Russian crisis in 1998 in spite ofthe large Ruble devaluation in mid-1998. Kazakhstan then made the strategic mistake ofmaintaining a fixed exchange rate regime despite the significant loss ofcompetitiveness against Russia and countries that devalued with it. The overvaluation ofthe exchange rate in the 10 months that followed the Russian currency crisis until Kazakhstan let the exchange rate float to find a new equilibrium in April 1999, caused a severe recession. As a consequence, the NBK hesitates to claim it has any exchange rate target (implicit or explicit), although it admits that exchange rate stability is a priority.
85. However Kazakhstan is now, and will be in the coming decade, in an entirely different situation than the one it found itself in after the Russia crisis. Rather than capital flights, fiscal deficits, and uncertainty, Kazakhstan is facing a period of strong confidence, fiscal surpluses, and growing capital inflows. In 1998, the monetary authorities faced the question ofhow much to let the exchange rate depreciate, while today the question is how much to allow the exchange rate to appreciate. While the pressures generated by capital inflows could be addressed by means other than the exchange rate policy (e.g., by controlling capital inflows), now is the time to review the pros and cons ofdifferent exchange rate regimes and the associated attitude towards capital flows-including the role that an (implicit or explicit) target on the exchange rate could play.
86. The current monetavypolicy stance is ambiguous. As highlighted in the Basic Directions for Monetary Policy for 2004-2006, the NBK has openly announced that it will begin to base its monetary interventions on a system ofinflation targeting rather than “stabilizing” the nominal exchange rate and offsetting the impact of capital inflows through a policy ofsterilized intervention. However, actual practice has focused much less on inflation than on stabilizing the exchange rate for a weighted basket of currencies. The NBK has tried to offset the ensuing capital inflows through sterilized intervention, buying large amounts ofreserves while issuing domestic debt. Outstanding NBK notes increased from a minimum amount in 2001 to about $2 billion now. Thus, monetary policy and exchange rate objectives seem inconsistent. This ambiguous policy stance, combined with the rapid pace ofasset accumulation in the government and the pension funds, has created significant expectations ofa strong currency revaluation-1 0- 15 years before the true oil windfall. 38
87. Current policies are unsustainable because Kazakhstan may end up facing two forces that lead to real appreciation beyond the long-run equilibrium level (in itself not constant): loose fiscal policy (putting pressure on non-tradable prices) and tight money (appreciating the nominal exchange rate). In the end, the attempt to compensate expansionary fiscal policy with excessively tight money can cause a recession that not only stops the growth process but also destroys the non-oil tradable sector. The key is to resist strong fiscal stimulus, by avoiding a widening ofthe non-oil deficit and moderating the pace at which aggregate spending grows in real terms. c. Supervision and Regulatory Policy and Policies towards Capital Inflows
88. The set ofrules and practices associated with official oversight of financial institutions is very relevant in the context ofmanaging the oil boom. International experience suggests that large and volatile capital flows can exacerbate existing weaknesses in the financial systems (see Background Paper No. 8).
89. The international experience. Prior to the 1997 crisis, East Asian financial institutions suffered from excessive rates ofleveraging, unhedged foreign currency debt, weak corporate and financial sector governance, and ineffective official supervision. In Mexico, credit was growing eight times faster than GDP prior to the 1994 crisis. In Argentina, currency mismatch was extreme prior to the 2001 crisis. This is not the case in Kazakhstan, but it is not difficult to imagine this type ofbehavior occurring amid the euphoria ofan oil boom.
90. If commercial banks’ in-house risk management systems were developed, and if the regulatory and supervisory frameworks were uniformly effective, the concerns that a country’s banking sector would be adversely affected by the oil-related capital inflows would be much less, But the international experience suggests that these are not really prevalent conditions in most middle income countries. Some countries tend to allocate a fixed proportion ofloans to particular sectors (heavy industry, agriculture) on non-commercial terms, and this behavior is worse ifthere exist ownership links between banks and those sectors, or where government intervention or pressure is strong. Economic policies that increase prices ofnon-tradable goods will, in any case, provide incentives for banks to concentrate their portfolios on sectors (such as construction and real estate) that are known to be vulnerable to interest rate and cyclical fluctuations.
9 1. Kazakhstan is at risk. Banking supervision systems have been put in place rapidly in Kazakhstan, and the country is following intemational trends to move to a fully integrated and independent financial supervision authority. Commercial banks are also making efforts to improve risks management systems. However, the financial sector in Kazakhstan is at a cross roads. It can be a leader in the CIS, but, at the pace that credit is expanding, Kazakhstan’ financial sector could also be tripped up by its own success. Part ofthe expansion ofnon-oil GDP is due to a credit boom fuelling private expenditure. At about 40 percent in real terms, bank credits are accelerating at a very fast clip, raising a whole series of financial sector issues in addition to concerns about the real exchange rate impact ofa sharp rise in expenditure stimulated through this credit boom. 39
92. Fast credit growth raises questions ofrisk exposure by banks; if credit expands too fast, quality control is likely to slip. New loans (and the companies or persons taking them out) would be harder to screen, as the monitoring resources ofbanks are stretched. In addition, in good times, it is easy to appear solvent, but this may change if the economic situation deteriorates. Finding out the capacity of firms to actually generate cash is compromised by the fact that the banking system as a whole can capitalize all interests owed and still expand credit, without requiring firms to actually give cash back to banks. Collateral appears ample as asset prices are high and rising. These factors can change very quickly once the economy enters into more difficult times. Firms’ cash flows suffer, asset prices decline, thus collateral value decreases, and interest rates go up just as the capacity of firms to repay is compromised. Indicators ofcredit quality can turn from rosy to worrisome in a very short period oftime. In this context, when the situation turns bad, concentrated exposure to particular sectors, such as real estate, may cause serious banking problems.
93. Moreover, much ofthis credit boom is financed by foreign borrowing, leading to a significant exposure to foreign exchange risk. Although some ofthe foreign borrowing by commercial banks is siphoned off through NBK’s sterilization operations, a substantial part of it is passed on, apparently to a large degree as dollar-denominated loans. Ifthe foreign loans are on-lent in Tenge, the bank may loose its capital in a currency crash, as the value ofits assets would decline relative to that ofits liabilities. Ifinstead, it lends in dollars to firms that sell in the domestic market it may achieve a mostly spurious degree ofcoverage as currency risk is disguised in the form ofcredit risk. Firms may find themselves unable to pay dollar debts when the currency crashes. In anticipation ofthis concern, depositors may run on banks if they perceive a high risk ofcurrency depreciation. In the end, the bank is exposed to an exchange rate risk in spite oftheir apparent coverage; exchange rate related risk is transformed into commercial risk, but it is still exchange rate related. On top ofthat comes the fact that Tenge-denominated loans are increasing even faster than dollar-denominated loans, which obviously directly poses exchange risk exposure issues.
94. To mitigate exchange rate and credit vulnerabilities, there is a need for the fiscal, monetary, and financial regulation authorities to:
0 Adopt a package of measures to slow down the pace of credit growth and banking sector expansion - including, inter alia; the introduction ofreserve requirements on foreign borrowing, and possible measures to signal the need for prudent cross-border lending and commercial bank’s offshore operations. These measures may increase lending margins in the banking sector in the short-term (on average), which in itself are desirable, as it would reinforce the need to contain credit growth. Given the large availability ofcapital in the market, it is unlikely that such an increase in margins will affect medium or large enterprises-but it may affect smaller business borrowers.
0 Make a concerted effort to strengthen the institutional set up within and across agencies that will need to serve as the “eyes” and “ears” ofthe policy makers regarding structural and business cycle-related risks in the financial sector. Emphasis will have to be placed on supporting efforts of the Financial Supervision Agency (FSA) to strengthen key functions including: comprehensive consolidated supervision, prompt corrective 40
action and resolution (including the role of the deposit insurance fund), and onsite examinatiodoff-site analysis in the case ofboth banking and non-banking services. Some elements ofthe regulatory framework merit a review to ensure the FSA has authority to oversee and effectively control lending to related-parties, sectoral exposures, and loan classification and provision requirements. Institutional development is also needed for the FSA to be able to address some complex issues associated with non-bank regulatory design (e.g. pension, collective investment schemes, securitization, and annuities regulation).
95. Other issues relevant to the financial sector (e.g., greater domestic intermediation of pension assets, capital market development, and regulation of the pension system) are discussed in Background Paper No. 8.
c. THE STRUCTURAL REFORM AGENDAFOR COMPETITIVENESS
96. As was illustrated in Diagram 1 (Chapter 2), there are five potential areas in which structural reforms will need to be formulated to increase sustainable competitiveness in Kazakhstan: (1) human capital, (2) infrastructure, (3) government institutions, (4) R&D and Innovation, and (5) sector (industry) policies. For each ofthese five areas there are a number of sub-areas. In this section we would focus on two specific areas:
0 Infrastructure -but only on the sub-area oftelecommunications sector reforms 0 Sectoral policies - but only on local content policies for oil and gas
97. These two cases were selected for two reasons. First, they provide good examples of areas where large efficiency gains can be induced in non-oil sectors without the need to spend government funds, or at least not in any significant amounts. Second, these two areas are important to the overall agenda ofthe government.
1. Infrastructure: the Case of Telecommunication Reform
98. Strategic context. Both government officials and business people are well aware ofthe important central role that the telecommunication sector plays in fostering diversification and competitiveness. This role is also well documented in the international context.22
99. There is also awareness ofthe fact that Kazakhstan has still a long-way to go before it can exploit the advantages ofmodem Information and Communication Technology (ICT). Benchmarking exercises provided in Chapter 2 and Background Papers No. 9 and 11 suggest that Kazakhstan performs reasonably well in the regional context in terms ofgrowth ofaccess but performs poorly in a wider group of peers. For example, while the GDP per capita in Kazakhstan
22 See, for instance, the recent edition of 'death of the distance' which highlights how the rapid technological change in the sector has dramatically reduced the costs of communications and of transporting ideas and information http:'iwww.deathofdistance.cod. There is also empirical evidence to suggest that flows of Foreign Direct Investment (FDI) are higher in economies where telecommunications intensity (measured as a proportion of GDP spent on telecommunications). 41 is twice that ofUkraine, Ukraine has twice as many telephone lines per 100 people as Kazakhstan. This state of affairs produces a “digital divide” within Kazakhstan between those locations with adequate access and those with little or no access.
100. The Reform Agenda. The telecommunication agenda ofthe Government ofKazakhstan (GOK) includes:
a. Market liberalization to promote greater access by licensing additional fixed and mobile operators;
b. Tariff rebalancing to encourage sustainable investment and market entry;
c. Interconnection to facilitate market entry and greater access;
d. Establishing roles and responsibilities among different agencies, most notably the creation of an independent regulator in which the market has confidence and preparing KazakhTelecom for a liberalized market; and
e. Universal Access andlor Service involving: o subsidies to existing rural consumers to maintain existing levels ofaccess o expansion ofthe network to unserved areas
101. This is a comprehensive agenda and some pieces are already being implemented (e.g., tariff re-balancing, determining interconnection policies and prices and market liberalization), We discuss some ofthe above steps. a. Market Liberalization
102. The negotiation position ofthe GOK in WTO accession talks has been to maximize the period for exclusivity rights for the current operator. In the narrow context, this is a justifiable negotiation strategy as it ensures that the timetable for the liberalization ofthe telecommunication sector is dictated domestically rather than from outside. However, it could be argued that such a position undermines the timetable for the implementation ofthe Telecommunication Program, but signaling that change will only come several years after accession.
103. It is important that the GOK’hannonizeits negotiation position with WTO and its Telecommunication Program; and make a clear public statement that it is doing so. Drastically shortening the offer by WTO (eg, to the point ofaccession) will likely facilitate accession, but more importantly, it will provide a strong signal to domestic players to prepare for a liberalized market. All operators in the market should know that changes are coming and that they must respond in some way. Investors will need to receive assurances ofgreater security and predictability in the rules-based environment that WTO membership represents. Users and consumers should also be clear that they will receive a greater variety ofchoices and, at least, reduced prices for long distance services. 42 b. Tariff Rebalancing
104. The current high (substantially above cost) tariffs for intemational calls will attract numerous new entrants whereas the local call market (where tariffs are below costs) will not attract new entrants. The investment decisions ofnew entrants will be based on inaccurate price signals and there will be over (and non-sustainable) investment in some markets and under investment in others. Equally, the investment decisions based on distorted tariffs (as described above) are unlikely to bring about any extension of access to unserved areas so that the Universal Access and/or Service component ofthe telecommunication reform agenda will not be fulfilled.
105. The direction of tariff rebalancing is clear for everyone, i.e. the GOK should proceed to reduce tariffs for intemational calls and increase tariffs for local calls. The final (end point) prices to be charged for local and intemational calls are less clear. In this respect, the GOK is advised to:
P Develop a suitable methodology for domestic tariffs (e.g., flat fees, time-related prices, two part tariffs) and make it public in draft (for discussions and comments) before it is finally adopted.
> Develop a simple financial model ofthe telecommunication sector to calculate the possible end-point for domestic and international tariffs. The purpose ofsuch model is primarily to check the consistency ofthe various cost components oftariffs that are under the control ofthe regulators (e.g., interconnection prices with user tariffs). A five-year (rolling) tariff rebalancing plan should be prepared and made public before its adoption, Naturally, the rolling nature of such a plan should be emphasized, in that the regulator will maintain its right to update its rolling plan.
C. Interconnection
106. There are many types of telecommunications networks and services, and to the extent that they are interconnected, the economic and social benefits ofinvestment in these networks and services will be greater. The Annex and Reference Paper for WTO accession specify some basic principles to ensure transparent, reasonable and non-discriminatory interconnection services. The issues of cost-oriented interconnection at any technically feasible point that is sufficiently unbundled is part ofthe Reference Paper and applies mainly to the monopoly provider (KazakhTelecom in the case ofKazakhstan). Interconnection prices are the wholesale prices paid by one operator to another for the provision ofessential services, such as call termination. The nature ofthe interconnection market and the level ofprices is a key determinant ofthe nature of investment in the market by new players. Typically interconnection prices are set on the basis of costs or estimates of costs established, for example, through benchmarking studies.
107. The principles of interconnection prices take into account three basic cost elements: one- time start up costs, cost of network elements that incumbents make available to new entrants, and contribution to the funding of universal service. Placing too high a price on any ofthese elements (singly or in combination) can make it difficult or impossible for long-term sustainable competition to take root. 43
108. In Kazakhstan, there are two key issues that need to be addressed with regard to the interconnection market. The first is that the current structure ofretail tariffs has an adverse impact on the opening up ofthe market through the creation ofa price squeeze between ‘cost’ based wholesale prices (Le. interconnection prices) and artificially low retail prices. New entrants will be unwilling to pay interconnection charges that are above retail tariffs. Consequently, where the retail charges ofKazakhTelecom are below costs (e.g., for local calls), any wholesale price, based on costs, will be above the retail prices, thereby making entry uneconomic regardless ofthe efficiency ofthe new operator. Conversely, where retail prices are significantly above costs, cost-based interconnection prices can support inefficient entry. In effect the unbalanced retail tariffs can create inaccurate price signals in wholesale markets which can result in non-sustainable and distorted investment to the detriment ofthe development ofthe sector.
109. The progressive rebalancing oftariffs - including access charges - to the level where tariffs cover costs for each service will send accurate signals to the market leading to economic investment decisions. Where access and usage charges reflect costs, investments by all players may substantially extend access and thereby contribute to improved competitiveness and the broader economic objectives ofthe GOK.
110. The second issue is the continuing presence ofthe exclusive rights held by KazakhTelecom in the interconnection market. With regard to calls originating and terminating on mobile networks these exclusive rights result in a premium being paid ofup to 5 cents per minute for ‘transiting’ the KazakhTelecom network. The mobile operators suggest that this fee artificially inflates retail prices, in some cases, by some 20%. In the fixedimobile market interconnection prices account for approximately 30% to 50% ofthe retail price. Cost based interconnection prices and increased competitive pressure will result in lower retail prices and stimulate the demand for services.
111. The reform ofthe interconnection regime is an important early step in the liberalization of telecommunications markets. It is clear that the interconnection market in Kazakhstan needs to be reformed based on the principles ofcost orientated, non-discriminatory, and transparent prices. The adoption ofcost based tariffs requires the collection ofconsiderable data which is currently unavailable. The initial reform could be based on the adoption ofintemational benchmarked prices. Reform of the interconnection regime has been identified as a key priority through discussions with the Agency for Informatization and Communications (AIC) and the Agency for Regulation ofNatural Monopolies and Competition Protection (ARNMCP).
112. However, the effective implementation ofthe liberalization agenda, supported by the issuance ofnew licenses, tariff re-balancing and interconnection will not resolve all the items on the telecommunications agenda ofthe GOK. The govemment is right to be concemed about customers who will not be able to afford the access provided by market forces owing to their low income or location (e.g., the rural poor). This issue is discussed in Section e below. 44 d. Roles and Responsibilities of Different Players
113. An effective regulatory environment. The effective implementation of a 21Stcentury regulatory environment that promotes private investment, competition increased access, and supports the sustainable development and diversification objectives ofKazakhstan is a key priority. In addition to the actions on tariffs and interconnections, a number ofactions are required in the areas of licensing, spectrum, and institutional building:
3 The establishment oflight-touch licensing or authorization procedures to promote the rapid market entry for service and infrastructure provision without any Universal Service Obligation (including the removal of a Universal Service obligation to KazakhTelecom).
3 The need to establish an open and competitive tender process for the licensing ofa third GSM operator.
3 A continuing need for capacity building for the relevant regulatory agencies to ensure their credibility to all market players and customers. This involves not merely training, but also the introduction of some ofthe important elements of an independent regulator. The continuing involvement ofthe AIC in the management ofKazakhTelecom through the membership ofits board is one example where the existing institutional arrangements do not meet best international practices. Further, the adoption ofa more open and transparent process ofconsultation with regard to the AIC decisions would more closely align it with best international practices.
3 The management ofthe spectrum will require some basic steps to outline the steps forward:
o Subcontracting a segment to review and rationalize spectrum use in Kazakhstan, including development ofa spectrum allocation plan, a database of spectrum use and the potential for creating additional usable spectrum by re-farming the existing assignments;
o Structure an open and transparent policy for the use ofthe spectrum;
o Develop a spectrum pricing and trading policy;
o Training for relevant agency staff in addressing spectrum management and monitoring issues; and
o It is likely that the relevant agency will need to procure and implement a Spectrum Management and Monitoring System (SMMS) so that it has the tools to effectively manage the radio spectrum. Consultants should be hired to assist the relevant agency in the development oftechnical specifications for the SMMS, preparation ofbidding documents, bid evaluation and contract administration of the system. 45
114. The modernization of KazakhTelecom. Reform ofKazakhTelecom in light of a changing market environment is an important corollary to sector reform. The company is, and is likely to remain for some time, the country’s leading ‘hi-tech’ vehicle and the supplier ofmost ofthe country’s electronic communications infrastructure. Consequently, decisions made by the company have an impact across the entire economy and on the broader economic objectives of GOK. At a strategic level, the current decision making process, such as the approval of investment decisions and the reform ofworking practices to increase productivity, are influenced by broader concerns about the sector as a whole. Moreover, the interdependency between the government, the regulator, and the firm are reflected in the composition ofthe board and the approval ofboard decisions by government departments. Reform ofthe governance structure of KazakhTelecom may well increase its ability to respond to a competitive environment.
115. At an operational level there is some prima facie evidence that the processes ofthe company are not yet adapted to the requirements of a competitive market. The financial systems ofthe company are undergoing reform, but as ofyet, good cost data is unavailable. Network modemization is incomplete and provision ofper secondhtemized billing is not common. Headline measures of productivity, such as lines per employee, suggest that there are significant deviations from international best practices.
116. As a matter ofpriority it is suggested that resources be devoted to the review of KazakhTelecom to help establish it as a world class operator. In this context the GOK should consider hiring the services ofinternational consultants to develop and implement, in very close co-operation with the management ofKazakhTelecom, a forward looking business plan that will enable the company to not only become “the supplier ofchoice” in an open and competitive market but also an active contributor to the achievement ofdiversified and sustainable growth in Kazakhstan. The implementation ofsuch a business plan would add to the value of KazakhTelecom and make it more attractive to private investors in the event that the GOK decides to further reduce its shareholding in the company. Any further sale of shares would have positive secondary outcomes. For example, it would add substantially to the volume available on the Kazakhstan equity market. This would in turn provide an outlet for funds generated by private and public insurance schemes.
117. Alternatively, the revamping of KazakhTelecom into world class operator could be the objective ofa further sale ofthe company by GOK. e. Promoting Universal Access in Rural Areas
118. The liberalization ofthe market would extend access to commercially viable customers and, in the case ofKazakhstan, this increase ofthe customer base could be substantial. But, as in many other countries, certain groups ofpotential customers are not sufficiently economically attractive to private investors.
119. In the Bank’s experience, in circumstances such as these, targeted rather than generalized initiatives provide the best solutions. One form oftargeted initiative - “the smart subsidy” approach - see Background Papers No. 9 and 11. Noticeably, where the smart subsidy has been used, the actual subsidy granted following a tender was below the maximum allowed. In this 46 way, the economic objectives ofthe government (social inclusion, competitiveness) were achieved with efficient and minimum subsidies.
120. Generally, about 2.5% of GDP is spent on telecommunications services. In poor rural areas, 2.5% ofincome is not likely to be commercially attractive to private investors to provide access to individual customers. However, aggregating the demand ofindividual customers in specific locations with that ofthe private and public sector may result in “public” or “shared access” (to electronic communications including the intemet) becoming commercially viable, or at least becoming so with a relatively small subsidy. The smart subsidy approach mobilizes private investors to provide shared or “Universal Access”.
121. The government would need to formulate the following action plan:
> Develop preparatory demand studies; 9 Design and implement the ‘smart subsidy’ approach to a small number oftargeted pilot projects (with the World Bank’s assistance). The implementation ofthe pilots would provide the GOK with cost estimates for scaling up the operation (see below); and P Scale up ofthe smart subsidy approach by GOK to provide Universal Access throughout Kazakhstan and thereby promote social inclusion, narrow the digital divide and fulfill the broader economic objectives.
122. The implementation ofthe suggested action plan would ensure that in conduction with enjoying the benefits of market liberalization and the necessary tariff re-balancing, ‘at risk’ geographic markets would gain access to ICT and telecommunications infrastructure and services. This would facilitate widespread improvements in competitiveness and support diversified and sustainable growth.
123. The preparatory demand studies entail producing a distribution ofthe proportion ofthe population without access residing within various distances from the nearest access points to one ofthe electronic communications networks (including, for example, those operated by the railway company, the oil and gas company, and the mobile phone companies), where the networks are those ofexisting suppliers or potential new entrants.
124. The studies would then be refined to take into account population densities and potential aggregated expenditure by distance from the nearest access points and the cost ofnetwork expansion relative to potential income.
125. Based on the information gathered in the preparatory studies, it would be possible to categorize different rural communities along these dimensions (for example, there may be four categories ofcommunity ranging from most easy to most difficult to provide access on a commercial basis). The design and implementation ofpilot projects for each category could then be undertaken by applying the smart subsidy approach.
126. Importantly, the use of ‘smart subsidies’ to provide access in unprofitable areas allows the GOK to implement a policy ofuniversal access without encumbering KazakhTelecom with a set of unprofitable obligations that would distort its ability to compete. Thus, a policy ofmarket 47 liberalization, that would address the ‘market gap’, can be implemented without having to directly accommodate the distortions that can be created by the obligation to extend network coverage to unprofitable areas.
127. The results of the pilot projects (in terms ofrequired subsidies) would then guide the GOK in scaling up the initiative and thereby strengthening the prospects for the fulfillment ofthe broader economic objectives ofGOK. Further, the wider economic impact ofthe pilots could be assessed in terms of the development ofsmall and medium enterprises, firm, product or process innovation, distance learning, e-health and e-government, and the benefits of these additional outcomes could be factored into the scaling up process.
Box 4: Strategic Directions for Telecommunication Reforms and the Vehicles to Achieve Them
Kazakhstan has commendable objectives with regard to its telecommunication sector as it wishes to:
Position well the sector (and its main operator, Le. KazakhTelecom) for an enlarged market, when and if this becomes a reality, such as the creation ofa CES with Russia, Ukraine and Belarus Position well the sector (and its main operator) in the global economy, particularly in the transit and routing markets between Asia and Europe Secure some level ofbasic telecommunication services for the entire population-i.e. in poor rural areas.
A program has been designed including elements oftariff rebalancing, liberalization, and universal access provision, This program, nonetheless is a good example ofinfant industry policies as it supports:
A highly distorted price regime over the medium term, which redirects significant resources from non- telecommunication sectors into the telecommunication sector. The use of a small part ofthe rents to heavily subsidize local calls for rich and poor households alike and for all types ofbusiness. But the bulk ofthe rents are left with the main operator (KT), for it to make sound investment decisions. Limited competition, by imposing strong restriction on entry, and restriction on foreign ownership, and by constraining the type oflicenses that operators owned by foreign investors can obtain. Heavy dominance ofKazakhTelecom in the market is further secured via its ownership in cellular phone suppliers, A strong dominance of the sector by the state (in addition to KT which is owned partially by the state, two SOEs own telecommunication companies, the gas transportation company, and the railways company); however, it is unclear whether or not the state is truly able to represent the interest ofthe population as it is susceptible to “state- capture” by the conglomerate that holds 49% ofthe shares in KT. Keeping the formal representatives ofthe GOK in the industry ‘weak,’ by fragmenting policy making over three agencies, and by given the Informatization Agency, the key agency of the three, significant functions outside its core mandate (e.g., the administration ofa large e-government program).
The implicit strategy is, thus, one in which enough financial resources and protection are given to the incumbents, primarily KT, in the hope they will be carrying out the investments and modernization that is necessary to compete in the global market when and if liberalization takes place. In this context, the following questions arise:
Would the corporate govemance structure, and the distorted relative prices provide the demand signals that KT requires to make efficient investment decisions? Would the diffused regulatory environment be able to implement the public comtment ofintroducing a fully liberalized regime, or would their efforts be permanently blocked by the current incumbents? Who are the winners and losers ofthe current situation, and is the current situation fostering or preventing the diversification and industrialization policy that the government wants to pursue? 48
2. Sector Policies: The Case of Local Content for the Oil and Gas Sector a. Background: Partnering with Multinationals
128. Kazakhstan already has significant foreign direct investment (FDI) concentrated primarily in oil and gas and other natural resource extractive industries. Now the govemment’s goal is to maximize the economic development benefits ofthat FDI.23In the case ofKazakhstan, this means getting more than just tax revenues and direct employment benefits.
129. Win-win schemes. It should, however, be said upfront that oil operators (foreign or local) have a ‘reservation price’ for the total required payments they will make for their license to operate, whether in the form of taxes, social programs, petty corruption, or uneconomical local content development. Thus, GOK must decide how to balance these payments, but should expect that more pressure in one area will lead to less focus by oil companies on other areas.24Clearly, only ifthe government asks oil operators to carry out economically viable local contents developments, they will regard these outside the “reservation price”. Only schemes that are win- win for the government and the operators (in the sense of truly reducing the operator’s costs, while generating an increased amount of spillovers for the non-oil economy) will qualify as an economically viable proposition. In this case, local companies can truly become competitive with their intemational counterparts. They will win contracts on the basis ofcost and quality. If there is a business case for sourcing content locally, Kazakhstan will benefit both from required payments and contracting to local companies over and above these payments.
130. This means ensuring that Kazakhstani workers, managers, and enterprises have the skills and capability to provide high wage, high value added goods and services both to foreign investors and to such dynamic Kazakhstani firms as KazMunaiGaz. IfKazakhstani companies can supply high value added goods and services to global firms operating in Kazakhstan, there is no reason why they cannot also supply similar goods and services to firms operating in the greater Caspian area as well as throughout the world. In other words, Kazakhstan should strive to become a global supplier of knowledge-intensive value added goods and services to the global extractive industry-a specialization which can endure long after local oil and gas resources are depleted. For example, Houston, remains a center ofthe oil industry even though East Texas oil fields were depleted decades ago. This section outlines a strategic direction for how this can be ac~omplished.~~
13 1. To foster the competitiveness of firms in any sector requires:
Of course, attracting FDI in non-oil and non-extractive sectors (e.g., pharmaceuticals, tourism, plastics) is a goal of its own that Kazakhstan has not explicitly set for itself yet. 24 A case in point is the draft law on production sharing agreements which suggest that tenders for exploitation of oil field maximize both local content efforts (e.g., an investment in a petrochemical plant) and tax, bonuses or royalty payments. Clearly, oil companies will see these two eligibility criteria as substitutes and most likely reduce the amount of revenues they will have leave to the government in the absence of any local content criteria. From the budget perspective, this clear industrial policy is therefore being implemented through a ‘quasifiscal’ instrument, since a tax concession is in fact being given to subsidize the development of certain industries. Of course, if the tax regime is binding (like it is currently is), many players may restrain from participating in bids of new exploration sectors. 25 The World Bank has done similar work in other parts of the world, most notably, From Natural Resources to the Knowledge Economy, which looks at these issues with regard to Latin America and the Caribbean. 49
0 A friendly business environment in which local firms can be set up and operate under low administrative costs and red tape;
0 Strong competition between local firms, and between local firms and similar foreign firms, to ensure that only the ‘fittest’ survive; and
0 Ease of exit, as some local firms will naturally have to go bankrupt while others will grow and prosper and even conquer markets in neighboring countries.
132. However, the focus of this section is not on the above fundamental preconditions, but rather on the types of technical assistance that the govemment could provide to ensure that some firms will adopt the business and management practices they need to effectively apply either the technology they currently possess or they might acquire in the future. Today, many Kazakhstani firms lack the capability, in terms of both technical and business processes, to access international oil companies (IOCS),~~and the national oil company (KazMunaiGaz-KMG) value chains. Selected technical assistance will give them the capacities that they need to build linkages. While technical assistance and building linkages with IOCs and KMG are not synonymous processes, they are mutually reinforcing, as greater capability enables firms to win oil company tenders, while the experience of working with oil companies enhances the capability of firms. Diagram 2 illustrates in greater detail some ofthe key actors in this market.
6. Obstacles to Domestic Supply into the Oil and Gas Sector
133. In Kazakhstan, as in many oil producing countries, there are five major obstacles blocking local firms from becoming suppliers to the oil and gas sector:
1. Dominance of global over local supply chains. IOCs prefer to deal with their global suppliers for a number of well justified reasons (including the fact that they do not have the infrastructure to deal with small suppliers in many countries). For cost-savings reason, they are reluctant to break these supplier relationships in order to source locally in each country where they operate. Kazakhstani firms will need to offer sufficient value, in terms of local expertise and cost, ifthey want to have a chance of breaking into these supplier relationships. As explained below, forming ties with global suppliers is one way in which many Turkish firms have become global suppliers. In Kazakhstan, for example, Enka, one of Turkey’s largest construction companies, has formed an alliance with Bechtel, a key global supplier to ChevronTexaco, to supply the TengizChevrOil project.
2. Difficulty identzfiing where to enter the value chain. IOCs often contract out project management and award major service contracts to specialist firms like Parsons, Flour, and Daniel (PFD), Schlumberger, and Halliburton whose reputation and capital will guarantee a sound product or service. These are normal practices for industries where for
26 ‘IOCs’ refers only to international oil companies, while ‘oil companies’ refers to both Kazakhstani and international oil companies. ‘Operator’ refers to the oil company or oil companies that operate the field TengizChevrOil for example is operated by ChevronTexaco, although a number of other oil companies also own a share of the project 50
which the reputation ofa supplier to provide quality goods and services in a timely manner and offollowing the strictest environmental and working standards is ofthe essence, The best option for local companies is usuallv to become a supplier to a supplier, not directly to an oil company. In the case ofdrilling fluids, for example, IOCs operating in Kazakhstan source the bulk oftheir drilling fluids from M-IDrilling Fluids, an international firm. As shown in Diagrams 3 and 4, Kazakhstani firms often try to access the upstream value chain by appealing directly to 100, while it would often be easier to access the value chain by going to a PFD, Schlumberger, or M-I, as the case may be. For example, the Kazakh Institute for Chemical Sciences unsuccessfully bid to supply TengizChevrOil (KO) with corrosion inhibitors, despite the fact that the Kazakhstani corrosion inhibitors were cheaper than its international counterpart. The Institute would likely have been much more successful had it approached an international supplier ofoil field chemicals, such as M-I.GYPS, an Aktobe producer ofbarite, another oil field chemical, was able to enter the value chain by selling directly to M-I.
3. Information gaps. It is often difficult for many oil companies, both international and Kazakhstani, to identify and assess the suitability ofKazakhstani suppliers as these unknown have very short track records (reputation) or little equity substantiate up their offers. At the same time, it is also difficult for Kazakhstani suppliers to know about opportunities to supply goods and services to IOCs and KMG. This lack ofinformation on both sides prevents suppliers from identifying projects for which they might bid and makes it both costly and difficult for oil companies to identify local contractors.
4. Standards. Standards ofquality and safety are major concerns for oil companies. Accordingly, oil companies are often hesitant to source from a local firm that has not been granted international certification, such as ISO, API, or ASME, regardless ofthe quality of the firm’s work. Insurance requirements and concerns for the environmental integnty of the work, among others, motivate oil companies to source only from internationally certified suppliers.
5. Safety and Environmental Concerns. Local firms need to be able to accommodate IOC and KMG concerns about safety and working practices, including environmental working practices, as no operator can afford human or environmental casualties. TCO, for example, requires that all personnel, whether local or international, have three weeks of training in safety and business practices before entering the TCO work site. This requires that local contractors working on the site maintain continuity ofpersonnel, as all new personnel will be required to undergo this training to ensure that they meet TCO’s standards for health, safety, and environmental protection.
134. DifJicultly Jinding highly skilled local labor. Highly skilled labor often is not available locally, particularly those with engineering and management skills. This hurts local companies in two ways, On the one hand, they may have difficulty finding local engineers who are qualified in the technical disciplines needed to supply the oil and gas sector. On the other hand, it raises the price of skilled labor. When a particular skill is in short demand, workers with this skill will demand higher wages and are more likely to be poached by firms looking for that skill. Training workers would be very expensive for firms, because they may have difficultly retaining these 51 workers. As such, the scarcity of skilled local labor both imposes greater costs on local firms and provides an incentive for firms to train as few workers as possible. c. A Three-Pronged Strategy to Foster Competitiveness of Suppliers
135. The key policy objective must be to maximize the direct exposure ofthe local labor force and local suppliers to the technologies and standards ofmultinational firms. The government should reward efforts by multinationals to create opportunities for local employees to acquire skills and, over time, to gain managerial responsibilities.
136. Local suppliers able to link with foreign investors in the oil & gas sector will have the best opportunities to reach intemational quality standards. Opportunities for local suppliers to link-up with foreign companies can be promoted through a variety ofmeans. The most important ofthese are the formation of Joint Ventures. But for this the government will need to remove disincentives to set up local companies (Le. VAT exemption for foreign purchases); more broadly, structuring arrangements that make it attractive for internationally recognized companies (e.g., Halliburton, FMC, PetroKazakhstan, PFD) to make the investment to set up a more permanent suppliers and service business in Kazakhstan.
137. A number of other changes will need to be enacted to foster the competitiveness of local suppliers to the oil and gas industry. The remainder ofthis section leaves aside the general but important preconditions (e.g., ensuring competition, and improving the overall business environment for firms in any industry) and focuses on three fundamental pillars to promote suppliers to the oil and gas industry:
0 Training and skills for Kazakhstani workers regardless ofwhether they work for a supplier or an operator; 0 Rules and regulations on local content imposed on operators; and 0 Best practice supplier development programs.
1. Training of a Kazakhjtani cadre of specialists
138. Kazakhstan needs a cadre of local specialists to support the oil and gas industry. These specialists need the business skills necessary to run local suppliers and to interface successfully with oil companies and the technical skills to use and apply intemational oil and gas technologies. Training this cadre of specialists will require strong academic institutions in disciplines relating to oil and gas, strong connections between these academic institutions and business, and opportunities for Kazakhstani professionals to work with their intemational counterparts, both in Kazakhstan and abroad. It is beyond the scope ofthis paper to assess how much ofthis infrastructure is already in place, or is beginning to be put in place, and only needs fine-tuning.
139. Strong academic institutions in areas such as petroleum engineering, geology, and business management are crucial to train local professionals. Kazakhstan inherited strong institutions ofbasic science from the Soviet period. These disciplines remain strong, including those in sciences relating to oil and gas, like geology and chemistry. However, assessments made by the World Bank in other CIS countries suggest that this infrastructure lacks the fundamental 52 links with industry. Also based on the World Bank experience in other CIS countries, it is likely that Kazakhstani institutions lack experience with international equipment and standards, and that courses in the petroleum sciences do not incorporate the latest international best practices. As such, training and education programs need to be developed in applied technical subjects, such as petroleum engineering and petroleum geophysics, which incorporate the latest intemational processes, theory, and technology.
140. Working alone, however, academic institutions will fail to adequately address Kazakhstan’s training needs. More and stronger linkages are needed between academia and the business community. Such linkages would enable universities to offer courses ofstudy that produce candidates who meet the needs of oil companies; and, would help universities participate in the research and development processes ofoil companies. Oil production in Kazakhstan, particularly offshore production, poses major technical challenges that will require new research and development to solve. Both Venezuela and Norway have derived benefits from their natural resource endowments by ensuring that a portion ofthe research and development needed to cope with their unique geology was done locally. In Norway, new techniques for offshore gas extraction were developed, while Venezuela developed oriemulsion, a new technology for exploiting its heavy crude reserves. Kazakhstan could similarly develop new technology for the shallow water offshore drilling needed in the North Caspian. Kazakhstani academic institutions can play a role by conducting the research necessary to solve these problems and training the engineers who will apply that research.
141. Academia, however, is only one part ofthe training picture. It is also important that Kazakhstani professionals have the opportunity to work alongside international specialists both in Kazakhstan and abroad, learning from them as they work. Kazakhstan can benefit enormously from the international work and training experiences available to employees of international oil companies. Foreign direct investment by intemational oil companies opens a wide range of international on the job training opportunities to Kazakhstani professionals that will enable them to leam international best practices and then apply them it in Kazakhstan.
142. Norway has been particularly successful in such training programs. It has a policy of promoting centers of excellence in offshore technology and has encouraged oil companies to collaborate in R&D projects with Norwegian firms. Norway has recognized that a highly skilled workforce in the petroleum sciences is a crucial prerequisite for the growth of local firms in the oil and gas sector. ii. Rules and Regulations regarding local content
143. Kazakhstan needs to ensure that its rules and regulations for the oil and gas industry facilitate local content growth (see Diagram 5). Incentives to international companies to invest in Kazakhstan must not disadvantage local companies nor go beyond industry standards for operators. Rather, rules and regulations should be designed to provide incentives so that oil companies will look for local suppliers as part oftheir operational work rather than as an add-on administrative requirement. In order to do this, local content requirements should be stable and predictable throughout the lifetime ofeach project. Stable and predictable rules and regulations 53 encourage oil companies to invest time, effort, and money in developing new processes to encourage local content. Today, Kazakhstan’s rules and regulations:
0 Provide disincentives for IOCs and KMG to use local firms in many areas (e.g. VAT exemptions, and local firms are subject to Kazakhstani and international standards); 0 Are excessively administrative in nature, and create significant room for bargaining and disagreements in interpretation between companies and regulators (e.g., work permits, reporting requirements, and procurement rules); 0 Are unstable-this is a corollary ofthe above point, as there is significant room for interpretation; and 0 Lack transparency-Local companies do not know about the potential opportunities, particularly local content requirements that a given PSA has provided to them, and must resort to government administration to find out. When local companies do bid for contracts, opaque decision making processes at oil companies hinder their ability to learn from failed bids. iii. Supplier Development
144. There are three major areas that a supplier development program should address. First, few Kazakhstani firms have received the international certifications necessary to work for IOCs. IOCs are often unable to employ local firms that have not received international qualification because they are concerned about quality and also have insurance policies that require that subcontractors be internationally certified. Second, Kazakhstani firms also need assistance with business practices. Many Kazakhstani companies are lacking in business and management practices and need assistance in these areas. In Azerbaijan, the BP Enterprise Centre goes so far as to explicitly separate two different work streams-one looks at capacity building and focuses on certification and training while the other looks at business assistance, chiefly identifying opportunities for local supply and offering ad hoc assistance in response to particular needs. Third, in Kazakhstan oil companies and local suppliers often lack information about one another. Many Kazakh firms do not know how and where to integrate into the supply chains ofoil companies, while oil companies lack information about local firms and their competencies.
145. Helping local firms become internationally certified requires structured programs to identify firms for technical assistance and target that technical assistance to key areas for improvement. For example, the Czech government introduced a Pilot Supplier Development Program in the electronic industry in 2000-2002 to spread the benefits ofincoming FDI to the rest ofthe economy. The Czech program worked jointly with local firms and transnational corporations (TNCs). A survey was conducted oflocal firms and TNCs, which showed that local firms and TNCs identified different areas as important for technical assistance. In particular, while local companies thought that their greatest deficiencies were technical, TNCs identified deficiencies in business and management practices. Thus, it was found that local companies did not understand the needs ofTNCs. Once local companies did, they could identify those areas in which they needed to improve. The government organized a series ofseminars to help the firms improve in certain areas, and gave them intensive management training, with experts visiting them to help them develop concrete improvement strategies. Then a small subset ofthe most 54 successful firms was given intensive training for further improvement. The program was successful in helping firms get more contracts in the long term.
146. Meanwhile, assistance with business practices is often needed in both a structured manner and on an ad hoc basis, in response, for example, to the announcement ofa particular tender. In Azerbaijan, the BP-funded Enterprise Centre has run a successful series ofseminars, under the broad heading, “How to do Business with Oil Companies,” which covers topics ranging from the IOC bidding process to steps to IS0~ertification.~’ The Enterprise Centre coordinates its training programs with a range ofdevelopment organizations such as the German development agency GTZ and certification institutions like Moody International. The Enterprise Centre also provides targeted assistance to individual firms. It begins by assessing the suitability of a firm to supply the oil and gas sector. If the firm is suitable to supply this sector, the Enterprise Centre identifies particular areas where the local firm would benefit from technical assistance. These needs are then addressed both through customized technical assistance and the seminars discussed above. Once the firm isjudged able to successfully complete projects, the Enterprise Centre will identify tenders that the firm might be able to win. It will walk the firm’s management through the tender process, providing assistance with both technology and business processes necessary to complete the tender. These programs have been successful in linking more firms into oil and gas supply chains, upgrading the technical capabilities oflocal firms, and supporting innovation by local firms.
147. Both types of assistance help local firms better understand oil companies and would assist local firms with promoting themselves to oil companies. Once local firms understand the importance ofpromoting themselves, they will begin to market themselves to oil companies on the basis ofcertifications, competencies, and past work. In the best case, this information would go directly to the databases of local firms that oil companies use to identify suppliers.
148. Finally, it is important to bear in mind that technical assistance, technology upgrading, and supplier development are about more than technology acquisition. That is, the hardware side ofthe equation and it is undoubtedly important. But even more important are managerial competence, planning, quality control, skill development for workers, and assistance identifying where to integrate into energy industry supply chains. Academic work on Kazakhstan and Azerbaijan suggests that successful and unsuccessful local suppliers are differentiated not by their technical capabilities but by the quality of their management and business processes. Technical assistance programs thus should focus on these areas.
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c, 9 2 e e8 v E 0 .3 Y f a 0 f 0 Q) c, 0 E U 0 0 ANNEXTABLE 1 : KAZAKHSTAN\SKEYECONOMIC INDICATORS, 1999-2004
1999 2000 2001 2002 2003 2004 Actual Actual Actual Actual Actual Prelim. I1
National income GDP at current prices, billion tenge 2016 2600 325 I 3776 4612 5543 Oil 21 196 365 427 537 66 I Non-oil 1820 2235 !824 3240 395 I GDP at current prices, US%billion 17 I8 22 25 31 41 Oil 2: 2 3 3 4 4 Non-oil IS 16 19 21 26 Real GDP growth, '%I 2.7 98 13.5 9.8 9.3 9.4 011 21 18.6 26.5 23.2 12.9 10.5 Non-oil I .5 8.0 II 9 9.3 9.0 Prices and exchange rates CPI inflation (pa), 'XI change 8.3 13.2 8.4 5.8 6.4 6.9 REER (up=depreciation), 2000=100 31 94 IO0 101 10.6 111 I07 USD 92 IO0 98 98 92 SO EUR I07 IO0 93 98 110 105 RUR 89 100 I I2 119 I26 I28 Monetary and financial sector ('% of GDP) Broad money, M3 14 15 I8 20 21 28 Deposits in the banking system 8 II 14 16 16 23 Commercial banks' lending 7 I1 I5 18 21 27 Pension fund accumulations 3 4 6 7 8 9
External sector Current account balance. USBB -0.2 0.6 -I.2 -0.8 0.04 0.2 Exports ofgoods, f.0.b.. USBB, ofwhich 60 9.3 8.9 10.0 13.2 20.3 Fuel and oil products 2.3 4.8 48 5.6 7.9 9.0 41 Ferrous metals 0.9 I .z I .o 1.1 2.1 2.4 41 Copper and copper products 0.6 0.7 0.7 0.7 0.7 0.8 41 Imports ofgoods, f.o.b., USBB, ofwhich 5.6 6.8 7.6 7.7 9. I 13.3 Food 0.3 0.3 0.4 0.4 0.5 0.3 41 Other consumer goods 2.2 ?.I I .4 I .5 1 .z 0.8 4' Petroleum and energy products 0.3 0.6 0.8 0.8 0.9 I .2 41 intermediate goods 1 .I I8 2.3 2.2 3.0 2.0 4: Capital goods I .7 2.1 2.6 2.9 3.6 4.0 41 Gross FDI inflows, '%I ofGDP 11.0 15.2 20.6 16.7 14.9 13.2 4/ Oil and gas 9.2 12.8 16.6 12.2 10.8 10.4 41 Non-oil-and-gas 1 .8 2.4 3.9 4.4 4.2 2.8 41
Government finance, of GDP (except otherwise specified) Total budget revenue 17.9 21.9 22.1 21.1 21.5 23.0 Budget oil revenue 0.7 3 .z 2.3 23 2.7 3.6 Budget non-oil rewnue 17 2 18.6 19.7 18.8 18.8 19.4 Total budget expenditure and net lending 23.1 22.8 23.0 21.4 22.5 23.4 Education 3.9 3.3 3.3 3.2 3.2 3.4 Healthcare 2.2 2.1 I .9 I .9 I .9 2.4 Social security and welfare 7.9 6.6 5.7 5.3 5.2 4.9 Agriculture 0.3 0.4 0.7 0.8 I .o I .3 Transport and communication 0.6 I .5 I .4 I .5 I .s I .9 State Budget balance. deficit(-):surplus(&) -5.2 -I .o -0.9 -0.3 -1 .o -0.3 Yon-oil balance, deficit(-)lsurplus(+) -5.9 -4.2 -3.2 -2.6 -3.7 -4 0 NFRK savings 0.0 0.0 5.8 2.9 5.0 2.5 NFRK oil reYenue 00 0.0 2.3 I .2 2.7 2.3 NFRK non-oil revenue 0.0 0.0 0.2 0.2 0.3 0.0 NFRK capital rebenue 0.0 0.0 3.3 I .5 2.0 0.2 Budget capital rmenue 1.7 0.8 0.5 0.5 0.1 0.1 Consolidated budget balance. deficit(-)Isurplus(+) -3.5 -0.1 5.4 3.1 4.0 2.3
Labor market Employment, thousand people 6105 6201 6699 6709 6985 7148
Employment growth. I%, -0.4 I .6 8.0 0.2 4.1 2.3 Unemployment rate, 'X, of labor force 13.5 12 8 10.4 9.3 8.8 8.6 Participation rate, labor force as '% of 66.0 66.0 70.2 70.1 70.0 70.6 population at the age 15+ Real average wage growth, 'X 11.0 4.5 16.4 10.6 7.0 14.3
Sources: World Bank staff calculations based on the official data from the Karakh authorities. I 12005-07 Medium Term Socio-Economic Development Plan and 2005-07 .Medium Term Fiscal Frame,, ork. 21 Oil and gas extraction, extraction related sewices. and oil related construction and transportation. 31 Real effective exchange rate (REER) is a weighted average ofexchange rates oftenge to currencies of 24 countries, 41 January-September 2004 (actual). ANNEXTABLE 2: KAZAKHSTAN: GDP GROWTH,1999-2005
1999 2000 2001 2002 2003 2004e 2005~ Real GDP (1990=1) 63.23 69.42 78.80 86.52 94.56 103.45 111.73 Growth in Real GDP, % Total, of which 2.7 9.8 13.5 9.8 9.3 9.4 8.0 Oil GDP 1/ 18.6 26.5 23.2 12.9 10.5 15.1 10.1 Industry (incl. construction) 19.4 27.2 24.0 12.5 10.8 15.6 10.3 Mining 12.7 15.4 17.2 20.6 8.3 15.7 8.7 Oil refinery I:28.8) 3.8 23.7 6.5 12.4 10.0 10.0 Construction 58.4 76.8 50.6 (9.5) 19.4 18.0 17.0 Services 13.1 20.1 15.4 16.8 8.1 10.3 8.2 Non-oil GDP 1.6 7.7 11.9 9.2 9.0 8.4 7.6 Agriculture 21.7 (3.2) 17.1 3.2 2.2 1.o 1.o Industry (incl. construction) (0.4) 10.9 11.0 11.4 8.3 6.0 6.4 Services (0.7) 8.2 11.5 9.1 10.4 10.7 9.0 Source: Statistical Agency of the Republic ofKazakhstan; WB staff estimates. I/Oil and gas extraction, extraction related services, and oil related construction and transportation.
ANNEXTABLE 3: KAZAKHSTAN:STRUCTURE OF GDP, 2003
Nominal GDP by sectors, % 1999 2000 2001 2002 2003
Total 100.0 100.0 100.0 100.0 100.0 Oil and gas 1/ 10.3 15.0 14.1 15.3 15.8 Oil services 10.4 9.2 10.6 11.0 12.0 Nonoil mining 4.4 4.0 3.7 3.3 3 .O Metal manufacturing 5.4 8.3 7.4 6.6 7.0 Other 69.5 63.4 64.2 63.7 62.2 Agriculture 10.5 8.7 9.4 8.6 7.8 Manufacturing, excluding metals 8.8 8.3 8.9 7.8 7.0 Power, water 3.9 3.3 3 .O 3.1 3.1 Construction 3.1 3.0 3.1 4.2 3.9 Trade, commerce 14.4 13.3 13.0 13.1 13.0 Transport & com 12.1 11.2 11.0 11.3 11.7 Public services 12.2 10.7 10.5 10.5 10.5 Other services 4.5 5.0 5.4 5.1 5.2
Source: Statistical Agency of the Republic of Kazakhstan; WB staff estimates. 1/ Kational Accounts for the oil and non-oil sectors are not produced officially, but the Agency is planning to undertake such task. The numbers are, therefore, subject to change. 61
ANNEXTABLE 4: KAZAKHSTAN: VALUE ADDEDIN REGIONS, 1996-2003 (In US dollars per capita, by official rate) 1996 1997 1998 1999 2000 2001 2002 2003 prelim. Gross domestic product 1350 1446 1469 1130 1229 1491 1659 1996 Gross Value Added by Regions 1235 1329 1321 1017 1100 1324 1474 1784 Akmola oblast 1051 775 703 742 670 843 875 1053 Aktobe oblast 1109 1434 1541 1040 1104 1321 1549 1912 Almaty oblast 770 794 718 491 499 631 674 807 Atyrau oblast 2927 3282 2752 2418 3762 4413 5390 7349 East-Kazakhstan oblast 1159 1303 1435 1051 993 1120 1133 1315 Zhambyl oblast 660 588 538 367 361 409 465 610 West-Kazakhstan oblast 710 1107 1120 972 1272 1608 1812 2159 Karaganda oblast 1387 1576 1562 1267 1335 1463 1518 1820 Kostanai oblast 2065 2049 1394 1030 1041 1132 1164 1451 Kyzylorda oblast 427 593 750 494 610 742 983 1267 Mangistau oblast 3579 2824 2229 2087 2715 2992 3696 3787 Pavlodar oblast 1946 1469 1961 1144 1355 1631 1647 1938 Korth-Kazakhstan oblast 1689 1346 986 766 637 898 877 988 South-Kazakhstan oblast 608 630 578 460 542 665 662 737 Astana city na 1160 1873 1842 1999 2287 2765 3414 Almaty city 2471 2965 3154 2377 2237 2991 3485 4183
Source: Statistical Agency of the Republic of Kazakhstan.
ANNEXTABLE 5: KAZAKHSTAN:REALEXCHANGE RATE, 2000-2004
Dec 2000 = 100, down = appreciation
Der-00 Dec-01 Dec-02 Dec-03 Jan-04 Feb-04 Mar-04 Apr-04 .\Ia)-04 Jun-04 Jul-04 Aug-04 Sep-04 Oct-04 Nou-04 Dee-04 I.TmdeableE~ontradeablcE (Dec 2000 = 100) 1000 957 943 915 909 903 898 897 896 901 911 915 913 905 901 893 Inflation ('%,changeoverpre, month) I30 100 I40 090 070 0 50 040 040 020 030 020 040 0 80 I IO 090 0 90 Tradeables 065 022 078 053 025 (001) 004 023 012 060 097 067 068 056 060 027 Non-tradeables I52 132 173 117 093 070 055 042 019 007 (011) 023 090 135 108 118 Consumer price Index (Dec 7000 = 100) Tradeables 100 104 IO9 115 I15 115 115 115 116 116 I17 118 119 120 120 121 Non-tradeables 100 108 116 125 127 127 128 129 129 129 129 129 130 132 134 135 2. Kamk Tenge \is a vis US Dollar 100 99 98 88 85 81 84 83 83 83 82 82 81 79 77 76 Memo Xomnal exchange rate 144 I50 155 145 141 139 139 138 137 136 136 136 135 133 131 130 3.RealEflectiveExchangeRatelndex1/ 100 101 109 Ill Ill 110 108 107 106 106 108 106 105 104 104 106
Source Statistical Agency of the Republic of Kazakhstan. National Bank of Kazakhstan. WB staff eslimates I/Xational Bank of the Republic of Kazakhstan 62
ANNEXTABLE 6: KAZAKHSTAN: SAVINGS AND INVESTMENT RATES, 1999-2004 (% OF GDP)
1999 2000 2001 2002 2003 2004 prelim. proj.
Total savings 17.8 23.0 26.9 27.3 26.6 27.3 External -2.3 -8.6 0.9 -0.9 -6.2 -6.1 Domestic 20.1 31.6 26.0 28.2 32.8 33.4 Government 11 -2.5 1.4 5.1 5.2 7.9 8.9 Rest of the economy 22.6 30.1 20.9 23.0 24.9 24.5
Total investment (National Accounts) 17.8 23.0 26.9 27.3 26.6 21.3 Government 1.5 1.3 1.8 3.3 4.4 5.0 Rest of the economy 16.2 21.7 25.1 24.0 22.2 22.3 Yon-extractive sectors 5.0 5.7 5.5 5.2 4.5 4.6 Yon-extractive sectors 5.1 5.7 7.0 7.0 6.2 6.3 Statistical discrepancy -0.1 -1.5 -1.8 -1.7 -1.7 Mining and infrastructure 10.7 15.3 19.4 18.9 17.4 Oil and gas sector 21 9.1 13.6 16.9 16.3 14.8 Memo: non-oil and gas, % non-oil GDP 9.8 11.2 12.3 13.5 14.1 of which nongovernment 8.1 9.6 10.3 9.1 9.0
Memorandum ifems: actual 6 months Total Investments 18.3 22.9 29.0 29.1 28.8 16.6 Oil. gas and mining 21 9.1 13.6 16.9 16.3 14.8 10.0 Government services 2.0 1.3 2.5 3.3 3.6 2.7 Infrastructure 31 1.6 1.7 2.5 2.6 2.7 2.0 Others, of rvhich 5.6 6.4 7.2 6.9 7.7 6.6 Tradeables (agriculture, manufacturing) 2.3 2.9 3.3 2.9 3.0 2.3 Rest (construction, trade, hotels, commerce and services) 3.3 3.5 3.9 3.9 4.7 4.3 Gross FDI inflow 11.0 15.2 20.6 16.7 14.9 13.9 Sources. Statistical Agency of the Republic of Kazakhstan. National Bank of Kazakhstan, Ministry of Finance of Kazakhstan, WB staff estimates I/ Current consolidated budget revenue minus current consolidated budget expenditure. 21 Includes oil & gas extraction, services incidental to oil & gas extraction, mining. geological exploration & engineering related to oil&gas and transportation via pipelines. The latter includes fixed capital for the CPC construction. 31 Includes power, non-oil transport. communications, and other infrastructure. 63
ANNEXTABLE 7: KAZAKHSTAN: EXPORTSOF KEY COMMODITIES, 1999-2004 (in millions ofUS dollars) 1999 2000 2001 2002 2003 2003 2004 9 months 9 months
Exports of goo& (BOP) 5989 9288 8928, 10027 13233 9622 14483
Exports of goo& (customs declarations) 5872 8812 8639 9670 12927 9455 14093 Total primary commodities 4722 7971 7635 8686 Major primary commodities 4060 7239 6829 7841 11282 8411 12503 Fuel and oil products 2288 4827 4760 5641 7907 5929 895 1 O.W. Oil and gas 2392 4387 4464 5363 __ __ -_ Ferrous metals 886 1 I78 1008 . 1 I39 2069 1607 2363 Copper and copper products 576 738 718 715 742 53 1 850 Grain 311 496 344 346 565 345 340 O.W. Wheat 267 450 321 325 Other primary commodities 662 732 806 845 Live stock and live stock products 22 IO 18 19 Crop prodxtion (excl. Grain) 68 63 49 62 Cotton 51 81 86 107 Minerals (excl. Fuel and oil prohcts) 165 219 269 276 Base metals and base metals products (excl 1 356 358 3 84 380 Manufactures (adjusted to personal shoppers: 1266 1317 1293 1341 O.W. Food (Processed agricultural products) 24 35 48 43 Fats. animal and vegetable oil 1 1 4 4 Food products, alcohol and soft drinks, vineg 23 33 43 39
Memorandum items. Agriculture 476 686 544 517 -- __ __
Source: National Bank of the Republic ofKazakhstan. Agency of Statistics of the Republic of Kazakhstan ANNEXTABLE 8: KAZAKHSTAN:CONSOLIDATED GOVERNMENT FISCAL ACCOUNTS, 1999- 2007
1999 2000 2001 2002 2003 2004 2005 2006 2007 Actual Actual Actual Actual Actual Prelim. WB Est. WB Proj. WB Proj.
(In percent o~CDPJ h'on-oil budget revenue 17.2 18.6 19.7 18.8 18.8 19.4 19.0 19.1 19.3 Current programs' expenses. net 20.3 20.3 19.5 17.8 17.2 18.0 18.4 18.8 19.5 Development programs' expenses, net 2.7 2.5 3.5 3.6 5.3 5.4 7.2 5.2 4.5 SON-OIL STATE BUDGET DEFICIT -5.9 -4.2 -3.2 -2.6 -3.7 -4.0 -6.6 -5.0 -4.7 Oil revenue spent through the budget 0.7 3.2 2.3 2.3 2.7 3.6 4.7 4.4 41 STATE BUDGET DEFICIT -5.2 -1.0 -0.9 -0.3 -1.0 -0.3 -1.9 -0.6 -0.6 NFRK savings 0.0 0.0 5.8 2.9 5.0 2.5 13 0.3 -0.1 Oil revenue sa\ed in NFRK 0.0 0.0 2.3 1.2 2.7 2.3 I.2 0.3 -0.1 Non-oil revenue sabed in NFRK 00 0.0 0.2 0.2 0.3 0.0 0.0 0.0 0.0 Net imeshnent income from NFRK management 0.0 0.0 0.3 0.2 0.1 -0.3 0.0 0.0 0.0 Other non-prohibited revenue saved in NFRK (pn\,atization 0.0 0.0 3.0 1.3 1.9 0.4 0.0 0.0 0.0 and sale ofstate oil shares) Sale of land 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Privatization to the budget 1.7 0.8 0.5 0.5 0.1 0. I 0.0 0.0 0.0 CONSOLIDATED BUDGET BALANCE -3.5 -0.1 5.4 3.1 4.0 2.3 -0.6 -0.3 -0.7
Consolidated government revenue 17.9 21.9 24.9 22.7 24.5 25.1 24.9 23.7 23.3 Total oil revenue 0.7 3.2 4.7 3.5 5.3 6.0 5.9 4.7 4.0 Total non-oil revenue 17.2 18.6 20.2 19.1 19.2 19.2 19.0 19.1 19.3 Total state budget expenditure, net 23.1 22.8 23.0 21.4 22.5 23.4 25.6 24.1 24.0 State budget expenses, net 22.2 77 7 21.5 20.6 20.7 22.5 24.3 23.6 24.0 Current expenses. net 20.3 20.3 19.5 17.2 16.6 17.2 17.5 17.8 18.5 Wages and social contributions 4.9 4. I 3.8 4.0 3.7 4.3 4.6 4.9 5.5 Goods and services 6.2 7.6 8.6 6.7 6.7 7.1 7.1 7.1 7.1 Interest 1.1 1.4 I.2 1 .o 0.8 0.6 0.6 0.6 0.6 Subsidies and current transfers 8.1 7.3 6.0 5.5 5.5 5.2 5.3 5.2 5.3 of which: Pensions ... 3.9 3.4 3.2 3.2 3.1 3.2 3.3 3.3 Capital expenses, net I .9 I .8 2.0 3.3 4.1 5.3 6.8 5.8 5.5 State budget expenses, net 22.2 77 7 21.5 20.6 20.7 22 5 24.3 23.6 24.0 General public services 1.4 I.4 I.6 I.2 1.4 I.5 15 I.5 I .5 Defense 0.9 0.8 IO 1 .O I .o 1 .o I.2 1 .2 15 Public order and safety I.6 I .8 20 2.1 2.0 2.1 2.3 2.2 77 Education 3.9 3.3 3.3 3.2 3.2 3.4 3.6 3.6 4.0 Healthcare 2.2 2.1 I.9 I.9 I.9 2.4 2.8 2.9 3.0 Social security and welfare 7.9 6.6 5.7 5.3 5.2 4.9 5.3 5.3 5.2 Housing 0.3 0.9 0.9 0.7 0.7 I.2 I .7 I .6 I .6 Culture, sports, tourism and informational space 0.6 0.7 0.6 0.6 0.7 0.8 0.8 0.7 07 Fuel, energy and sub-surface use 0.0 00 0.2 0.2 0.2 0.5 0.5 0.2 0.1 Agriculture 0.3 0.4 0.7 0.8 I.o I.3 I .6 I.6 I .5 Industry and construction 0.1 0.3 0. I 0.1 0.1 0.0 0.0 0.0 0.0 Transport and communication 0.6 I .5 1.4 I.5 I.8 1.9 I.8 I .9 I.9 Other I.3 I.2 1 .o I.o 0.6 0.7 0.6 0.3 0.3 Interest 10 I.4 I.2 I.o 0.8 0.6 0.6 0.6 0.5 Net budget lending 09 0.7 0.6 0.5 0.5 0.3 0.2 -0.1 0.1 Financial assets operations 0.0 0.0 0.8 0.3 I.3 0.6 I.3 0.8 0.7 Discrepancy 0.0 0.0 0.0 0.0 0.0 00 -0.2 -0.3 -0.8 Total capital revenue I.7 0.8 3.5 I.8 2.0 0.5 0.1 0.0 0.0 NFRK capital rebenue 0.0 0.0 3.0 1.3 I .9 0.4 0. I 0.0 0.0 Budget capital revenue I.7 0.8 0.5 0.5 0.1 0.1 0.0 0.0 00 CONSOLIDATED BUDGET BALANCE -3.5 -0.1 5.4 3.1 4.0 2.3 -0.6 -0.3 -0.7
DEFICIT FINASCING (-) 3.5 0.1 -5.4 -3.1 -4.0 -2.3 0.6 0.3 0.7 Toral "VFRK savings (-j 0.0 0.0 -5.8 -2.9 -5.0 -2.5 -1.3 -0.3 0.1 Total net borrowing (-j 3.5 0.1 0.4 -0.2 0.9 0.2 I.9 0.6 0.6 Net extemal borroaing 2.4 I .2 0.3 -1.4 0.2 -0.9 0.0 0.0 -0.5 Net domestic borrouing I.O -1.1 0. I I.2 0.8 1.1 I.9 0.6 1.1
VET FINANCIAL GO\'EK\>lENT ASSETS (eop) -31.6 -25.5 -14.5 -9.7 -3.5 0.0 -0.7 -0.9 -1.5 NFRK stock (eop) 0.0 0.0 5.8 7.9 11.5 12.0 11.7 10.5 9.0 Totalgovernment debt (eop) 31.6 25.5 20.4 17.7 15.0 12 I 12.3 1 I .4 10.5 External debt (eop) 24.8 21.8 17.6 14.3 11.3 7.9 6.8 6.0 4.7 Domestic debt (eop) 6.8 3.6 2.8 3.3 3.6 4.2 5.5 5.4 5.8
Lourre World Bank st~ffrrlculaliambared on the official data from the Kuakh aulhoriliei 65
ANNEXTABLE 9: KAZAKHSTAN: COMMERCIAL BANK LOANS BY SECTOR, 1998-2004 (billion current and constant tenge, end ofperiod)
1998 1999 2000 2001 2002 2003 2004 March June Sept Dee March June Sept Dee
(Billion currenf tenge) Total, of which: 86 139 216 490 612 697 782 879 978 1037 1184 1329 1484 lndushy 22 32 84 167 23 1 234 246 255 273 275 29 1 286 290 Agriculture 9 12 26 51 77 75 93 101 117 I06 99 IO8 125 Construction 7 6 I2 23 43 43 57 72 75 87 118 137 159 Transport 5 5 17 21 20 18 20 23 31 38, 43 47 56 Communication 1 3 6 I2 13 13 13 II 8 IO 13 I5 20 Trade 22 41 92 151 198 209 225 249 277 296 334 366 399 Other 25 40 40 65 91 I04 129 169 I96 225 286 370 436
(Billion conslanr ZOO2 lenge, end ofperiod) Total, of which: 126 173 313 522 672 685 165 855 916 956 1081 1197 1299 Industry 32 40 96 I78 23 I 230 240 248 256 253 266 258 253 Agriculture 14 15 29 54 77 74 91 99 IIO 97 91 97 110 Construction 3 7 14 25 43 43 56 70 70 80 108 123 139 Transport 7 6 19 22 20 18 19 23 29 35 39 42 49 Conununicat ion 2 4 7 12 13 12 12 IO 7 9 12 14 17 Trade 33 52 I04 161 198 206 220 242 259 273 305 330 349 Other 36 50 45 70 91 102 126 164 I84 207 26 I 333 382
Real Growth (%) Total, of which: 31.3 80.9 66.6 28.8 28.3 34.0 41.1 36.2 39.5 41.4 40.0 41.8 Industry 26 I38 86 30 25 24 24 II 10 11 4 -1 Agriculture 8 IO0 84 42 40 59 61 43 31 I I 0 Construction 147 90 81 74 46 63 74 65 89 93 77 98 Transport -16 22 1 20 -10 -I1 -20 0 45 92 104 86 67 Communication 77 85 85 3 -9 2 -36 -43 -16 -2 36 I38 Trade 58 I02 55 23 24 27 33 31 33 39 36 35 Other 39 -10 54 31 51 64 94 101 103 107 103 108
Composition of loans by sector (%) Total, of H hich: 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Industry 25.4 23.2 30.5 34.1 34.3 33.6 31.4 29.0 28.0 26.5 24.6 21.5 19.5 AgricuINre 10.8 8.5 9.4 10.3 11.4 10.8 11.9 11.5 12.0 10.2 8.4 8.1 8.4 Construction 2.3 4.1 4.3 4.7 6.4 6.2 7.3 8.1 7.7 8.4 10.0 10.3 10.7 Transport 5.5 3.4 6.0 4.3 3.0 2.7 25 2.7 3.2 37 3.6 3.5 3.8 Conmiunication I.6 2.1 2.1 2.4 I.9 I.8 1.6 I.1 0.8 I.o 1.1 I2 1.3 Trade 25.8 29.8 33.2 30.9 29 4 30.0 28.8 28.3 28.3 28.6 18.2 27.5 26.9 Other 28.6 29.0 14.4 13.3 13.6 14.9 16.5 19.2 20.0 21.7 24. I 27.8 29.4
Memo: CPI eop (2002=100) 68.1 80.3 88.2 93.8 100.0 101.7 102.3 102.8 106.8 108.5 109.5 111.0 114.3
Source: National Bank ofthe Republic of Kazakhstan and WB staff calculations 66
ANNEXTABLE 10: SELECTED INDICATORS FOR KAZAKHSTAN AND COMPARATOR COUNTRIES, 1990-2003
1990 1991 1992 1993 1994 199.5 1996 1997 1998 1999 2000 2001 2002 2003
GDP Per Capita US$ at aver'age exchange rates Chezh Republic 3,366 2.181 2.903 3.328 3.975 5.036 5,598 5.141 5,535 5.347 5,007 5,593 6.814 8.375 Estonia 2.831 2,978 2.527 2.461 2,562 2.810 3.077 3,296 3.772 3.775 3.756 1.106 4.792 6,210 H%w 3.189 3.231 3,609 3,749 4,045 4.367 4.43 I 4.503 4.652 4.772 1.657 5,088 6.390 8.182 Latwa 2.573 2.731 1.904 1,708 1.812 1.902 2,045 2,297 2.526 2.782 3.025 3.249 3.595 4.167 Lithuania 2.771 2.712 2.260 1,968 1.857 2.018 2.386 2,750 3.121 3.070 3.247 3.473 4,052 5,273 Poland 1.547 1.998 2.198 2,232 2.556 3.293 3,724 3,976 1.363 4,251 4.309 4,808 5.w 5.487 Slovakia 2.931 2.053 2.215 2.51 I 2,893 3.617 3,876 3,938 1.111 3.778 3.750 3.883 4.196 5.922 Slovenia 5.781 6.330 6.271 6.443 7.233 9.419 9,481 9. I67 9.876 10.106 9.533 9.877 11.181 13.383 Russian Federation 3,485 3.127 3.095 2.929 2.663 2.670 2.651 2.749 I.su 1,339 1,784 2.118 2.399 3.022 Ukraine 1,570 1.490 I,418 1.258 1.012 936 872 989 833 633 632 771 870 1.024 Kazakhslan 1,647 1,512 1.515 1.429 1.316 1.288 1.350 1.146 1.469 1.130 1,229 1.191 1.659 1.995 EUS (weighted average) 2.370 2.441 2.603 2.701 3.050 3.754 4.105 4 220 4.565 4.487 4.152 1.898 5,484 6.170 Ukraine and Russia (w.a.) 2,989 2.925 2.660 2.495 2.235 2,222 2,194 2 298 1.586 1.159 1.492 1.778 2.012 2.519
Savings ratio, X GDP Chezh Republic .. 294 248 23 8 26 8 25 I 23 I 220 199 203 Estonia .- 220 176 I5 9 20 1 I9 3 197 201 175 176 H%w -- 164 189 20 7 189 I8 8 179 202 185 145 Lahla - -- 119 128 12 6 I6 6 I54 196 174 180 177 Lithuania - -- 136 12 5 I3 0 12 5 II 2 129 I55 158 163 Poland -- 193 185 I8 3 I9 5 161 176 178 I58 159 SlOvdkia - -- 270 222 21 9 26 5 23 9 225 24 8 19 8 259 Slovenia -- 21 I 229 21 2 21 2 24 3 22 8 24 I 24 3 247 Russian Federalion -- 228 228 I8 3 162 26 9 349 299 261 273 Ukraine -- 209 I8 I I7 2 I6 5 24 5 244 234 273 271 Kuakhstan -- 220 137 12 6 102 I5 2 210 187 212 234 EU8 (weighted average) -- 205 193 I9 5 20 7 Is5 188 193 171 174 Ukraine and Russia (w.a.) .- 223 21 6 I8 0 I6 3 26 3 322 283 266 27 2
Investment Ratio. "Ail GDP Chezh Republic -- 266 268 298 340 342 326 300 28 1 29 5 30 1 28 9 28 7 Estonia -- 26 9 267 274 266 27 8 31 0 293 215 27 8 28 9 31 4 33 3 Hwar, -- 16 I 200 222 224 255 266 289 287 30 9 27 I 211 24 2 Lan id -- 412 92 191 169 186 231 277 269 27 0 29 2 27 3 26 0 Lithuania -- I57 192 184 233 211 249 258 227 I9 8 20 6 22 I 26 9 Poland -- 152 I56 177 197 219 230 216 219 24 7 20 7 IS 9 IS 9 Sloiakia -- 28 I 217 21 0 24 8 347 34 5 310 276 26 I 30 0 29 1 24 7 Sloiema -- 1-8 193 206 235 235 246 258 288 27 0 21 2 23 5 24 8 Rus~dnFederation -- 34 6 270 25 5 254 23 7 22 0 I5 0 148 187 __77 -7 21 I 196 Lkrame -- 345 363 353 267 227 214 208 175 20 2 21 8 I8 7 196 Kadhstan .- 315 200 287 233 161 I56 I58 1'8 18 I 26 9 27 3 27 4 EL8 (weighted a\erage) -- 191 187 206 228 251 260 269 261 26 3 21 1 22 6 22 5 Ckraine and Russia (w.a.) -- 346 294 280 257 234 218 165 I55 19 I 22 1 20 5 196
Government spending, '% GDP Chezh Republic - 419 418 391 385 384 376 370 392 391 38 0 41 1 Estonia .. 333 330 349 329 315 320 363 334 318 32 0 32 4 Hunguy - 568 57 8 19 1 415 45 5 49 I 46 I 307 303 34 9 31 0 Latvia - 359 409 415 395 381 134 419 401 371 38 6 37 8 Lithuania -- 33 8 364 310 342 33 5 369 396 33 0 31 I 30 8 31 I Poland - 578 163 418 414 410 393 395 371 119 42 7 16 1 Sloiakia -- 441 124 133 412 44 I +I5 128 100 380 25 6 39 9 Slo\enia - 467 161 429 421 431 432 439 419 128 43 0 13 0 Russian Federation - 471 48 1 431 453 178 425 367 33 8 347 38 2 36 3 Lkraine -- 709 506 42 7 399 13 6 38 0 31 I 345 311 35 2 35 I Kazakhsian -- 254 2% 1 25 7 25 9 28 I 26 I 23 1 22 8 23 0 21 4 23 3 EU8 (weighted average) -- 51 8 460 43 6 427 409 405 405 368 388 38 8 42 4 Ukraine and Russia (n.a.1 -. 53 5 488 13 2 13 9 46 7 41 1 360 339 346 371 360 Source World Bank. LVorld Development Indicators. IMF International Statistics, and \Voild Bank stafTestimdies ANNEXTABLE 10 ---CONTINUED
1990 1991 1992 1993 1991 1995 1996 1997 1998 1999 2000 2001 2002 2003
Rlanufacturing labor productivit), USS per worker Chezh Republic -. 7.179 8,621 10.418 13.216 14.659 13.640 11.974 14.979 14,692 16.013 18.967 22.961 Estonia -- 6.287 5,576 5.842 5,814 6.101 6,500 8.093 7.985 8.405 9.331 10,922 14.376 Hunzav -- 11.569 11.997 12.708 13.971 14.035 14,777 14.267 13.723 13.661 14.105 17,564 22.514 LatLia -. 6.576 5,141 5.284 6.723 7.053 7,941 7.039 6.805 7.061 7.763 8.586 10.085 Lithuania -. 11.116 9.096 7.779 7,056 7,076 8.194 9.224 9.178 10.949 11.719 12,429 16.869 Poland -- 6.401 7.175 8.126 10.865 11.600 11,308 11.782 11.688 12,345 12,963 13.271 14,936 Slovakia -- 5.044 5,783 7.331 11.197 10.944 9.821 10.105 10.295 10.486 I 1.494 11,931 15.250 Slo\enia -. 21.293 18.572 21.986 25.731 25.943 26.069 28.696 29.882 28,355 28.518 32.000 38,370 Russian Federation , -. -- 6.074 5.673 5.687 5.123 5,515 6.095 4.132 2.921 3.799 4.216 4,529 5.669 Lkraine -- 9.031 5.341 4.796 4.524 3,910 4.226 3.815 2.703 1.628 2.151 2.745 3.415 Kazakhstan -- 1.136 4.120 4.392 3,121 3,126 3.623 4.213 3.787 5.181 7,064 7.090 8,695 EU8 (weighted ayerage) -- 7.771 8.251 9.231 11.620 12.221 12.015 12.553 12.166 12838 13.562 11.835 17.689 Ukraine and Russia (w.a.) -- 6.812 5,587 5.456 1.968 5.102 5.616 4.051 2.866 3.218 3.693 4.078 5,100
Agricultural labor productii worker Chezh Republic 3.147 4.085 5,194 6.384 7.668 6.956 8,402 7.670 7.639 9.036 9,333 11.119 Estonia 3,229 3,079 3,352 1.395 4,816 5,023 5,496 5,808 5,913 6.171 6.757 8.682 Hungary 6.43 I 6.131 6,707 7.677 7,335 6.873 6.7 I6 6.096 5.758 6.729 8.379 10.711 Latvia 2.946 1,829 1.550 2.132 1.837 1.174 1.090 1.471 2 058 1.935 2.082 2.41 I Lithuania 2,824 2,620 2.102 2,125 2.828 3,049 2.869 2.531 2.629 3,096 3.407 4.378 Poland 1.354 1.344 1.491 2.029 2.138 1.953 1.962 1.716 I635 1.943 1.712 1.880 Slovakia 2.544 3.118 3.864 4.669 1.662 4.689 5,124 1.716 5 323 6.399 6.710 7.931 Slo\enia 6,324 5.998 5.482 7.690 7.792 6.080 6.340 6.300 6.491 5,969 6.147 7,73 1 Russian Federalion 2.960 2.918 2.115 2.418 2.637 2.853 I787 1.608 1806 2.160 2.163 2.401 Ukraine 2,850 2.579 1.360 1.126 944 1.078 861 823 997 1.256 1.275 1.352 Kazakhstan 3.395 2.097 2.063 1.678 1.819 1.61 I 1,309 1.178 738 833 838 891 EL8 (neighted auerage) 2.697 2.759 3.076 3,828 4.035 3.722 3.942 3.596 3.578 4.157 1.383 5,265 Ukraine and Russia (w.a.) 2.931 2.830 1.919 2.085 2.202 2.398 1.551 1.409 1.600 1.931 1.939 2.137
Infant Rlortalitg ratio. per 1000 persons Chezh Republic 10 7 5 4 Estonia 15 -- I4 -- i 1 -- IO Hungary I5 -- I I 8 8 Latiia 16 -- 19 -- I? -- I7 Lithuania I7 -- 22 -- I7 8 Poland 16 -- I1 9 8 Sloiakia 14 -- I I 8 8 Slovenia 8 6 5 4 Russian Federation 21 -- IS -- I8 -- I8 Ukraine I8 .. 20 -- I7 -- 16 Kazakhstan 41 .- 52 .. 7 I .- 76 EU8 (weighted aberage) 14 -- 13 IO 8 Ukraine and Russia (!\.a,) 20 -- 19 18 -. I7
Spending in education & health.'% GDP Chezh Republic -- 103 102 101 97 99 97 102 Estonia -- 81 91 83 82 92 84 70 Hungary -- 79 78 81 85 80 80 81 Lati ia -. 57 57 53 57 56 51 50 Lithuania -. 27 31 51 63 62 59 61 Poiand .. 95 98 95 96 99 101 106 Slovakia .- I30 I21 116 107 106 Io5 105 SloLenia -- 94 98 101 100 99 95 98 Russian Federdtlon -- 64 67 80 62 67 52 53 Ukraine .. 101 87 95 79 67 72 72 Kazakhstan .. 75 72 71 62 61 53 52 EU8 (neighted aterage) -- 91 93 92 92 94 91 97 Ukraine and Russia (w.a.1 -. 48 50 60 46 50 39 10 Source World Bank. h'orld Deielopment Indicators. IAIF International Statistics. and U'orld Bank staffestimates
68
ANNEX2: LISTOF BACKGROUNDPAPERS AND ACTIVITIES
Background Papers:
1. The Role ofa Public Investment Fund in Promoting Diversification in Kazakhstan, Gregory T. Jedrzejczak and Pedro L. Rodriguez, January 2003.
2. Economic Diversification in Kazakhstan, with Special Emphasis on the Oil and Gas Value Chain, Gary Gereffi (Duke University, Durham, North Carolina, USA), Pedro L. Rodriguez, and Zhanar Abdildina, September 2003.
3. Selected Issues on the Management of Oil Windfalls, Samuel Otoo, Nina Budina, and Pedro L. Rodriguez, December 2003.
4. Elements ofa Competitive Environment in Kazakhstan, Samuel Otoo, Nina Budina, and Pedro L. Rodriguez, December 2003.
5. Supplier Development in the Kazakh Oil and Gas Sector, Paul Domjan and Alfred Waltkins, April 2004.
6. Note on Macroeconomic Management and National Fund Concept, Ricardo Hausmann, Sweder Van Wijnbergen, Pedro L. Rodriguez, Madi Umbetaliev, and Ilyas Sarsenov, August 2004.
7. Investment Strategy for Kazakhstan’s Oil Stabilization and Savings Fund, Roberto Rigobon, October 2004.
8. Priorities for Financial Sector Reform: Selected Issues and Options, Thomas Glaessner, Joaquin Gutierrez, Pedro L Rodriguez, Aslan Sarinzhipov, and Ilyas Sarsenov, October 2004.
9. Entering the Information and Communication Technology, Gareth Locksley and Howard Williams, April 2004.
10. Fiscal Policy and the Oil Windfall Management, Nina Budina and Arthur Radzvill, January 2001
11. The Bottleneck to Sustainable Development: Telecommunications in Kazakhstan. Summary comments and suggestions based on a brainstorming Seminar on Electronic Communication and Sustainable Development (Astana, February 17- 18, 2005) 69
Other Activities:
1. Comments on the Government’s Innovation Industrial Development Policy and Action Plan (June 2003). 2. Note on Technoparks (June 2003).
3. Comments on the draft 2004-2006 Medium-Term Expenditure Framework (June 2003). 4. Seminar on ways to foster Innovation (East Asia Experience); Sponsored by Japanese Government and WBI (April 2004). 5. Video conferences on promoting innovation (WB innovation grant) (April 2004- June 2004). 6. Comments on 2005-2007 Medium-Term Expenditure Framework (August 2004).
7. Video Conference series on Economic Management (February 3 and March 11,2005) 70
ANNEX3: REFERENCES
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